Amazon (NASDAQ:AMZN) stock was one of the biggest initial winners from the pandemic.
Shares exploded higher in 2020 once it was clear how much digital commerce was benefitting from the stay-at-home orders.
However, the tide has turned for AMZN stock in 2021. It’s up just 7% year-to-date, badly trailing its large-cap tech stock peers.
To make matters worse, Amazon stock tanked after its most recent earnings report. In addition to its earnings slowdown, some strategic concerns are building.
That’s particularly true with founder Jeff Bezos recently stepping aside. As Amazon’s proverbial “Day 1” has ended, AMZN stock investors should take notice. Because we’ve seen what happens when retailers get complacent before. Consider Walmart.
Peak Walmart (NYSE:WMT) was 1999. At that point, the company’s dominated American retail and looked utterly invincible. Investors loved it, and management loved being a hot stock. When you went to customer service at Walmart or Sam’s Club, they had a display with the WMT stock price posted prominently.
When Walmart Ruled the World
Everyone was getting wealthy in the stock market, and a big part of that was due to Walmart’s meteoric rise. Many people think the 90s boom was only in dot-com stocks, but WMT stock soared 500% in the late 1990s as well.
And then it just stopped.
From 2000 on, WMT stock would not go a dollar higher for the next decade. It finally made new all-time highs in 2012. That’s a long wait for people buying in 1999. What went wrong?
For one, Walmart was already so big that it simply couldn’t grow much more. Meanwhile, complacency set in. Walmart was big, but customers didn’t love it. In fact, many hated it.
This created an opportunity for places with lower prices or better service such as Costco (NASDAQ:COST) to step in. Traditional grocery chains such as Kroger (NYSE:KR) also figured out Walmart’s tricks and fought back.
Meanwhile, Amazon started to rise online. While Amazon didn’t hit Walmart directly, Amazon made investors adjust their valuation multiple down for Walmart drastically.
Walmart got as high as a mid-40s P/E ratio in the late 1990s. While its earnings would grow throughout the 2000s, its stock price never went up an inch because it got caught in a long period of P/E ratio contraction. By the time it was over, WMT stock sold for less than 15x earnings. It went from the retail king to the retail utility.
Amazon: Moving Past Its Prime
Amazon is well into its evolution from unstoppable juggernaut to aging giant that has lost a step.
On the e-commerce side, Amazon is giving up ground all over the place.
Seemingly out of nowhere, Shopify (NYSE:SHOP) has emerged as a massive threat to Amazon’s once unrivaled grip over online retail. Shopify offers merchants a friendlier and higher-margin alternative. Meanwhile, niche e-retailers are taking off in all sorts of verticals such as furniture, cars, appliances, pet supplies and many more.
Amazon has been dogged by concerns over product quality. Dropshippers bringing in low-quality goods from overseas have dinged Amazon’s credibility with many consumers. Fake reviews abound on the site.
Meanwhile, traditional brick and mortar stores like Walmart and Target (NYSE:TGT) proved to have solid e-commerce capabilities during the pandemic. Amazon’s Whole Foods embarrassingly lost significant market share to other grocery giants.
Cloud: Overhyped and Overblown
Amazon Web Services (AWS) is a fantastic business. There’s no argument there. However, the valuation is totally out of whack with reality right now.
AWS generates approximately $4 billion a quarter in operating income. So that’s $16 billion a year. This is operating income, not earnings, as things such as taxes have to be paid.
But we’ll be generous and assume that 100% of this operating income ends up as earnings. What do we value AWS as a standalone company at? Since it’s still growing quickly, 30x earnings sounds about right.
Alphabet (NASDAQ:GOOGL) and Microsoft (NASDAQ:MSFT), both of which have huge cloud businesses, are at 28x and 35x earnings to provide some perspective.
Ultimately, AWS will be a utility and should trade at something closer to a 12-18x P/E like telecoms, banks, power generation, and other such competitive commodity businesses once it is a mature business. The big commodity tech businesses like Cisco (NASDAQ:CSCO) tend to sell for a similarly low multiple most of the time as well.
For now, though, AWS is growing quickly, so we’ll give it a 30 multiple on operating income. Anyways, this gets us to a $480 billion valuation for AWS.
Meanwhile, Amazon has a $1.8 trillion market cap. That’s a big number! Even using a fairly kind set of assumptions for Amazon’s beloved cloud division, we have a huge gap here.
Is Amazon’s retail business really worth the other $1.3 trillion? You could buy out all of Walmart, Home Depot (NYSE:HD), Costco and Target for $1.1 trillion and have $200 billion left to buy a few smaller e-commerce companies.
Stock Dilution: A Hidden Burden
Over the past decade, Amazon has added 50 million shares to its outstanding share count to incentivize its employees. What’s 50 million among friends, anyway? At a stock price of $3,400 per share, however, this is $170 billion of newly emitted stock.
As discussed above, Amazon’s prized Web Services division earns roughly $16 billion per year. So, in terms of stock compensation, it would take 11 years of profits from its star asset merely to defray the cost of its past 10 years of stock issuance. Not ideal.
Long story short, Amazon’s apparent profits are less valuable than they might first seem. While profits are rising, the result is simply more and more stock dilution. If the company paid employees with cash instead of stock, the investment would look much less attractive.
AMZN Stock Verdict
Amazon has been one of the greatest investments of the past 20 years. And it remains one of America’s most impressive retail and technology firms.
However, investors have gotten wildly ahead of themselves in bidding the stock up to current levels. Like Walmart 20 years ago, AMZN stock will witness a long period of P/E ratio compression as investors dial back their expectations to a much more reasonable level.
On the date of publication, Ian Bezek did not have (either directly or indirectly) any positions in the securities mentioned in this article. The opinions expressed in this article are those of the writer, subject to the InvestorPlace.com Publishing Guidelines.
Ian Bezek has written more than 1,000 articles for InvestorPlace.com and Seeking Alpha. He also worked as a Junior Analyst for Kerrisdale Capital, a $300 million New York City-based hedge fund. You can reach him on Twitter at @irbezek.
