Amazon (NASDAQ:AMZN) stock trades at a huge premium to the market, but it may not really be worth that high valuation. Despite the massive potential of Amazon stock, investors should wait for cheaper prices before getting in.
As of Friday, May 8, Amazon was trading less than 4% below its all-time high of $2,475 per share. This implies that the company has a market valuation of $1.16 trillion.
That may be too high given that its free cash flow in the latest quarter was negative. Amazon likes to look at its last 12 months (LTM) free cash flow. Its LTM FCF rose to $24.3 billion, up 5.6% from a year ago.
Amazon’s Free Cash Flow Problems
The problem is what this implies about the valuation. If you divide $24.3 billion by the market valuation of $1.16 trillion, the FCF yield is just 2.1%. That is a very low FCF yield for most investors.
For example, Microsoft (NASDAQ:MSFT) has a similar market valuation, at $1.4 trillion. It generates almost twice as much free cash flow. Microsoft’s LTM FCF in Q1 was $43.4 billion — 78% higher than that of Amazon.
But here is the thing: MSFT stock has a much higher FCF yield, at 3.1% ($43.4 billion divided by $1.4 trillion) compared to Amazon.
What Are Analysts Saying About Amazon Stock?
As usual, no one on Wall Street will say a stock is too high. Some, like Wedbush analyst Michael Pachter, raised their price target ahead of the earnings release. His target is now $2,750, 15.5% higher than today’s share price.
One analyst on Seeking Alpha, Michael Wiggins De Oliveira, believes Amazon stock is a bargain at 29 times its cash flow. That is because its three-year average is 32 times cash flow.
But in the same article, he points out that Amazon’s AWS service had much lower growth than Microsoft. This is because AWS is usage-based, but its cloud competitors’ services are subscription-based.
In addition, AWS tends to serve much smaller and less affluent businesses than Microsoft’s large enterprise clientele. So that is a little bit of a paradox. Higher valuation based on lower-quality earnings?
I suspect that is the sort of religion that much of Wall Street still practices about Amazon stock. Of course, believers all overlook the actual losses that the company is making on a net income basis. Never mind that competitors in this trillion-dollar market club are all super profitable, pandemic or not.
Barron’s made a point about the skyrocketing valuations of the top 10 stocks in the Nasdaq Composite, which include Amazon. Together they account for 44% of the market value of the 2,700-stock index. But here is the thing. Their average price-earnings ratio is high at 47 times estimated 2020 earnings.
Paint Me a Skeptic, But I Like to See Results
If you believe CEO Jeff Bezos, the company will make $4 billion in operating profit during Q2 that it will plow back into expenses to improve the company.
MarketWatch pointed out that analysts had expected this $4 billion to hit in Q2. But now the company is guiding to an operating loss of $1.5 billion.
That has not hurt Amazon stock at all. Analysts and shareholders are used to hearing this kind of news from the company. They believe that the investments the company makes will lead to higher revenue and higher potential future profits. Harvesting that profit can be left to some future period, if at all.
The problem with this is that eventually Amazon’s competitors, with their profitability, might have the ability to weather storms better or take advantage of opportunities. So far that hasn’t happened. So, one might think I could be wrong in the long term.
Nevertheless, I think investors should look for an opportunity to buy Amazon stock at a better price. It’s not worth a buy here close to its all-time high.
As of this writing, Mark Hake, CFA does not hold a position in any of the aforementioned securities. Mark Hake runs the Total Yield Value Guide, which you can review here.
