Why You Should Not Own Amazon Stock (AMZN)

September 12, 2014

 

Mythological Creature

I try to be an optimistic person. While optimism is generally a good thing, optimism to the point of being delusional clearly is not. I've had plenty to say about Amazon stock, but up until now, I've mostly relegated those comments to message boards. I just wanted to go on record here, in case any of my readers actually own AMZN. My strong personal opinion is that this is a very dangerous stock to own right now.

You can click on the link above, and scroll down to the comments section to get some of my more philosophical comments about the company. Just for good measure, here are a few examples (Yes, that's right. I am now quoting myself):

"Walmart's history involves benefiting consumers and shareholders at the expense of workers and suppliers. Amazon's history involves benefiting consumers at the expense of shareholders, though shareholders haven't actually felt the pain yet because the market is still buying into a fantasy. My point is, I don't see how the story will end well for either of these companies. It seems more likely that they will just destroy each other."

"So, the way Amazon takes advantage of the investing public, in my opinion, is through selling them hard on an "idea". The idea being, that a business does not need to produce profits in order to benefit shareholders. It is "working" in a sense, so far, because enough new shareholders continue to buy into this premise, thereby driving up the stock price. In reality, they are not creating intrinsic value for shareholders. They are actually diluting them, and using them as a source of cash to make up the cash shortfall produced by their business. After 20 years or so in business, their full retained earnings are something like $2.17 billion, which is not terrible in and of itself, but is actually a negligible amount for a company with a market cap of $156 billion. It averages out to something like $100 million per year. I think that the management of Amazon continues to distract and deceive investors by entering into new business lines, in which, like the existing business lines, it has no competitive advantage and very little hope of producing significant profits. I think the best example of this is the drone aircraft thing. In my opinion, that was the equivalent of dangling a shiny object in front of a baby so that he won't see you take away his pacifier. He's amused right now, but if he understood what was actually happening, he'd be pretty upset."

But, I will go ahead and note a few more things here.

First, the book value of shareholder's equity is $10.6 billion. The current market cap is $152.36 billion, giving AMZN a whopping Price to Book ratio of 14.37. High price to book and high price to sales ratios should obviously be reserved for companies with huge gross margins generated by brand equity, such as well-established luxury goods makers... that brings me to my next point. Amazon has no competitive advantage whatsoever. If we define competitive advantage as an ability to produce above average profits (either through charging customers more, or having lower costs, or both) and still maintain or increase market share, then AMZN doesn't have a single one. Not only that, but AMZN continues to set itself up more and more as a competitor in new spaces that are already very crowded. Further, those spaces already have major players with significant competitive advantages. In short, Amazon has sold the idea that it can compete in pretty much any business against strong companies with major competitive advantages, brand equity, etc. by operating at zero profit, which of course is nonsense. A company that can grow in perpetuity through investor funding, without ever producing significant profits relative to its sales and market cap, is a mythological creature, kind of like the unicorn at the top of this page. Of course, nonsense, delusions, myths, fantasies... these can be a very powerful force that causes many interesting phenomenons in financial markets:

"The time had come, as in all periods of speculation, when men sought not to be persuaded of the reality of things but to find excuses for escaping into the new world of fantasy." John Kenneth Galbraith, The Great Crash of 1929

I posit that Amazon, in spite of its popularity at the moment, has zero brand equity. No one cares whether they buy a commoditized product from Amazon or Walmart.com. Most people only care which one is cheaper. Sure, customers "love" Amazon now for their low prices and good service. But both of those things are unsustainable.

I think the absolute best case scenario for Amazon, and you have to be very hopeful to imagine this, but the best case would be for them to one day generate a 3% net profit at their current level of sales. At a 15 multiple, that would make the company worth $36.79 billion. At a 20 multiple, that would make the company worth $49 billion, or about 32% of today's market cap. Again, that is the absolute best case I can think of for this company.

They're in a war with Walmart for online sales of household goods. People love to talk about the (imaginary) advantage that Amazon's logistics infrastructure provides, but they seem to be missing the already existing vast infrastructure of brick and mortar retailers who are increasingly offering buy online, pick up in store and ship from store capabilities. Some of them, such as Macy's, are even experimenting with same day delivery. Retailers like Bed, Bath, and Beyond, Best Buy, hhgregg, et al. have recently started price matching Amazon. Amazon bullies suppliers, authors, Disney (or at least they tried to bully Disney), et al. This is not going to end well for them. Online retail sales rose .1% last month versus a .6% increase overall. People stayed home more last winter because of the harsh weather and storms, but are more likely to get out this winter, assuming we don't have a repeat of the severe weather. They're steadily losing their tax advantage. The point is, there are already plenty of chinks in the armor (note: that link shows Amazon.com web traffic down 6% year over year for July). It might be time to think about shorting...

And we're not even getting to the best part. The catalyst. The gravity that will bring this high flying, extremely overvalued stock back down to earth. It's a little Chinese company you might have heard mentioned in the news: Alibaba.

This company is poised to do to Amazon exactly what it has done to other retailers all of these years, which is to "steal" market share by using what are basically unfair advantages. If their past history against EBAY is any indication, they're even willing to operate at zero profit to do it. And they have one extremely strong competitive advantage. They have a loyal home base of extremely cheap suppliers. If you don't think the Chinese are partial to other Chinese businesses, you haven't been paying attention the last 15 years or so. Basically, I see the potential for partnerships and "collaborations" between Alibaba and Chinese suppliers that are pointed firmly against Amazon. Now, if U.S. consumers cared about supporting U.S. businesses, that might be a problem for Alibaba. But the last 40 years or so have proven handily that U.S. consumers have no such loyalty. Collaborations, partnerships, and loyalties aside, Alibaba is still poised to steal at least some market share from Amazon. And that's the thing... with a stock like Amazon, it will only take a small pin prick to burst what is clearly a speculative bubble.

UPDATE 9/20/2014: I just saw where Amazon is building not one, but THREE DOMED BIOSPHERES at its new campus. This may look like success to some. To me, it looks like arrogance, extravagance, grandiosity... and a complete disregard for using capital to create intrinsic shareholder value. I'm simply amazed that this is happening and shareholders aren't running over each other for the exits. Amazed.

UPDATE 10/1/2014: I read this piece last night and had to share: Why Amazon Has No Profits and Why It Works. This is written by an apparent Amazon fan, or investor, as a defense of the business model. I think the conclusion says a lot, so I've quoted it here:

"Still, investors put their money into companies, Amazon and any other, with the expectation that at some point they will get cash out. With Amazon, Bezos is deferring that profit-producing, investor-rewarding day almost indefinitely into the future. This prompts the suggestion that Amazon is the world's biggest 'lifestyle business' - Bezos is running it for fun, not to deliver economic returns to shareholders, at least not any time soon.

But while he certainly does seem to be having fun, he is also building a company, with all the cash he can get his hands on, to capture a larger and larger share of the future of commerce. When you buy Amazon stock (the main currency with which Amazon employees are paid, incidentally), you are buying a bet that he can convert a huge portion of all commerce to flow through the Amazon machine. The question to ask isn’t whether Amazon is some profitless ponzi scheme, but whether you believe Bezos can capture the future. That, and how long are you willing to wait?"

UPDATE 10/9/2014: Amazon is opening its first brick and mortar store. Just when I thought this company couldn't possibly do anything more confusing and misguided, it did. Hey, we're the company that's bringing on the death of brick and mortar retail - by opening brick and mortar retail stores! Confused, diluted business strategies simply don't work. Companies do well to focus on building one or a few sustainable competitive advantages in one or a few specific areas/business lines, practice sound capital management and stewardship, and then they can rule their own little corner of the world. This company wants to rule the entire world, and it's simply not going to work!

UPDATE 12/24/2014: After I wrote this piece, I had a nagging feeling that the passage about drone aircraft being the equivalent of dangling a shiny object in front of a baby may have been something I had heard or read somewhere, rather than an original thought I had. I can't be sure, but now I think I first heard this from the Rev. Fr. Emmanuel Lemelson, CIO of Lemelson Capital Management. Whether he did or didn't say it, I thought it was worth noting that it might not have been an original thought, as well as a good opportunity to add a note about a really amazing guy that has served as an inspiration to me! Be sure to check him out here, here, and here.