Amazon: Understanding the numbers behind what you own
Tuesday, February 22nd, 2016
Last year Amazon.com, Inc. (AMZN) was a big winner in the stock market. The company saw its stock price elevate from an opening price of $312.58 on January 2, 2015 to a closing price of $675.89 on December 31,2015. That is a return of 116.23% for 2015.
Amazon does deliver an exceptional product and I would be lying if I told you I didn’t use its services, but often investors get too hung up on the product or service itself than truly understanding what they are a part of. This causes the stock price to be driven far past the fair value of what it should be trading at.
It is important to understand that when you invest into a company, you become a partial owner of that company. This means that you should have a good understanding of the sales the company generates, its earnings, the debt levels, and all the key measures to running a healthy business. Like with owning a car or house, you should put the time into researching the company you are buying and understand the numbers behind your purchase.
One reason for Amazon’s stock appreciation has been the rate of growth on its sales and earnings. Over the last 12 months Amazon has grown its revenue 20.25% while the industry is only up 5.37%. Its earnings have grown at a rapid rate of 334.28% while the industry has grown at a rate of 42.6%.
While this sounds great, understanding the value of what you pay for the company is very important. Having a company grow its sales and earnings is good, but if you’re overpaying for a company the hype is often built in. And if the growth slows, you will see the stock price fall very quickly.
Current Price/Sales for Amazon is 2.35, which is above the industry average of 1.03. Current Price/Tangible book value is 26.17, well above the industry average of 14.08. Price/Cash Flow is 36.51, more than double the industry average of 15.63.
The final value measure we will take a look at is the P/E multiple. Amazon reported EPS on a GAAP basis of $1.25 for 2015. Using their current stock price of $559.50 we get a current P/E ratio of 447.6.
The current industry average is 60.95. I’d like to point out people began to panic and say the market was overpriced when the P/E was 20, so a P/E of 447.6 is extremely high.
For investors that believe Amazon’s P/E is justified because they will continue to grow their earnings, we can take a look at how much you are paying on a forward basis. Estimated EPS on a GAAP basis for 2017 is $8.80. This produces a forward P/E of 60.28. To put this into perspective, the 40-year average for the forward P/E on the S&P 500 is 16.5.
It is very concerning when you look at the high expectations that are being placed on Amazon. Within two years, it is expected they will grow their EPS from $1.25 in 2015 to $8.80 in 2017. That is expected growth of 604%. If Amazon cannot meet these expectations, you will see the stock price fall very quickly.
Even if Amazon can produce an EPS of $8.80 in 2017, the company is still extremely overvalued. There are two ways a stock price can have its P/E normalize. They can either grow their earnings, or the stock price can fall.
At the current price of $559.50 the company would need to produce an EPS of $33.90 to have a forward P/E of 16.5. That means the company would have to grow their earnings at a rate of 2,612%. Using the forty-year average forward P/E of 16.5 and the expected EPS in 2017 of $8.80, we would get a current fair price for Amazon of $145.20. That price is currently 74% below their actual current price.
History has shown that you simply don’t overpay for the earnings of a company, because when you do your results as an investor suffer. As you can see below when you invested in years like 1929, 2000, and 2008 when the P/E was very high, you did not fair too well. However, if you invested in years when the P/E was low, you did extremely well.
Don’t get sucked into the hype of Amazon and other similar companies. Be a wise investor and understand the numbers behind what you are investing in.
Do you have a question or a company you'd like me to take a look at? Email me at Chase@WilseyAssetManagement.com!
Chase is a financial analyst for Wilsey Asset Management and can be heard every Saturday at 8 a.m. on KFMB AM760 as the co-host for the Smart Investing show with his father Brent Wilsey. Information is provided by Reuters.
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