Amazon Is Still Vulnerable to the Downside

Source: Thinkstock

So far this year, Amazon (NASDAQ:AMZN) has been a lousy stock to own. Shares have traded down 22 percent year to date versus the S&P 500, which is up 3 percent. The company’s weak performance can be attributed to a couple of factors.

The first is that Amazon’s revenue growth is decelerating. Revenue growth used to come in at around 30 percent per year, but in the most recent quarter, revenue growth slowed to 22 percent. When investors come up with projections, they will often assume that ongoing trends will continue unless there is a specific catalyst.

My guess is that many investors who were long the stock toward the end of last year saw this deceleration of revenue growth and presumed that it would continue. This can lead to projects of 15 percent revenue growth in 2015-2016, and revenue growth as low as 10 percent in 2017 or 2018. For a company that is valued largely on its growth potential this is problematic, and it has likely sent some investors to the exits.

The second is that Amazon doesn’t really earn any money. The company takes the vast majority of its profits and reinvests them in its business. In fact, despite the company’s $312 share price, it has earned less than $5 per share in the past four years. Investors have justified this by claiming that the company could theoretically be growing its profits but isn’t because it is investing in its business.

However, it has always seemed as if profits were just around the corner. Unfortunately this has not happened, and as a result, I think some investors are becoming frustrated. This process has become exacerbated, as investors have become nervous about the stock market; they have sold growth stocks more broadly while bidding up more defensive stocks that generate a lot of cash flow and pay dividends.

These two factors sent shares down to as low as $288 in April. More recently they have rebounded, and they currently trade at $312. This is still down considerably from the $408 per share high, but considering the stellar performance of the stock over the past several years — shares are up over 600 percent in the last decade – the correction has been modest.

Where does the stock go from here?

I think that the recent $24 per share upswing has created a selling opportunity for investors who didn’t sell at the beginning of the year. Technically the stock is trading at a critical level that acted as support in early April before rising slightly and then falling sharply. I think a lot of investors could be targeting the $312 per share level as a result, and it isn’t surprising that the shares closed at this level on a Friday before a long weekend.

Second, despite the fact that the stock has fallen, the analyst community has yet to react. Often, as a stock falls, analysts become more bearish. As a contrarian investor, a good time to buy is when a stock is down and when analysts are bearish. This means that there are fewer investors left to sell.

With Amazon the stock has fallen, but analysts are still bullish with an average 12-month price target of $416 per share. This is extremely bullish, and it tells me that several analysts and the funds and brokerage firms that they work for still own the stock. In short, there is a lot of pent-up supply of Amazon shares.

Thus, while analysts are applauding the company’s recent move into entertainment and into online streaming — Amazon just announced its first original kid’s series, called Tumble Leaf – I think the company is largely in the same position it was in at the beginning of the year. It is a company that is rapidly growing its revenues and its distribution infrastructure. It is a retailer that is competitive on price in nearly every market. But it is saturating the market and this is going to reduce revenue growth. It is also not profitable, and as a result investors have a tough time valuing the shares.

If the company can rectify the latter situation and start generating some profits, we can revisit Amazon as an investable stock. But for now I think it is largely speculative. Investors looking to bet on the global rise in e-commerce have other options, notably eBay (NASDAQ:EBAY). While eBay doesn’t have the growth that Amazon has it is highly profitable, and it is growing both its sales and its revenues.

It is also returning capital to shareholders through a stock repurchase program. While eBay may not be as exciting as Amazon, it has qualities that make it a solid investment, and that is what really matters when you are picking stocks.

Disclosure: Ben Kramer-Miller has no position in Amazon or in eBay.

More From Wall St. Cheat Sheet: