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Amazon Stock: The 'No-Brainer' Myth Is Broken

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My main coverage in the past couple of years has been Chinese American Depositary Receipts [ADRs] as I reckoned my frequent travels to China (before the COVID-19 pandemic struck) enabled me to provide the on-the-ground perspective. Hence, I believe the majority of my followers on Seeking Alpha became acquainted with my writings on Chinese companies like Alibaba Group Holding Limited (BABA), JD.com Inc. (JD), and Baidu, Inc. (BIDU).

However, Amazon.com Inc. (NASDAQ:AMZN) is among my earliest stock coverage. Amazon’s On-Demand Manufacturing Patent: Sounding The Death Knell For Apparel Manufacturers? and Amazon Muscling Into Another Industry And It’s Synergistic, both written in 2017, were my first two articles on AMZN stock.

Last year, as Chinese ADRs came under regulatory pressures from Beijing, trumped up fears over their use of the Variable Interest Entity [VIE] structure, and delisting concerns due to the potential enforcement of the Holding Foreign Companies Accountable Act [HFCAA], there were rampant comments in related articles along the line of “why bother with BABA stock when AMZN stock is a no-brainer?” Indeed, a search on Google (GOOGL)(GOOG) will reveal numerous write-ups calling Amazon a “no-brainer” investment.

Unfortunately for AMZN shareholders, the past three weeks must have been excruciating, with the share price of Amazon plunging nearly 30% before recovering some grounds to settle at a 22.6% decline. During the same period, BABA stock is up 2.5%, even as Alibaba suffered from the same selling pressure by investors amid weak sentiment and a woeful lack of appetite for tech stocks.

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Year-to-date, Chinese ADRs like Alibaba Group continued to find it tough to regain investor favor given the economic slowdown in China amid the country’s strict adherence to its “dynamic COVID-zero” policy and the successive additions of companies to a list of organizations facing possible delisting from U.S. exchanges under the HFCAA. Yet, BABA stock was able to outperform AMZN stock, declining 25.9% against the 32.2% drop experienced by the American e-commerce and cloud titan.

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Perhaps the saving grace for Amazon is that it is only down 39.4% over the past year, while Alibaba is lower by 61.7% in the same period.

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Placing $10,000 each into AMZN and BABA stocks equally a year ago, an investor would have seen the value of his AMZN holding dropping to $7,152 while his BABA holding would be worth only $4,270. However, it is expected that a typical American portfolio holding both stocks would have a much larger weighting of AMZN versus BABA. Thus, the sting from the current downdraft could be several times that of the BABA loss in the past year. The myth that an investment in Amazon is a “no-brainer” is debunked, at least when done so last year. BABA shareholders who listened to the chorus of “advice” telling them to dump BABA stock for AMZN are finding themselves in another hole.

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Amazon’s high valuation multiple is making it stick out among the FANG like a sore thumb

As one of the four members of the well-followed FANG stocks, the damage is exacerbated by the usually outsized contribution of AMZN stock to the ETFs and unit trusts that an investor could have held, on top of direct ownership of Amazon. Yet, despite the extensive bloodletting, the compression in the valuation multiple of Amazon may still have some way to go. Amazon’s forward price-to-earnings [PE] ratio of 138 times is way ahead of the other FANG stocks and Alibaba, which at 11 times, is finding itself at the bottom of the heap.

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The contrast may become starker as Amazon’s PE ratio (forward basis) becomes further raised if analysts keep on lowering their earnings estimates for Amazon. Amazon’s EPS estimates for the next fiscal year have plunged 24.7% over the past 30 days, compared with a mere 7.7% reduction for Alibaba Group.

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The steep downward change in estimates has been reflected in the F score that Amazon has received for its factor grade on revisions, worsening from the D+ score three months ago. Amazon’s F score for valuation currently is also a deterioration from the D- score it received three months ago. This signals that AMZN stock may have more room to drop based on valuation, even though its share price has already shed a hefty chunk away. The overall quant rating on Amazon is a ‘hold’.

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The wide range in EPS estimates for the second fiscal quarter ending June 2022 among the 31 analysts covering AMZN stock suggests Wall Street remains in flux regarding the company’s prospects. We are already in the midst of the quarter. Yet, analysts are forecasting Amazon could report a loss of as much as $0.60 or a positive EPS as high as $8.13. As we look further away to the third fiscal quarter of 2022, the disparity between the lowest and highest EPS estimates becomes more pronounced, extending from an $8.63 gap to $11.58 ($14.66-$3.08).

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The macro environment for Amazon has become more challenging – worsening supply chain disruptions due to the lockdowns in China and higher fuel prices resulting from the Russia-Ukraine conflict. Amazon could also record further valuation losses from its investment in electric vehicle maker Rivian Automotive (RIVN), given the share price slump in the latter.

On a full fiscal year basis, the range of EPS estimates is also very wide. Analysts are expecting Amazon to report as low as $1.19 or as high as $36.40 in the fiscal period ending December 2022. The so-called consensus EPS estimate at $16.36 hardly resembles either end of the range.

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The price target for AMZN stock has more downside

This could be a result of some analysts becoming too bearish, lagging analysts who have yet to revisit their thesis for Amazon, or a combination of both. When the latter starts revising their forecasts, the direction is expected to be downwards, bringing the consensus EPS estimate nearer to the simple average of the low and the high end of the estimates (the prevailing simple average for the fiscal period ending December 2022 is $18.80 versus the consensus estimate at $16.36).

The relatively small change in the consensus price target supports the above postulation. The share price of Amazon has fallen from around $3700 in November 2021 to $2261 currently, a drop of about 40%. However, the consensus price target has declined from $4100 to $3685, a mere 10%. This indicates that some analysts have yet to respond to the change in Amazon’s prospects and plunging share price.

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From the following chart, the idea that some analysts have yet to react may be more apparent. Kudos to the analysts who correctly predicted the downfall of AMZN stock since February. The low end of the price target has been adjusted swiftly downwards from around $3850 in January to $2250 currently, a decline of 42%, in-line with the year-to-date change in the share price. On the contrary, the high end of the price target is only down $345, a change of 7%, indicating that some analysts are still ultra bullish or have yet to wake up to the bloodbath in the tech sector.

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The following chart provides another data point for the postulation. The price target upside (daily) hit a multi-year high of 75% recently before settling at 63%, still a multi-year high. To the disappointment of AMZN shareholders, this typically suggests a slow adjustment in the price target rather than an attractive upside literally.

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Is AMZN stock a Buy, Hold, or Sell?

If Amazon stock is sold off while others have not, there may be a strong case to say market players could have overreacted. However, as investors know very well with our investment portfolios in a sea of red, the entire market, and the tech sector especially, is under a lot of selling pressure. Investors have transitioned from FOMO (fear of missing out) to SON (staying out now).

In an unabated inflationary environment, Amazon can pass on the higher operating costs to sellers (it implemented fuel and inflation surcharge for the first time). We do not know yet whether Amazon can fully pass on the additional costs or simply mitigate the burden. Furthermore, there is the risk that sellers raise their prices to cover the surcharges and turn off customers. Pandemic lockdowns are a thing of the past for the main markets that Amazon operates in. Shoppers who had to rely on e-commerce now have plenty of offline options.

In a rising interest rate environment, Amazon’s deteriorating free cash flow trend could also be used as a bearish driver by short-sellers to further drive down the share price. Amazon’s FCF (less principal repayments of finance leases and financing obligations on a trailing-twelve-month basis) has reversed from a positive $14.9 billion in Q1 2021 to a negative $29.3 billion in Q1 2022.

Amazon.com Inc

Meanwhile, the regulators such as the FTC are getting more emboldened and Amazon is finding itself under increasing pressure from the ongoing unionization efforts. Investors who have gotten (paper) rich from AMZN stock may now be reflecting on their over-reliance on the company for their investment goals or retirement.

Shareholders who initiated or added to their AMZN positions after “giving up” on Alibaba Group, often affectionately named the Chinese Amazon, could reverse their stance with the “Great Wall of Worry” seemingly crumbling, adding to the selling momentum. Nonetheless, with the mega-cap having declined 39.4% from its recent high, the downside may be limited. Hence, I believe AMZN is a “Hold” at this point.