The Recovery in Amazon Is Exaggerated

Stocks to sell

Amazon (NASDAQ:AMZN) stock has surged by more than 12% (on a relative basis) in the past month amid enthusiasm about its 20-for-1 stock split. Many investors seem over the moon about their gains, and rightly so. However, it’s time to think about matters prospectively. I sincerely doubt that Amazon stock will resume its upward trajectory as we move forward because it possesses clear fault lines.

I know many of you might disagree with me but just hear me out. First of all, Amazon’s recent retracement is likely artificial due to a technical price level bounce, which coalesced with its stock split event. Secondly, key metrics suggest that Amazon stock remains overbought. I’m thus exceptionally bearish; here’s why.

AMZN, Inc. $108.36

Stock Split Analysis

Amazon executed its 20-for-1 stock split over the weekend in an attempt to make its stock more investable to the retail crowd. Although the split could add some value, it seems as though most of the benefits were already priced in leading up to the event, with AMZN stock rising by more than 12% in the last month.

It’s likely that institutional investors were the ones that speculated on the stock split and that actual post-split retail buying won’t suffice. I say this because retail market participation continues to wane, and AMZN’s stock split momentum peaked pre-event.

Even if we flip the scenario around and assume that AMZN’s stock split will result in a bullish trend, it’s still unlikely that it would make that big of a difference. According to a Cambridge University published study, the market underreacts to stock splits, which means that the stock split price anomaly remains a folk tale rather than objective theory.

Cyclical Headwinds

Although it remains open to debate, Amazon’s primary exposure is to the cyclical consumer goods market. The company’s e-commerce platform, which still accounts for roughly 44% of the business’ revenue, is inextricably linked to the real economy. Thus, the bulk of Amazon’s sales will likely fade if the yield curve’s implied interest rates materialize. The intuition here is that a series of increases in the benchmark interest rate would contract the economy, in turn reducing cyclical good spending. 

On the upside, I see Amazon Web Services (around 16% of its total revenue mix) as a breadwinner due to its secular growth properties. However, AWS is a long-run valuation consideration and won’t significantly affect the stock until it takes up a larger part of AMZN’s total revenue.

Relative Valuation Concerns

Amazon stock is overvalued on a relative basis. Firstly, AMZN stock is trading at 1.98x its sales and 15.81x its cash flow, conveying that the stock’s overvalued on both an accrual and a cash basis. Furthermore, AMZN’s price-to-earnings ratio of 47.62x implies that the market overestimates the company’s earnings-per-share capabilities.

I don’t see Amazon’s overvalued price multiples justified by growth. Sure, the company holds a strong market position, but its growth is relatively disappointing if it’s considered that AMZN’s earnings-before-interest-and-tax (EBIT) growth is projected at only 13.86% for the next year. In addition, Amazon’s forward diluted earnings-per-share is forecasted to be 84.78% lower than its 5-year average, implying that its growth prospects aren’t bright at all.

On the date of publication, Steve Booyens did not hold any position (either directly or indirectly) in the securities mentioned in this article. The opinions expressed in this article are those of the writer, subject to the Publishing Guidelines.

Steve co-founded Pearl Gray Equity and Research in 2020 and has been responsible for institutional equity research and PR ever since. Before founding the firm, Steve spent time working in various finance roles in London and South Africa. He holds an MSc in Investment Banking from Queen Mary – University of London and is working towards his Ph.D. in Finance, in which he’s attempting to challenge the renowned Fama-French 5-factor pricing model by incorporating ESG factors. His articles are published on various reputable web pages such as Seeking Alpha, TipRanks, Yahoo Finance, and Benzinga. Steve’s articles on InvestorPlace form an interesting juxtaposition between mainstream opinion and objective theory. Readers can expect coverage on frequently traded stocks, cryptocurrencies, crowdfunding, and ETFs.

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