February 7, 2013

The coming Amazon crash?


In a provocative article for Forbes, Igor Greenwald ponders Amazon’s high, high stock price—and predicts a big crash.

He begins by asking what it is that keeps share prices so high. Amazon, Greenwald writes,

is a company with $61 billion in annual revenue, accounting for more than 15% of U.S. online sales. That’s basically your vintage 2003 Dell. The one way in which Amazon is more like the 2003 Apple is in the lofty multiple its shares fetch, at some 180 times this year’s projected earnings. So this is already a jumbo jet attempting to take off from an aircraft carrier. The chances of this ending well for passengers are low.

The way for Amazon to keep its share price up, Greenwald then suggests, is to just keep doing what Amazon does best … growing market-share. But is this possible?

Will Amazon continue disrupting bricks-and-mortar merchants? Absolutely. Though it’s already the dominant e-tailer, online sales still account for barely 5% of the U.S. total, and are still growing at least three times faster. So Amazon’s revenue, currently up 23% year-over-year, may continue expanding nicely for a while.

But the runway will continue to shorten. The neighborhood booksellers are now largely gone, and the depleted competition in electronics may soon follow them into oblivion. Those low-hanging fruit have either already been picked or will be soon. To keep up the growth pace, Amazon will have to keep finding new markets to squeeze, be they in content streaming or electronic payments.

And let’s assume it will find them and masterfully squeeze them, applying its current low-margin strategy. Amazon would then become an even larger company, but still not a particularly profitable one.

Finally, as to the question of whether investors will tire of this strategy:

[A]ll Amazon needs to do to justify its sky-high valuation is to keep finding new markets, squeeze out competitors and then successfully raise prices like it’s never tried to do, and preferably without provoking renewed competition. That seems like a dubious proposition.

There have been plenty of high-multiple stocks that have worked out, but none that I can think of that started with a earnings yield of less than 1% and a valuation above $100 billion. Maybe Amazon will be the first. More likely, it will succumb to the laws of gravity and large numbers. And when it does, the price paid by the shareholders will be brutal.

Kelly Burdick is the executive editor of Melville House.