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Last month, Amazon.com (NASDAQ:AMZN) got clobbered after it reported earnings. The stock was down as much as 25% following the earnings report. Now it’s bouncing higher on news of an increased repurchase authorization.
I see this as a terrible sign for Amazon.
To understand why, let’s first look at those earnings. Yes, the last quarter was robust in many ways. Fourth-quarter sales were up 22% and operating income climbed 88%. Net income shot up 126%. Numbers were up very strongly for the entire year as well. Prime memberships grew 51% globally. The balance sheet is terrific, with $19.8 billion in cash and investments, against $8.23 billion in debt.
The Question of Valuation
On the surface, then, things look pretty good. However, when we examine valuation, things start to look ugly. Net income for the year was $596 million. The stock’s present valuation is $245 billion. Thus, the price-earnings ratio is … 411!
I know that many investors say that profits don’t matter with Amazon. To a certain extent, that’s true. We should always be hesitant to say that net income is not important. Amazon is a weird beast in that it has its hands in many things, and is spending tons of money developing venture-capital-type stuff that may explode in the future. A company that has $107 billion in annual revenue can afford to invest in such things.
Indeed, I don’t recall any time in the past 17 years that Amazon has ever traded at a “reasonable” multiple.
So why whine about the Amazon buyback?
I want a company to spend money on its own stock when it is clearly undervalued. It may be difficult to pin down exactly what Amazon is worth, but it sure is not worth a P/E of 411. Spending shareholder money to buy back stock means that management believes it is offers good long-term appreciation potential.
On the other hand, buying back shares when they are overvalued means it is a long-term hit to shareholder value. It is certainly possible that this will be the case, but let’s also remember that the stock was at $300 just one year ago and it is now 65% above that price – after a middling 2015 for the markets and with 2016 off to a terrible start.
Behind the Amazon Buyback
My concern is that this was a public relations move. Companies often announce buybacks on the heels of bad news. And let’s be fair, Amazon did say it would buy back stock if it felt doing so would enhance long-term value for shareholders. So maybe it won’t buy back much at all at these prices.
I have other concerns. Free cash flow (FCF) is not as robust as it first appears. That’s because the company uses capital leases, which are accounted for as an asset purchase. Those purchases can then be depreciated. Depreciation is added back to the cash flow statement, thus artificially boosting true operating cash flow.
So while Amazon appears to have $7.3 billion in free cash flow, in reality it’s really closer to $2.6 billion. We can also value companies on a price-to-FCF basis, and here it comes out 99. That’s still outrageously expensive.
I think the Amazon buyback is a sign that the company is trying to reassure shareholders instead of keeping its eye on just doing business.
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