Amazon's Valuation Is Hard To Justify (AMZN)

An analyst's infamous 1998 target price that quickly became a self-fulfilling prophecy may be emblematic of the dot-com bubble. But, in Amazon.com Inc.'s AMZN +2.51% case, it turned out to be conservative. On a split-adjusted basis, today's share price is the equivalent of $1,166.

An analyst's infamous 1998 target price that quickly became a self-fulfilling prophecy may be emblematic of the dot-com bubble. But, in Amazon.com Inc.'s AMZN +2.51% case, it turned out to be conservative. On a split-adjusted basis, today's share price is the equivalent of $1,166.

Despite all its success since then, Amazon's valuation still attracts plenty of skeptics. They felt vindicated in October and January when third- and fourth-quarter results disappointed and the share price dove. With expectations suitably tempered and fellow e-commerce company eBay Inc. having beaten expectations, there may be room for positive surprises when Amazon reports first-quarter results Thursday. Analysts expect earnings per share of only seven cents versus 44 cents a year earlier.

But even if it clears that relatively low hurdle, Amazon's valuation remains difficult to justify. The Internet company can ignore the retail mantra of "location, location, location," but not the adage that "you've got to spend money to make money." It nearly doubled capital spending in 2011 versus a year earlier. And while expensive initiatives such as fulfillment centers and subsidizing the Kindle Fire tablet will continue to depress 2012 earnings, even on 2013 forecasts, the stock sports a price/earnings ratio of 76 times.

As hybrid retail, media and information-technology company—"bricks, flicks and clicks," as Nomura says—it is hard to find a perfect proxy for Amazon. Even so, in addition to being in a different orbit than global retailer Wal-Mart Stores Inc., WMT +1.12% which trades below 11 times 2013 earnings, Amazon is pricey compared with Apple Inc. AAPL +1.56% and even Netflix Inc. NFLX +0.14% They trade at 11.4 and 38 times forecast 2013 earnings, respectively.

On the basis of price to sales, a reflection of long-term growth and margin assumptions, Amazon trades at 3½ times Wal-Mart's multiple. And while Amazon's 2012 operating margin is forecast at just half the average level of the past nine years, it faces hurdles in returning to old form. A big one is the possibility its U.S. customers soon will have to pay sales tax, forcing it to be more aggressive on price or to sacrifice some sales, probably both.

Based on the article, Amazon.com nearly doubled its capital spending on items such as fulfillment centers (sophisticated warehouses where it finds, packages, and ships goods to customers). Discuss the implications that this spending would have on the company’s return on assets.