When Growth Stocks Shrink, Amazon Edition

Last week, in the wake of Netflix’ (NFLX) latest post-earnings, thrashing, we updated our earlier question from February’s “What happens when a leading growth stock stops growing?” to “When Growth Stocks Shrink.”Many had feared that Meta Platforms (FB) would offer the sequel to NFLX’ woes, as it did last quarter, but investors were instead so encouraged by their most recent report that they took FB shares 17.5% higher yesterday and used that enthusiasm as the basis for a broad-based rally that took US indices 2.5%-3.5% higher.

It would have been nice to pen a piece today entitled “When Growth Stocks Report Better than Feared Results”, or something with a similar but less unwieldy title, but then Amazon’s (AMZN) report after the close changed the narrative once again. To put it mildly, this was a stunning report. The company reported its first loss in seven years and acknowledged the potential for an operating loss next quarter while guiding estimates lower. Some investors were concerned about the likelihood of difficult comparisons versus last year’s stay-at-home trends, but no one anticipated this result.

Certainly, the options market wasn’t anticipating this result. We noted yesterday that the options market was placing its highest probability on a roughly 5% rise to the $2,900 level. One could argue that result was fully priced in when the stock closed at $2,891.93 shortly before the earnings were announced. Stock traders were enthusiastic when a key FAANG stock and several others beat estimates – why shouldn’t that enthusiasm carry over to AMZN (and Apple (AAPL), which was up 4.5% ahead of its earnings)?

In yesterday’s piece, we noted that AMZN had beaten its estimate 5 of the last 8 quarters, but saw its stock fall 6 of 8 times nonetheless. Thus, it did seem a bit odd that traders were apparently sanguine ahead of earnings. And I will argue that despite today’s 12.5% drop (or 9% on a two-day basis) might nonetheless be considered a decent reaction. Over the years I’ve referred to AMZN as the original faith-based stock, with an evangelical zeal amongst its supporters that presaged what we now see in Tesla (TSLA). That zeal was well-earned, with AMZN stock rewarding the faithful through stellar, relatively uninterrupted appreciation. In return, the faithful allow AMZN to sport a huge valuation premium. Even after the first-quarter loss, AMZN shows a trailing P/E of about 72 and a forward P/E of just under 80 (though analysts are likely to be revising some estimates lower).

Let’s put that P/E ratio in perspective. It is much higher even than flagship retailers like Walmart (WMT) and Costco (COST), which have estimated P/E’s of 22.6 and 41.65 respectively. Yet AMZN has never been valued as a retailer, it’s been valued as a tech company. That is probably more accurate now than before since AMZN’s fastest growth and highest margin business is cloud computing. Let’s compare it to other cloud giants like Microsoft (MSFT) and Alphabet (GOOG, GOOGL). They have estimated P/E’s of 29.81 and 20.50 respectively. All these companies sport a premium to the S&P 500 Index’ 18.43, yet AMZN is in a different league entirely. AMZN is a great company, but that is already more than reflected in its valuation.

Let’s finish with a bit of perspective. The chart below shows what a phenomenal investment AMZN has been for the past five years, with a line drawn at the company’s peak prior to Covid. On one hand, there is plenty of reason for investors to continue their faith; on the other, the stock has plenty of room to dip further if its valuations normalize.