Amazon.com (AMZN) is arguably one of the most successful business stories in the history of America. The company started out with humble beginnings as an online bookseller and is now a diversified technology conglomerate with a number of huge businesses across Internet retail, grocery stores, health care, media, and more.

It is no surprise that Amazon has captured the attention of investors, both large and small. Multiple institutional investors—often referred to as the “smart money”—have created huge positions in Amazon. One of them is Melvin Capital Management a $13 billion fund that seeks superior risk-adjusted returns by using a long-short equity strategy, among other securities.

Melvin’s largest position by a wide margin is technology giant Amazon. But investors should never blindly follow the holdings of a hedge fund. It is always important to do your own due diligence, part of which is an assessment of the individual’s risk tolerance. We see Amazon stock as significantly overvalued today and recommend investors avoid the stock at the current price, despite the company’s high growth rate.

Growth At An Unreasonable Price

Amazon is one of the largest companies in the world, sporting a $1.55 trillion market capitalization. This size and scale affords it certain benefits when it comes to competing in a global marketplace. The company continues to generate huge growth. In the 2020 first quarter, Amazon generated $75.5 billion in revenue, above prior guidance of $69 -$73 billion, representing a 26.4% improvement compared to Q1 2019. This result was driven by a 22.0% increase in product sales and a 32.2% increase in service sales.

 Notably, service sales made up 44.5% of all revenue. Operating income equaled $3.99 billion, down from $4.42 billion in the year-ago period, but within prior guidance of $3.0 -$4.2 billion. Net income equaled $2.54 billion ($5.01 per share) compared to$3.56 billion ($7.09 per share) in Q1 2019. Amazon also provided guidance for the second quarter of 2020. The company expects Net Sales of between $75.0 billion and $81.0 billion, indicating 18% to 28% growth, along with Operating Income of -$1.5 billion to +$1.5 billion.

We see Amazon’s impressive growth run continuing for the foreseeable future, but not necessarily to the extent that it has in the past. Amazon has grown its cash flow per share – our preferred growth measure for the company with very little GAAP earnings – by an average rate of 38% annually in the past decade. We see future growth at 11% annually given Amazon’s unprecedented size and scale in the industries it serves.

Amazon’s retail business should continue to grow nicely in the coming years as it continuously reinvests in lower pricing and quicker delivery options with its world-class supply chain. However, Amazon Web Services, or AWS, continues to be the standout when it comes to growth.

AWS has taken full advantage of the mega-trend of moving from on-premise servers that are expensive and inflexible to cloud servers that offer lower running costs and the ability to easily and quickly scale up or down capacity. With Amazon reinvesting cash flow into the business for future growth, we see the future as very bright, particularly for AWS.

We also see Amazon as expensively priced today after a very strong rally. Indeed, we see the stock at 175% of fair value today, so we recommend investors avoid the shares until the valuation improves. In addition, Amazon stock is not an attractive holding for a very large subset of investors—retirees, who typically desire income from their investment portfolios. Amazon is not likely to pay a dividend any time soon, due to the constant need to invest every available dollar back into the business to support its continued growth.

The Bottom Line

Melvin Capital seeks to provide its clients with strong risk-adjusted returns through bottom-up analysis of a company’s fundamentals. It has made significant bets on its top 10 holdings, including a massive $1.7 billion position in Amazon.

While we see the growth runway for Amazon as significant in the coming years, we also see the stock as trading well in excess of fair value, effectively pricing much of this growth into shares. With Melvin investing 20% of its portfolio in Amazon, this could become an issue should Amazon revert back towards fair value, which we see at ~$1,750 per share.