YCG Investments
“If you buy above average businesses at below average prices, on average, we believe you should come out ahead.” — Brian Yacktman

Amazon – Poised for Disappointment

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As many of you know we manage separate accounts and implement a multi-strategy when it comes to managing our client portfolios. We have few constraints, allowing us to go long, short, or hedge our positions using options (you’ll find that we often sell cash secured or “naked” puts and/or covered calls). We recently took advantage of this flexible mandate by shorting Amazon (AMZN), with its’ lofty valuation we see tremendous downside in this stock and are happy to take the short side of this trade.

It’s funny how history repeats itself. Many life lessons can be learned by studying the past. In the case of AMZN, we see a stock price that has reached an all time high (adjusted for stock splits— even higher than that of the price seen during the 1999 “tech bubble.” Looking at AMZN’s current price ($143) you would think there was no “tech bubble”. Ironic, considering that our economy is going through the worst recession since World War II and yet this online retailer continues to move higher and higher. Are we Amazon haters? Of course not, it’s a wonderful business, not to mention we buy the occasional book and gifts from Amazon ourselves. But with AMZN having reached a 52 week high of $145, a 74 times 2009’s estimated profit of $1.95 a share, and 56 times 2010’s projected $2.55 profit per share seems unrealistic and overpriced! Another anecdotal observation from the past is that we’ve seen recent discussion over the stock possibly participating in a stock split. The last stock split event occurred in September 1999, three months prior to the stock reaching its all time high back then. Its subsequent plummet to the lows made towards the end of 2001. Will history repeat itself in this case? Who knows, but the irrational euphoria surrounding investor expectations and the bidding up of the stock’s price beyond any reasonable fundamental valuation of the stock has us convinced that Amazon is poised to disappoint current shareholders.

Wall Street estimates assume that Amazon will maintain its annual 25% growth year over year, meaning that Amazon will increase current revenues of around $19 billion (2008) to approximately $180 billion in the next ten years-a near impossible feat especially as the company gets larger and larger in market capitalization. Not to mention that over the next ten years, Amazon will no doubt face huge competition from Apple, Inc., Google, EBAY, Inc. to name a few. According to our calculation AMZN would be attractive around $55, but certainly not in the $140’s! Remember, even a great business at a high price is a poor investment. If AMZN were to correct in the near term, we would expect to make approximately a 50% return by going short. If instead it trades sideways, we can utilize the proceeds from our sale to invest in more profitable ventures – much like a bank borrows at a low rate and lends it back out at higher rate. Time will tell if we are right.

Disclaimer: The specific securities identified and discussed should not be considered a recommendation to purchase or sell any particular security. Rather, this commentary is presented solely for the purpose of illustrating YCG’s investment approach. These commentaries contain our views and opinions at the time such commentaries were written and are subject to change thereafter. The securities discussed do not represent an account’s entire portfolio and in the aggregate may represent only a small percentage of an account’s portfolio holdings. These commentaries may include “forward looking statements” which may or may not be accurate in the long-term. It should not be assumed that any of the securities transactions or holdings discussed were or will prove to be profitable. Past performance is no guarantee of future results.

Posted by: Will Kruger | December 04, 2009 | Permalink

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