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Does Amazon's Triple Digit Stock Price Make It Truly Expensive?
Read MoreHide Full Article
Spoiler Alert: The answer is Yes and No.
In the not-so-distant past, U.S. companies who’s share prices were growing would regularly “split” their shares to bring the price lower and more affordable for individual investors. In reality, the value of a company that votes to split the shares remains exactly the same – there are simply twice as many shares at half the price – the market capitalization remains unchanged.
Investors have generally cheered stock splits in shares they owned, taking it as a sign of strength (the shares must have upward momentum for a split to occur) and a bullish outlook for the future – there was a well-founded perception that companies that had split would continue to rally.
There’s also a psychological concept at play. Investors now owned more shares. It’s certainly encouraging to look at a brokerage statement as 100 shares turns into 200, then 200 turns into 400 and so forth. Because splits generally occurred only when the shares were rising in value, investors came to associate splits with strong price performance.
There was also a practical reason to split. Until the early 1970’s, stock trades happened in-person between parties on the floor of an exchange and trading in odd numbers of shares complicated the process. Professionals preferred to deal in “round lots” of 100 shares – or multiples of 100 shares – for expediency. The advent of the Nasdaq didn’t change this much, because although quotes were displayed electronically, the process was still heavily dependent on human input from traders and back-office personnel and round-lots were still the norm.
The past 20 years or so have brought an explosion in the number of venues on which shares could be traded and virtually all stock trades are now executed and cleared electronically. There’s no longer any compelling reason why trading 32 shares or 1,361 shares is any less convenient than trading in multiples of 100.
The Beginning of the End for Splits
Not surprisingly, the first stock to rise to 4-digit and then 5-digit share prices without splitting was Warren Buffet’s Berkshire Hathaway (BRK.A). Buffet, ever the pragmatist, correctly believes that a stock split is an artificial convention that has no actual effect on the true value of the holding. Buffet also encourages investors to think long-term (really long-term, actually) and undertaking a change that allows investors to trade into and out of the stock more frequently runs counter to his buy-and-hold Value approach.
(Note: Even Berkshire eventually introduced a B-class share with a lower price that is functionally identical to the more expensive A-shares, but allows smaller investors a less expensive ownership option. This was also done in part to compensate small investors in Burlington Northern Railroad after a stock buyout.)
Price Weighted Indexes
One final consideration about stock splits - for a small number of companies who are large enough - is for inclusion in the Dow Jones Industrial Average Index which is price weighted. The S&P 500, Nasdaq 100 and Russell 2000 indexes are all capitalization weighted, so the relative weights of stocks in the index and their daily contribution to the index price calculation are all based on market cap and independent of the number of shares outstanding.
The Dow however is calculated using the actual price of shares, so a $200 stock that moves 1% will have double the impact on the index price as a $100 stock with twice as many shares outstanding that makes the same percentage move, even though the change in market cap is identical. Companies aiming at being included in the Dow will sometimes split their shares to achieve a lower stock price that will not immediately have an outsized effect in index price moves. Apple (AAPL - Free Report) performed a 7-for-1 split in 2014 primarily for this purpose.
Amazon Valuation Metrics
At its current share price of $1,624 Amazon (AMZN - Free Report) is the fifth highest priced stock in the U.S. and its market cap of $783B makes it the second most valuable company overall – behind only Apple.
If the high stock price is not an indication of a truly high price, what does a more traditional valuation method tell us about Amazon’s stock price?
At $1624, Amazon is trading at a 12-month forward P/E ratio of 133X. This is still much higher than similar companies like Chinese e-retailer Alibaba (BABA - Free Report) at 37X, the Retail Sector as a whole at 25X and Ebay (EBAY - Free Report) at 20X. With accelerating analyst estimates for 2018 earnings, Amazon is a Zacks Rank #1 (Strong Buy).
So obviously investors are willing to pay a sizeable premium for Amazon over its competitors, presumably because of expectations for continued growth. Throughout its history, Amazon has relentlessly expanded its offerings of goods and services, often at the expense of current earnings. The strategy has worked extremely well so far (with a few notable misses – do you know anyone who uses an “Amazon Phone”?). Amazon sales represented 44% of e-commerce sales in 2017. No other large business owns that type of market share, not even Samsung or Apple in smartphones with 23% and 16%, respectively.
Because Amazon spends so heavily to continue expanding, Price to Sales is a somewhat more valuable measure to compare it to its peers, and here things start to look a little more standard. With $178B in revenues in 2017, Amazon has a Price/Sales ratio of 4.1X, lower than Alibaba at 14X, and similar to Ebay at 3.9X, but still considerably higher than the retail sector as a whole at 1.1X.
The gap in valuation shrinks, but still shows extremely high expectations for future growth.
Conclusion
Yes, Amazon is a very expensive stock based on both share price and P/E ratio and still a fairly expensive stock on Price to Sales, all based on expectations for future growth. It’s often said that a stock is “priced for perfection”, though that’s not really the case for Amazon, as buyers seem willing to overlook periodic results in favor of focusing on long-term growth potential. (Note the chart above to see that Amazon stock has marched steadily upward through earnings beats and misses.) It would be more accurate to say that Amazon is “priced for trajectory” and as the second most valuable company in history, it shows no signs of slowing down now.
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Does Amazon's Triple Digit Stock Price Make It Truly Expensive?
Spoiler Alert: The answer is Yes and No.
In the not-so-distant past, U.S. companies who’s share prices were growing would regularly “split” their shares to bring the price lower and more affordable for individual investors. In reality, the value of a company that votes to split the shares remains exactly the same – there are simply twice as many shares at half the price – the market capitalization remains unchanged.
Investors have generally cheered stock splits in shares they owned, taking it as a sign of strength (the shares must have upward momentum for a split to occur) and a bullish outlook for the future – there was a well-founded perception that companies that had split would continue to rally.
There’s also a psychological concept at play. Investors now owned more shares. It’s certainly encouraging to look at a brokerage statement as 100 shares turns into 200, then 200 turns into 400 and so forth. Because splits generally occurred only when the shares were rising in value, investors came to associate splits with strong price performance.
There was also a practical reason to split. Until the early 1970’s, stock trades happened in-person between parties on the floor of an exchange and trading in odd numbers of shares complicated the process. Professionals preferred to deal in “round lots” of 100 shares – or multiples of 100 shares – for expediency. The advent of the Nasdaq didn’t change this much, because although quotes were displayed electronically, the process was still heavily dependent on human input from traders and back-office personnel and round-lots were still the norm.
The past 20 years or so have brought an explosion in the number of venues on which shares could be traded and virtually all stock trades are now executed and cleared electronically. There’s no longer any compelling reason why trading 32 shares or 1,361 shares is any less convenient than trading in multiples of 100.
The Beginning of the End for Splits
Not surprisingly, the first stock to rise to 4-digit and then 5-digit share prices without splitting was Warren Buffet’s Berkshire Hathaway (BRK.A). Buffet, ever the pragmatist, correctly believes that a stock split is an artificial convention that has no actual effect on the true value of the holding. Buffet also encourages investors to think long-term (really long-term, actually) and undertaking a change that allows investors to trade into and out of the stock more frequently runs counter to his buy-and-hold Value approach.
(Note: Even Berkshire eventually introduced a B-class share with a lower price that is functionally identical to the more expensive A-shares, but allows smaller investors a less expensive ownership option. This was also done in part to compensate small investors in Burlington Northern Railroad after a stock buyout.)
Price Weighted Indexes
One final consideration about stock splits - for a small number of companies who are large enough - is for inclusion in the Dow Jones Industrial Average Index which is price weighted. The S&P 500, Nasdaq 100 and Russell 2000 indexes are all capitalization weighted, so the relative weights of stocks in the index and their daily contribution to the index price calculation are all based on market cap and independent of the number of shares outstanding.
The Dow however is calculated using the actual price of shares, so a $200 stock that moves 1% will have double the impact on the index price as a $100 stock with twice as many shares outstanding that makes the same percentage move, even though the change in market cap is identical. Companies aiming at being included in the Dow will sometimes split their shares to achieve a lower stock price that will not immediately have an outsized effect in index price moves. Apple (AAPL - Free Report) performed a 7-for-1 split in 2014 primarily for this purpose.
Amazon Valuation Metrics
At its current share price of $1,624 Amazon (AMZN - Free Report) is the fifth highest priced stock in the U.S. and its market cap of $783B makes it the second most valuable company overall – behind only Apple.
If the high stock price is not an indication of a truly high price, what does a more traditional valuation method tell us about Amazon’s stock price?
At $1624, Amazon is trading at a 12-month forward P/E ratio of 133X. This is still much higher than similar companies like Chinese e-retailer Alibaba (BABA - Free Report) at 37X, the Retail Sector as a whole at 25X and Ebay (EBAY - Free Report) at 20X.
With accelerating analyst estimates for 2018 earnings, Amazon is a Zacks Rank #1 (Strong Buy).
So obviously investors are willing to pay a sizeable premium for Amazon over its competitors, presumably because of expectations for continued growth. Throughout its history, Amazon has relentlessly expanded its offerings of goods and services, often at the expense of current earnings. The strategy has worked extremely well so far (with a few notable misses – do you know anyone who uses an “Amazon Phone”?). Amazon sales represented 44% of e-commerce sales in 2017. No other large business owns that type of market share, not even Samsung or Apple in smartphones with 23% and 16%, respectively.
Because Amazon spends so heavily to continue expanding, Price to Sales is a somewhat more valuable measure to compare it to its peers, and here things start to look a little more standard. With $178B in revenues in 2017, Amazon has a Price/Sales ratio of 4.1X, lower than Alibaba at 14X, and similar to Ebay at 3.9X, but still considerably higher than the retail sector as a whole at 1.1X.
The gap in valuation shrinks, but still shows extremely high expectations for future growth.
Conclusion
Yes, Amazon is a very expensive stock based on both share price and P/E ratio and still a fairly expensive stock on Price to Sales, all based on expectations for future growth. It’s often said that a stock is “priced for perfection”, though that’s not really the case for Amazon, as buyers seem willing to overlook periodic results in favor of focusing on long-term growth potential. (Note the chart above to see that Amazon stock has marched steadily upward through earnings beats and misses.) It would be more accurate to say that Amazon is “priced for trajectory” and as the second most valuable company in history, it shows no signs of slowing down now.
Today's Stocks from Zacks' Hottest Strategies It's hard to believe, even for us at Zacks. But while the market gained +21.9% in 2017, our top stock-picking screens have returned +115.0%, +109.3%, +104.9%, +98.6%, and +67.1%. And this outperformance has not just been a recent phenomenon. Over the years it has been remarkably consistent. From 2000 - 2017, the composite yearly average gain for these strategies has beaten the market more than 19X over. Maybe even more remarkable is the fact that we're willing to share their latest stocks with you without cost or obligation. See Them Free>>