Amazon is Over on Taxes

Crista Huff
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Posted: Oct 26, 2011 12:01 AM

Amazon.com, Inc. (AMZN, $227.15), the giant online retailer, is about to experience a profit problem which analysts have largely not taken into account in their forward earnings estimates.  Coupled with price slashing which will affect gross margins, this double-whammy on earnings could be the event which stops the stock price dead in its tracks.

Amazon is planning to sell its new e-reader, the Kindle Fire tablet, at a loss, and at less than half the price of Apple’s I-Pad, in order to generate profitable sales of  music, books, movies and merchandise. It’s a gamble which will immediately affect profit, and lower earnings per share (EPS).

But the second earnings problem hasn’t even been figured into Wall Street estimates.  Under a new California law, Amazon will be required to charge customers state sales tax on internet transaction, beginning Sept. 2012. “If the online retailer has to increase prices to account for state taxes, it may lower 2012 profit by 19 percent, Rice said. A 5 percent price increase from taxes could spur a decrease in profit to $3.30 a share next year from his estimated $4.08, he said. Most analysts’ estimates don’t account for the effect of collecting levies.” – Amazon Profit May Fall by Half as New Kindle Squeezes MarginsBloomberg.com, Oct. 24, 2011.

Amazon.com Stock Chart

Amazon.com Stock Chart by YCharts

Amazon’s stock price has been going up for the last ten years, largely uninterrupted by market problems and pullbacks.  After the stock recovered from the recent August stock market correction, it began reaching new highs again, trading between $210 and $245.  I think the stock is likely to fall back to $210 immediately, and if it retraces the summer lows of $180, I’d say “goodbye” to any continued price increases through 2012.

Consensus earnings per share (EPS), which have not been adjusted for the sales tax problem, are projected to drop to $1.92 for FY2011, and then reach $3.18 in 2012.  That gives the stock a current price/earnings ratio (PE) of 124, and a forward PE of 71.  Compare that with Apple’s (AAPL, $405.77) 2012 PE of 11.8 and Microsoft’s (MSFT, $27.19) 2012 PE of 9.7, and you’ve got to ask yourself, “Do I feel lucky?”  Because there’s no rational basis in Amazon’s incredible stock price growth, and like tulip-mania in Holland, beanie babies as a collector’s item, and 2008 American real estate prices, this lucky streak will end, and it will be ugly.

If I owned Amazon, I would take the money and run