Amazon’s Growth Warrants an Upgrade

Analysts at Merrill Lynch/Bank of America (NYSE:BAC) gave a boost to Amazon.com (NASDAQ:AMZN) by issuing an upgrade to Buy from Neutral. Also, the analysts raised the price target for Amazon by $8 to $103, which would represent a 24% appreciation from Tuesday’s closing price. In early morning trading AMZN is trading higher by about 4.5% thanks in large part to this upgrade.

The upgrade is due to an improving outlook for the eCommerce sector, which Merrill Lynch/BAC believes will return to double digit year over year growth in 2010. Horrendous 4Q 2008 sales should enable the eCommerce sector to deliver 11% growth in this year’s fourth quarter. Amazon.com will take full advantage of this growth trend based on customer loyalty, distribution infrastructure, and technology investments. Furthermore, the analysts points to seasonality as AMZN has outperformed the market from Sept 15th through Nov. 30th for the previous four years. Concerns over competitive pressures on everything from the Kindle eReader to cloud computing have been overblown, according to this analyst.

This seems to be a very reasonable case for a stock that could take advantage of the continuing improvement in the economy. As far as valuation, the analysts reasoning gets a little weaker. The analyst points to potential valuation upside because the stock moved towards the higher end of historical price-to-sales ranges when it was beating estimates in 2007. While, that may be true, AMZN has beaten estimates for the last few quarters as well. He states that the historical range of price-to-sales for AMZN has been .8x to 2.0x, and according to our data the stock is currently splitting the middle at 1.4x.

At Ockham, our valuation methodology downgraded Amazon.com as of this weeks report to Fairly Valued from Undervalued. We agree with the BofA analyst that growth of AMZN is appealing, but that has been priced in at this point. The stock sells for a huge premium of the broad market, with a P/E of greater than 50 when looking at full year 2009 earnings estimates.

The valuation aspect of Amazon.com not attractive, even as the company continues to be extremely strong fundamentally speaking. This upgrade is much more based on momentum and AMZN’s competitive advantage. While the future may be bright for Amazon.com, value investors must be sure that they are getting an attractive price, and in this case we have our doubts. If there were to be a pull back of any significance, we may become interested in AMZN.

Amazon.com’s Growth Warrants an Upgrade

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Ockham Research is an independent equity research provider based in Atlanta, Georgia. Security analysis at Ockham Research is based upon the principle known as Ockham's Razor, named for the 14th- century Franciscan friar, William of Ockham. The principle states that a useful theory should utilize as few elements as possible, because efficiency is valuable. In this spirit, our goal is to make the investing environment as simple and understandable as possible, yet no simpler than is necessary.

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