Don’t Write Off Online Retailers Yet

10/09/2007 12:00 am EST

Focus:

Bernie Schaeffer

Chairman and CEO, Schaeffer's Investment Research

Bernie Schaeffer, chairman and chief investment officer of Schaeffer’s Investment Research, says media skepticism about high flyers Amazon and eBay is unfounded.

An October 1st article in The Wall Street Journal—“Why eBay, Amazon Shares Are Up” (subscription required)—notes that analysts are using new metrics to measure whether or not online merchants eBay (NASDAQ: EBAY) and Amazon.com (NASDAQ: AMZN) are performing well, now that they no longer qualify as "growth companies."

Rather than counting total auction listings and the number of new users, pundits are now honing in on revenue generated per Internet user, overall revenue growth, and operating margins— metrics that are more commonly used to appraise traditional brick-and-mortar retailers.

The author suggests that this shift in analysis is being embraced because, "as eBay and Amazon mature, both companies look increasingly weak measured by established Web measures." Now that both firms are established brand names with broad customer bases, it makes more sense to judge them by the same yardstick used to size up retailers like the Gap.

"Wall Street's change explains in part why eBay and Amazon's shares have risen this year," asserts the author, [Mylene Mangalindan].

This article represents something of a shift for Amazon's media coverage: previous articles harped on valuation concerns, and seemed to suggest the stock's rally was unsustainable and a pullback was imminent. Here, the author begrudgingly admits that Wall Street's changing analysis "helps some analysts and investors justify eBay and Amazon's expensive valuations," as if to explain away the stock's continuing gains.

It's natural to be concerned about valuation, with the shares trading near all-time highs, but Amazon seems to have the fundamental and technical strength to climb higher. The article itself states that "Amazon's free cash flow—which is operating cash flow minus capital expenditures and which acts as a proxy for operating profit—rose 87% in the second quarter from a year earlier." Not bad, considering Amazon is no longer considered a growth company.

Plus, the stock's recent rally is underlined by support from its daily, weekly, and monthly 10-unit moving averages.

However, this tepid WSJ article is just about as bullish as the Street is willing to get on this strong performer so far. AMZN carries a healthy short-interest ratio of 5.5 days to cover, as the bears pushed its short interest 6.5% higher during the latest reporting period. What's more, option traders have shown a distinct preference for puts, as the stock's Schaeffer's put/call open interest ratio rests at 1.27. Finally, analysts have awarded the shares ten “holds” and two “sells,” compared with just seven "buy" or better ratings.

Amazon may be riding high on the charts, but the wealth of pessimism we're witnessing from investors and analysts suggests the stock is hardly oversold. (The stock closed just below $96 Monday, within shouting distance of its 1999 all-time high—Editor.)

Subscribe to Option Advisor here…

Related Articles on