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Rumble in the Amazon Jungle

By Jim Pearce on April 6, 2018

Last week I used Facebook (NasdaqGS: FB) to illustrate the notion of “headline risk” after the company lost $100 billion in market value in less than a month when it admitted to a major security breach. Little did I know that if I had only waited a week I could have used Amazon.com (NasdaqGS: AMZN) as a better example; its market capitalization dropped nearly $40 billion in a single day after President Trump singled it out for unfair treatment from the U.S. Postal Service.

Reportedly, some of Trump’s business associates complained to him that their companies were suffering because of Amazon’s ability to ship products quickly and cheaply through the U.S. mail, which they believe is subsidized by taxpayers and therefore an unfair business advantage to Amazon. On Saturday, March 31 Trump tweeted, “it is reported that the U.S. Post Office will lose $1.50 on average for each package it delivers for Amazon. That amounts to Billions of Dollars.” He went on to say, “This Post Office scam must stop. Amazon must pay real costs (and taxes) now!”

I have long felt that Amazon was grossly overvalued, but I cannot honestly say that I thought this is what would send its share price downward. I figured investors would eventually wise up to the fact that Amazon is a marginally profitable company that is only one disruptive event away from quickly becoming a hugely unprofitable business.

Amazon is (was?) the second most valuable publicly traded company in the world, yet its debt to equity ratio of 160 could quickly become a problem if the equity half of the equation took a major hit since the debt side isn’t going away anytime soon. It is premature to start worrying about Amazon’s solvency, but it is not too soon to begin thinking about how Jeff Bezos intends to respond to Trump’s attack if his company’s share price keeps falling.

Perhaps the best response by Bezos would be to say nothing at all and let Trump’s attention wander to something else. Regardless of whether or not Amazon is receiving favorable treatment from the postal service, it would take an act of Congress to do something about it, which is unlikely. In the meantime, perhaps Bezos should use some of the massive cash hoard he is sitting on to buy back stock, something that his board authorized years ago but has never done.

As for me, a month ago I bought a long-term “LEAP” put option on Amazon with a strike price of $1,200 that expires in January of 2020. I already have a 20% gain in this position, but I am going to hold onto it regardless of what happens with Amazon this month. Near the end of last year, I predicted that Amazon would trade below $900 this year. I may end up being wrong about that, but if I am correct (by the end of next year) then I stand to make a 300% gain on my put option.

I don’t wish ill will on Amazon or any other business, but as an investor I have to make rational decisions based on what I see happening in the market. At the moment, I see many companies that are “priced for perfection”, only one bad quarterly report or Trump tweet away from a quick dive down the charts. I also see a few stocks that appear undervalued and may become the unwitting beneficiaries of a correction that shifts money from momentum to value stocks.

Of course, you may see things very differently from me, and you may have an entirely different approach to managing your portfolio even if we saw things the same way. That is the beauty of the stock market; it allows investors of all types to execute buy and sell orders with one another regardless of their reasons why.

Warren Buffett’s oft-stated admiration for Jeff Bezos notwithstanding, I believe in Amazon we have the ultimate example of an overvalued momentum stock that is destined for mediocrity. Amazon is not going to fail, but it’s not worth owning at 90 times next year’s profits, either. Somewhere in between is the appropriate value, and perhaps the stock market just took the first step in that direction.

Therein lays the opportunity for profit; as Buffett’s famous mentor Benjamin Graham once wrote, “In the short run, the market is a voting machine but in the long run, it is a weighing machine.”

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