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Reasons not to Own Amazon (AMZN) Stock…Yet

We all know about Amazon.com, Inc. (NASDAQ:AMZN), which now sports a massive $472 billion market cap. AMZN stock is “only” up 26% over the past 12 months. The rally seems somewhat reasonable, considering the S&P 500 ETF (NYSEARCA:SPY) is up 17% in the same time frame.

Amazon AMZN stock
Amazon AMZN stock

Source: C_osett via Flickr

Taken at face value, one might think, “Based on that rally, Amazon is probably going to take off.” But face value isn’t always accurate. Consider that AMZN stock is up more than 80% over the past two years and suddenly the one-year move seems less mellow. In any regard, it’s got investors scratching their heads on what to do next.

Sizing up AMZN Stock

Forget trying to nail Amazon. We didn’t need to see founder and CEO Jeff Bezos’ vision 25 years ago to get rich in AMZN stock. Up almost 300% in five years and over 1,000% in ten, we could have seen this coming sooner. For those that haven’t been long Amazon, there’s no rush to get in now. We’ve missed the so-called “easy money” and it will be harder for AMZN to post 300% gains from here then just five years ago.

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That’s not to say that Amazon won’t rally 300% at some point. That would make it a $1.3 trillion company. While the trillion-dollar mark seems crazy, consider that Apple, Inc. (NASDAQ:AAPL) is close, at over $800 billion.

Probably the biggest critique investors had of Amazon over the past five to ten years has been valuation. Trading at more than 245 times trailing earnings, 120 times forward earnings estimates and three times sales, one could make the same overvalued argument for AMZN stock now. However, we’ve seen what the company is capable of doing.

Its strides in cloud-computing, e-commerce dominance, entertainment and I-want-it-now shipping, Amazon’s dominance is clear. It’s clear that the future of commerce is online and the leader of that online revolution is Amazon. It only makes sense to be involved.

The Impact of Whole Foods

Amazon recently acquired Whole Foods Markets, Inc. (NASDAQ:WFM) for $13.7 billion. The impact of this is still relatively unknown. Obviously WFM will add directly to AMZN’s top line. Although the organic grocer has struggled from a comparable-store sales perspective, it has remained consistently profitable, earning about $540 million per year over the past four years.

Could that profit fall to Amazon’s bottom line? Possibly. AMZN uses its cloud business to not only drive the top line, but provide a bulk of its profits to the bottom line so Amazon can continue to grow its e-commerce and entertainment businesses. Whole Foods could act in a similar manner, driving bottom line earnings, while allowing management to focus on commerce expansion.

Amazon’s immediate discounting upon taken control of WFM may dent the latter’s profitability, but it may help with Prime. Morgan Stanley’ Brian Nowak says WFM could add about 2.5 million Amazon Prime subscribers. At $100 a pop, the $250 million annual subscription cash flow is nice, but not exactly what will recoup the $13.7 billion cash outlay for the whole company. But recouping the cost isn’t the goal with Prime, signing up new members is.

One report in April estimated more than 80 million Prime subscribers in the U.S. a rather eye-popping figure given the size of the U.S. population. This would represent nearly 1-in-4 people being a Prime member, but even that’s an inaccurate way to measure it. Amazon’s penetration is likely much deeper, given that one household wouldn’t need more than one membership.

Surely Whole Food members will see the in-store benefits of being a Prime member. But the real goldmine is realized by Amazon adding more customers to its Prime ecosystem. While Nowak says Whole Foods could drive Prime members to Amazon, there could be risks too. Operating a grocer is a low-margin, tough business.

The Bottom Line on Amazon

AMZN stock chart
AMZN stock chart

 Click to Enlarge

Even without a Whole Foods-induced pullback, investors could still get AMZN stock at a discount. A broad-market pullback could give us the chance we need. Over a five-week stretch in 2015, AMZN stock went from almost $700 to less than $500 on a market-wide pullback. That’s a 30% fall in a little more than a month. For reference, that would drive shares down to $700 from current levels.

However, I wouldn’t look for that kind of a drop. A 10% to 15% fall would be highly welcomed. Should it happen, AMZN stock should be bought. Amazon is positioned correctly in the cloud, e-commerce and possibly even bricks-and-mortar operations. It will continue to do well for decades to come.

Bret Kenwell is the manager and author of Future Blue Chips and is on Twitter @BretKenwell. As of this writing, Bret Kenwell did not hold a position in any of the aforementioned securities.

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