Valuation Amazon, Essay Example

The relative valuation for this online company has been derived using the three valuation multiple. That is, earnings per share forecast have been used as a transition value to calculate the target price. The price over earnings (P/E), price over book value (P/B) and price over sales projections (P/S) can be used effectively but since the analysis is about Amazon, an online business, the best valuation method to use is the price earnings ratio while making relevant assumption about the other variables.

From the consolidate statement of income, the earnings per share decrease steadily from $2.53 to $0.51 in the last quarter of 2013. Since this value decreases the quotient of P/E will be increasing. The P/E for Amazon seem to have outperformed the industry average for 2011, while the P/CF, P/S and P/B for the same period has been slightly  outperformed by the industry in general. So, it will be prudent to choose the target price at $69.97. This is can be because Amazon share is trading well above its book value and despite investor expectation of a rise in equity price there is a decline in growth of revenue from historical and predicted data.

Considering Amazon in listed under tech companies, the large P/E value is assumed to hold, because the major assets for the company is dictated by intellectual property and patents under their business model .However, from the historical data the sales growth declined from 39.56% in 2010 to 21.87% in 2013 which reduced the free cash flow for the same period from $1,152 to $549. But based on the future projection, the free cash flow seems to increase steadily to 2016 to a value of $6091. This may be the reason why the P/E ratio is large hence making the investors anticipates an increase in share price. The cash flow for previous years have been negative which implies amazon is planning to uptake up a project or revamp its marketing strategy thus leading to positive cash flow in 2016. This may be evident from it next generation platform and infrastructure that gives consumers unparalleled scope and value and also offers Amazon a high barrier that differentiate competition in the future.

In addition, the gearing ratio for the company is at 65.8% in 2010, compare to the industry average of 90%, which means that most tech companies have been borrowing from banks in order to do research and development for new business strategies. The profitability for Amazon as at 2010 of 27.2% is also below industry average of 55.8% which may also imply that Amazon had started on it business strategy in 2010 that lead to an acute profit margin as a result of the cost of implementing improved business model. By design, Amazon has reduced its short term profitability with the anticipation of capturing the massive market share and scale that will allow the business to bring down costs and uplift profitability in the future.

As per the financial statements, there is a distinct difference between the historical ratios and future ratios. The historical ratios are declining while the future ratio shows the business strength to be growing.  The company fair value is $170,939 based on a discounted rate of 5.9%. This rate is basically the weighted average cost of capital and a growth projection from 2011 to 2015 (time period of 5years).  The terminal value of $213,603 is higher, therefore Amazon seem to grow regardless. This fair value is arrived at by using a low leverage ratio, where debt is 10% while equity is 90%, this insinuates that Amazon is in a strong position to get creditors and investors support in any new initiative to increase investment returns

The target price of$ 69.97 per share will most definitely rise if the future projections are positive.  The company is taking risk by investing in new infrastructure which means the equity will perform well in the stock market if a sufficient return is achieved and all bank loans are paid in due time. The credit risk from fair value calculation is low, making the profits prior to the projections also to fall. The investors at this moment have anticipated the rise in share price from the presented projections, but on the other hand know that it will take time before suitable share capital gains are realized.

Hypothetically, the market will usually correct itself and if the fair value is understated or overstated the investor will settle for the premium above the target price since the dividends seem to fall.

You bought 1000 shares, at the target price of $69.97 and it rises to $90 in a few months as a result of positive projection. In order to protect this profit, you buy 60 day puts with an 80 strike price for about $2 per contract. Should your stock price fall back to $69.97, you exercise your puts and sell the shares at $80, hence making a profit of (90-80)*1000=$10,000 less any little commission which is the cost of the protective put.

The investor chooses a bull call spread; in this case he/she anticipates the share price of Amazon to go up in the near future so he eventually realizes a capital gain in the amount of equity held.  Our one year target price is $69.97. Assuming the price rises to $90 in a few months. You initiate a bull call trade since the Amazon projection assumes share price will go up.

Buy 70 strike price long calls at $6.997, hence paying 6.997*100shares=$699.7, at the same time sell 90 short call at $5 each, hence making $5*100=$500, this makes your total cost to be (699.7-500)=$199.7. Hence the maximum gain on the bull call trade, regardless, will be $(90-70)*100=$2000, hence gain=$2000-$199.7=$1800, and the most you can lose is the cost of $199.7.