Why Netflix Plunge Is a Problem for Amazon (AMZN)

Investors may be souring on glamour stocks in general, writes Jack Hough.

In early September this column argued that Netflix (NFLX) stock, which had gotten one-quarter cheaper since summer, was no bargain (see "Is Netflix Cheap Enough" ). It was $218 then. It's $80 or so now.

When glamour stocks begin losing fans, things can turn ugly -- and fast.
That raises the pressure on Amazon.com (AMZN), which reports third-quarter results Tuesday after the market close. Before its tumble, Netflix at 46 times earnings was three times as expensive as the average U.S. stock. Amazon sells for 121 times earnings.
Netflix tumbled on some operational missteps that led to a sudden drop in subscribers and forecasts for financial losses in coming quarters. For Amazon, meanwhile, expansion remains breathless. Wall Street expects it to report 43% sales growth from a year ago. (It might even have lured some of those departing Netflix customers to its own video rental service.)
Investors will also learn about pre-orders for the Kindle Fire, Amazon's touch-screen tablet computer, which sells for 60% less than Apple's (AAPL) cheapest iPad. Some analyst forecast that Amazon has received a million orders for the device.
The key risk facing Amazon, however, is that investors will become less enamored with growth stocks in general. That could lead them to nitpick results, question valuations and swiftly punish any perceived shortfall. If Apple can lose 5% of its stock market value in a day after reporting 54% earnings growth but missing analyst forecasts for the first time in 30 quarters, as it did last week, then no growth company is safe from scrutiny. And Apple wasn't particularly expensive.
Glamour stocks have been due for a correction. As I noted in September, the valuation gap between the U.S. stock market's cheapest slice and its most expensive slice has rarely been wider. (See "Decoding the Stock Market's Mixed Signals") That has historically been a good time to buy cheap shares, according to research by Brandes Investment Partners, a San Diego money manager. And it has been a poor time to favor expensive shares.

Only one of 34 analysts who cover Amazon stock recommends investors sell it. But the company isn't flawless. Its earnings are declining on infrastructure investments, and its generous shipping terms and other promotions have left margins thin. Dan Geiman of McAdams Wright Ragen, an investment bank, reckons Amazon turned just a penny and a half of each sales dollar into operating profits in its third quarter, down from three and a half cents a year earlier.
That suggests Amazon is only one-third as profitable as Wal-Mart (WMT). It also leaves little room for something to go wrong. For example, state and local governments are desperate for revenue at the moment. Internet sales must seem a tempting source. In some markets, Amazon is able to charge lower taxes than local merchants because of its lack of a physical presence. If that advantage is reduced by tax law changes, Amazon's sales could slip.
Amazon isn't the only stock that's looks worrisomely expensive, of course. Salesforce.com (CRM), which sells online customer contact software for companies, fetches 100 times earnings. It's expected to increase sales by 35% this year and 25% next year, but there are two problems. First, Google (GOOG) is growing about as fast, and it's one-sixth as expensive. Second, software giant Oracle (ORCL) has been snapping up companies that specialize in online customer contact software, suggesting it's going to take on Salesforce.com directly. Salesforce.com reports results in mid-November.
Amazon and Salesforce.com have defied skeptics for years and could exceed expectations in coming quarters. But if investors are turning less keen on the priciest segment of the stock market, valuations for these stocks could nonetheless contract. That makes now a good time to take profits.