Getting High At $1,000 Per Share

Amazon and Google are both in the red in today's pre-market trading, suggesting that the raging robo-machines may be taking a day off. But they probably are not quite done.

After all, Amazon did hit $993.38 per share yesterday---so its hard to imagine the robo-traders can't muster another 0.7% gain in order to tag the magic mountain of $1,000 per share.

Like the proverbial dog who finally catches the bus, however, the issue then becomes what happens next? And what does it say about the overall mania in the Wall Street casino?

At that point AMZN's market cap would sit at $478 billion. That means even after what was described by Wall Street as a "blow-out" quarter in Q1, the implied PE multiple would be an absurd 185X its LTM net income of $2.58 billion.

And for those who believe that "net income" is an antiquated concept, the story based on operating free cash flow is no less absurd. After nearly three decades of operation, AMZN still generates niggardly operating free cash flow relative to its nosebleed valuation.

In fact, at the magic $1,000 per share, AMZN would be valued at 51X its LTM operating free cash flow of $9.3 billion. That is to say, a sub-2% cash-on-cash return can be gotten on a Treasury note. Why get in harm's way by taking on Jeff Bezos' relentless empire building and megalomania?

Moreover, as we pointed out yesterday, AMZN's stock price rise since election day now stands at 26%, representing a $100 billion gain in market cap in less than six months.

Back in November, AMZN was trading at an already sporty 178X LTM net income and 44X operating free cash flow. So the question recurs as to what have been the performance improvements since then that merit a further push into fantasyland?

The short answer is comparatively none, and that includes the fact that Q1 results were no kind of "blow-out" at all. That it was greeted that way is just more evidence that's Wall Street ex-items earnings narrative has become so corrupted that literally "down" is the new "up".

For instance, Amazon's operating earnings actually fell during Q1 and the already razor thin operating margin of 3.7% that it had reported for Q1 2016 got whacked to just 2.8% during the quarter just completed.

The only basis for the blow-out earnings claim is that its tax rate dropped from an aberrantly high 45% in last year's Q1 to just 25% this year. But that's just accounting flim-flam.

On a pre-tax basis, in fact, Amazon's Q1 earnings dropped 11% from $2.24 to $1.99 per share.

Nevertheless, the Wall Street propaganda machine, which is pleased to call itself the financial press, gushed on effusively all the same:

While retailers continue to struggle and dead malls pile up in characterless suburbs across America, Amazon just keeps cashing in, as the e-commerce and media behemoth delivered first-quarter earnings that blew past expectations, sending its stock up 4 percent in after-hours trading.

Our point here is that AMZN is the last momo standing. Yet the casino is now so unhinged that the robo-machines keep driving its market cap higher and higher in the face of stunning evidence that the earnings of its $130 billion e-commerce juggernaut have vaporized entirely.

That's right. During last year's first quarter (Q1 2016). AMZN's core e-commerce business (excluding its AWS cloud service) had sales of $26.56 billion and operating income of $467 million. The resulting operating margin of 1.8% wasn't much to write home about after 25 years of scorched earth expansion in the retail sector.

But it was something---even if you might think that one of these days there would be economies of scale from conquering the better part of the entire retail world.

By contrast, during the quarter just completed Amazon's e-commerce sales were up 21% to $32.05 billion, but operating income was down a staggering 75% to just $115 million.

That computes to an operating margin of just 0.40%. And we don't mind rounding that to zero and moving on to the larger point.

Namely, even if you give the company's cloud service business (AWS) the benefit of the doubt and assume that it is an economic beanstalk that will grow to the sky, there is still n0 reason AMZN should be valued at $478 billion or be sitting atop the $1,000 per share magic mountain.

To wit, AWS's operating income of $3.4 billion during the last 12 months would amount to about $2.5 billion of net income using AMZN's latest 25% tax rate.

In turn, give the AWS cloud service segment a 40X multiple (compared to Microsoft's 31X) and a $100 billion market cap, and it still implies that AMZN's zero profit e-commerce business is worth $378 billion.

Then again, AMZN's total operating profits during the latest 12 months was $4.12 billion, but fully 83% of that was attributable to AWS. So the e-commerce business earned the grand sum of $725 million in operating profits on $130 billion of sales.

So we really do believe that its 0.6% LTM operating margin is a rounding error in the scheme of things.

More importantly, if you allocate a proportionate share of the company's $388 million of interest expense to the e-commerce segment and tax effect the result at 25%, the net income of Amazon's core business would amount to just $280 million during the LTM period ending in the alleged blow out quarter of March 2017.

Needless to say, that begs the question of why you would value any company at 1,350X net income!

But to capitalize at $378 billion the virtually profitless sales of an e-commerce monster that just keeps spending and expanding like some sci-fi blob is surely a measure of the mania at loose in the casino.

The fact is, every dime AMZN takes in is being recycled to more distribution centers, package handlers, hired delivery trucks and drone prototypes; and now, apparently, same hour delivery service by out-of-work actors and bank tellers who happen to own a Vespa and are willing to deliver meals packed by Martha Stewart---who is also out of work at K-Mart---for comparatively meager.

Needless to say, we do not think AMZN is a freakish outlier; it's actually the lens through which the entire stock market should be viewed because the whole enchilada is now in the grips of a pure mania.

Stated differently, Graham & Dodd should move over: The stock market is no longer a discounting mechanism nor even a weighing machine; it's become a pure gambling hall.

The current daily refrain on bubble vision that the impending doom of the Donald doesn't matter because earnings are off to the races on their own hind legs is surely evidence of that proposition. To wit, the ballyhooed "first quarter of double-digit profit growth in years" was nothing more than the Pig finally exiting the Python, not a sign of some permanent earnings breakout.

You do not need a high paid Goldman Sachs equity strategist to discover that. Just look at the published earnings reports from Howard Silverblatt at S&P Dow Jones.

They show that so-called S&P 500 "operating profits" for the June 2014 quarter were $29.34 per share---about as close as you please to being the identical twin of the $29.04 per share now posted for Q1 2017 with upwards of 96% of companies reporting

In fact, on an LTM basis there was a slight slippage---with Q1 2017 coming in at $111.33 per share compared to $111.83 per share in June 2014. This, too, might be considered close enough to zero for government work.

So the fact that Q1 earnings are up 21% on a year/year basis is a backward looking measure of the hit to profits that resulted from the post-2014 petroleum and commodity deflation, not a signal of a permanent growth breakout. Not with all these headwinds in the path ahead.

Indeed, the chart below is so crystal clear on this rebound vs. breakout point that you can literally see the pig slithering through the statistical python.

 

Next week we intend to examine the gale force domestic and global macroeconomic headwinds to corporate earnings growth---including the tottering Red Ponzi of China, which was downgraded by Moody's this week for the first time since 1989.  These headwinds make a mockery of Wall Street's current hockey stick projection of $146 per share of S&P 500 earnings by Q4 2018.

In the meanwhile, however, it is worth noting that with Howard Silverblatt's reckoning of first quarter results virtually complete, actual GAAP earnings on an LTM basis came in at $100.40 per share. That means at yesterday's close, the casino was valued at 24.1X.

It also means that GAAP net income per share---the kind that CEOs and CFOs must certify every quarter on penalty of jail time---was no higher than it was way back in Q4 2013, when it posted at $100.20 per share. That is, on a trend basis there has been no growth in S&P 500 profits for the last 39 months!

So by all means, let the boys and girls and machines on Wall Street get high at $1,000 per share if they must.

But then again, there is absolutely no reason for normal people to hang around the casino in harm's way. Recall that S&P 500 profits peaked at $85 per share prior to the financial crisis back in June 2007, meaning that the 10-year compound growth rate of earnings has been just 1.67% per annum.

And that doesn't even include the next recession, which is becoming more overdue and more likely by the day.

So unlike the clueless operators at CBO and the Trump White House, who are implicitly betting that the business cycle has been permanently abolished (or at least for 207 months), now would not be a good time to pay one of the highest PE multiples in history on earnings that reflect the lowest growth rate ever.

And that's especially the case because the day of reckoning after three decades of Bubble Finance is just around the corner.

David Stockman's Contra Corner is the only place where mainstream delusions and cant about the Warfare State, the Bailout State, Bubble Finance and Beltway Banditry are ripped, refuted and rebuked. Subscribe now to receive David Stockman’s latest posts by email each day as well as his model portfolio, Lee Adler’s Daily Data Dive and David’s personally curated insights and analysis from leading contrarian thinkers.

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