E-Tailers: 'Tis the Season to Be Wary


By Robert D. Hof Throughout the fall, investors have snapped up stocks of electronic-commerce companies with a fervor reminiscent of the late '90s. Buoyed by signs of a green Christmas for electronic-retailers, shares in eBay (EBAY), Amazon (AMZN), and Yahoo (YHOO) are soaring. On Nov. 25, Amazon's stock hit a two-year high of $24.25, up 43% since the start of October and a 102% gain for the year. Yahoo!, a growing force in online shopping, has shot up 73% since early October, to about $17, while eBay has jumped 30%, to some $69, in the same period. Are these investors nuts?

Pretty much. And they should know better by now. Last year, e-commerce stocks also rose in anticipation of the seasonal burst of business only to tumble once the holidays ended. Shares of eBay jumped from around $44 in late September to $70 in early December, for example, then fell below $50 by the first week of February. Yahoo and Amazon both had similar, though smaller, holiday gains, followed by a slide.

And as the glow of holiday eggnog wears off early next year, many investors are likely to be holding lumps of coal once again. "There's no justification for the run-up," says money manager Peter Doyle, who runs the Kinetics Internet Fund (KINAX). "I think people are going to get their heads handed to them on these stocks."

NO HO-HO-HO. Indeed, a little of the air has already come out of the stocks; Amazon is now down to $22. And even if e-commerce companies delivered perfectly on their ambitious goals, it's hard to see how the current prices make sense. Amazon, for instance, sports a price-earnings (p-e) ratio of 90 based on 2003 operating profits, which exclude options charges and other expenses. Yahoo's 2003 p-e is 63, and eBay's is 58. Those all dwarf the p-e of 26 shared by No. 1 retailer Wal-Mart Stores (WMT) and tech bellwether Microsoft (MSFT).

The stocks look all the more pricey given that even large e-tailers' sales remain just a small fraction of their land-based rivals'. Amazon's market cap of $8.4 billion is 95% higher than the combined valuations of Barnes & Noble (BKS), Borders (BGP), and Circuit City (CC).

Yet the trio's combined sales this year are expected to nearly quadruple Amazon's $3.9 billion. And their collective earnings, at an estimated $279 million, easily surpass Amazon's profit, which will hit about $51 million this year, according to Legg Mason Wood Walker Inc. The upshot is that even analysts with buys on the stocks figure there's little room for an upswing.

FOLLOW THE LEADER. So what explains the recent rise? For one, a classic mistake: Individual investors often throw money at sectors that are already popular. And after the e-tail shakeout, those investment dollars are focused tightly on the few remaining big names. For now, the pros, such as mutual funds, are buying, too, perhaps because there are few other attractive places to invest. But many are likely to sell in order to take profits after the holidays, leaving other investors in the lurch.

To be fair, there's some method to this madness. In a dicey retail season, online sales to date are up 29% over last year, according to market researcher comScore Media Metrix. And unlike the frothy days of 1999 and early 2000, e-tailers are logging solid results. In the third quarter, Amazon, eBay, and Yahoo all beat expectations. Says analyst Shawn Milne of Soundview Technology Group, who has buys on Amazon and eBay: "People want to find opportunities for long-term growth, and those are hard to find in this environment."

Moreover, these companies probably merit some valuation premium. Their growth rates are generally higher than those of traditional companies, and they don't require as much capital to grow as brick-and-mortar chains. E-tailers deserve credit for surviving, and for providing a little holiday cheer. But at these prices, they don't deserve more money from investors, who are likely to get better returns buying milk and cookies for Santa. Robert D. Hof is BusinessWeek's Silicon Valley bureau chief


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