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Amazon Multiple Will Compress, but How?

NEW YORK ( TheStreet) -- It was really inevitable. As hot sectors mature, the multiple folks are willing to pay for earnings has to decline, toward that of the market as a whole.

So this month, all the big cloud-related stocks have fallen faster than the market. Rackspace (RAX), Red Hat (RHT) and VMWare (VMW) are all down over 10% this month, a move that has accelerated as the month has gone on.

One result is that their price-to-earnings multiples are almost getting affordable. VMWare is down to 55, still rich but more in line with the 21.74 of EMC, which owns 80% of it.

Only one major cloud player hasn't played this game. Amazon.com (AMZN - Get Report) is down only 5% for the month.

But that has to change, especially with news that both Google (GOOG) and Microsoft (MSFT - Get Report) will target Amazon with new cloud offerings -- and that both are willing to compete on price.

Why does that matter? Because Amazon Web Services has become the de-facto public cloud standard, its Application Program Interface essential to deployments. AWS is why Amazon sells at a cloud multiple, not its retailing operation. Also, investors know that Amazon has been willing to forego short-term profits in order to maintain its high market share.

It's one thing to play price games with Rackspace, a much smaller competitor. It's something else to try and do it with Google and Microsoft.

Of course when I wrote about this issue in March, Amazon was sporting a price-to-earnings ratio of 134. Even with its latest drop in price that's now at 176, thanks to its most recent earnings.

Rather than look at net income, Amazon bulls are looking at gross profit, and how that compares with revenue. In its March quarter, Google Finance reports Amazon brought 23.9% of revenues to the gross profit line, although its actual net was just $130 million. In the previous quarter it brought 20.6% of revenues to gross profit.

To compete with Google and Microsoft Amazon will be pressed on gross profit this quarter, too, and for some time to come, especially if it wants to grow the top line. Not to mention WalMart (WMT), which also managed to bring 24.6% of revenue to gross profit last quarter, and which has enormous ambitions in online retailing.

All that spells earnings compression to me, although Amazon doesn't use its stock as a currency the way many companies do. Its most recent acquisition, logistics robot maker Kiva Systems, was made for all cash in March.

Which means I expect Amazon stock to be under pressure through the year. I own a few shares in my retirement account, and I'm keeping them. But I won't be adding to that position until the company proves it can handle the new pressures.

At the time of publication, the author was long AMZN.

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