Amazon Bears Take Cover

Shares rise nearly 25% as the online retailer wins new respect.
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It's a rough day for the

Amazon

(AMZN) - Get Report

bears.

On Tuesday, the company announced first-quarter results that blew past analyst estimates while lifting its guidance for the year. It also reported improving operating margins and said that the rate of its spending growth on technology and content in 2007 would be slower than the year before.

The blowout quarter caught Wall Street flatfooted. Shares soared nearly 25% to $55.53 in recent trading on Wednesday.

While it is by far the best-performing big Internet stock of the year, Amazon tends to be among the least liked by analysts and investors. Before Tuesday's earnings announcement, only seven analysts recommended buying the stock while 10 had a sell rating on it. And investors were short 15% of the company's outstanding shares in May -- well over twice the rate of

Yahoo!

(YHOO)

, the second most shorted big Internet name.

Investors covering their short positions no doubt helped fuel Wednesday's rally. Amazon also forced bearish analysts to backpedal and elicit a round of upgrades. One came from investment bank Piper Jaffray, which had downgraded the company just Monday.

A $50 price target that represented the height of analyst predictions suddenly became too bearish even for Amazon skeptics. Goldman Sachs analyst Anthony Noto raised his price target 57% to $55 from $35, while rating the stock neutral. Goldman Sachs makes a market in Amazon shares.

Noto wrote that the year could be particularly strong for Amazon given the mix of products hitting the market during the year. "We continue to believe that 2H2007 revenue growth should benefit from the favorable product cycle due to Harry Potter VII, strong video game sales and a blockbuster 3Q/4Q home video cycle with 11 sequel or franchise films being released in Summer 2007, thus yielding DVD releases in 2H2007," he wrote.

For the moment, Amazon bulls seem to be vindicated. "We continue to believe the market inappropriately focuses on Amazon as a low margin media (books, music, DVD) retailer," Stifel Nicolaus analyst Scott Devitt wrote in a research note on Wednesday. "We believe Amazon is a platform company with the capacity to grow significantly, not only with the media category, but in all categories of general merchandise retail and we believe the company retains real option value as a Web services and digital media business." Stifel Nicolaus makes a market in Amazon shares.

Still, Amazon remains a relative rarity among Internet analysts, with most of Wednesday's upgrades raising the company only to a hold rating. That puts it in a stark contrast with a company like

Google

(GOOG) - Get Report

. Widely loved on Wall Street and with high expectations built in, the search giant hardly budged after reporting its own blowout quarter last week.

But while Google's tendency to ignore Wall Street and do what it considers good for its business over the long term is widely noted, Amazon, too, may adhere to the principle. Amazon spent aggressively to grow its business by offering expensive promotions and continued to make costly investments even when it was derided for doing so by analysts.

And on Tuesday, CEO Jeff Bezos said the company would continue to invest indefinitely in new Web services like computing and storage it will be selling to other companies.

But not everyone is a convert in the wake of Amazon's impressive quarter. In a research note on Wednesday, J.P. Morgan analyst Imran Khan pointed to the company's rich valuation as a cause for concern. The average large-cap Internet stock trades at about 41 times 2007 and 32 times 2008 earnings estimates, Khan noted. Amazon, meanwhile, trades at 50 times 2007 and 42 times 2008 estimates. J.P. Morgan makes a market in Amazon shares.

"Is Amazon a Buy? We think the valuation is too rich," he wrote. "While Amazon's 1Q was solid, we think the valuation may not offer much upside."

For Amazon shareholders, Wednesday's stock performance should be enough upside for now.