This year, my top picks have been in the technology sector, with a strong emphasis on profitable growth. As a result, it may come as a surprise that Amazon (NASDAQ:AMZN) has unexpectedly become my top overall pick and the largest investment in my portfolio. Amazon stock has struggled in comparison to several mega-cap tech peers, as investors have been dismayed by AWS’s slowing growth rates. Investors are underestimating the company’s monopolistic position in the online e-commerce sector, which is potentially worth more than the present market cap. AMZN may not appear to be as profitable as its mega-cap tech contemporaries, and the stock has suffered as a result, but this is a corporation that has aggressively invested in long-term initiatives. This is an example of a corporation deciding to reduce margins through aggressive investment, resulting in an appealing investment opportunity for investors prepared to forego present earnings in exchange for greater long-term rewards. I reiterate a strong buy recommendation for the stock.
AMZN Share Price
The tech crash impacted practically all tech companies, profitable or not, and AMZN was not immune. The stock price was marginally higher than five years ago as of current trade.
I wrote on Amazon stock in March, when I recommended it as a buy due to the predicted margin increase. While the company did end up reporting a high-profit figure, I continue to believe that margin expansion has only just begun.
Key Metrics for AMZN Stock
Revenue increased by 9% to $127.4 billion in the most recent quarter, comfortably exceeding the upper end of the target range of $126 billion. Given the difficult macroenvironment, that was an excellent result.
Operating income, which came in at $4.8 billion, was undoubtedly the more spectacular outcome. Previously, management had projected operating income of between $0 and $4 billion.
The outstanding results were driven in large part by the e-commerce sectors, with North America demonstrating significant double-digit sales growth and a return to profitability, and the foreign business demonstrating solid sales growth with lower-than-expected operating losses.
AWS also delivered strong results, with revenue increasing 16% year on year.
AMZN was able to improve its trailing twelve months of free cash flow burn as profit margins began to stabilize.
AMZN closed the quarter with $64 billion in cash versus $67.1 billion in debt, indicating a healthy balance sheet. I should point out that the business did not buy back any stock during the quarter.
In the coming quarter, management expects revenues to increase by up to 10% to $133 billion, with operating income remaining strong at between $2 billion and $5.5 billion. These outcomes – and recommendations – look to be extremely strong.
Why did the stock underperform its peers after the report? That has to do with comments made by management on the conference call on AWS. The cloud optimization challenges have been exacerbated, with revenue growth in April being “about 500 basis points lower” than in the previous quarter, meaning an 11% growth rate in April. Investors may have hoped for a speedy resolution to these cloud optimization challenges, but such data does not reflect such a conclusion. Management reminded investors that “90-plus percent of global IT spend is still on-premises.” The premise is that the long-term investment thesis remains intact, even if the difficult macroeconomic environment dampens growth rates in the short term. Many investors, I believe, are just tolerating the loss-making e-commerce sector, under the notion that the entire stock value revolves around AWS. Given the segment’s continuous poor performance, it’s easy to understand why investors may have sold off the company.
Is Amazon Stock a Buy, Sell, or Hold?
AMZN was recently priced at about 81 times this year’s earnings projections. While it appears to be a high price, it is important to note that earnings are likely to expand at a quick pace in the following years.
AMZN’s market cap was recently around $1.3 trillion. In comparison, Microsoft had has a market cap of $2.5 trillion. The disparity appears to be misplaced.
Assuming AWS can accelerate to 15% growth, create 40% net margins over time, and trades at a 1.5x price-to-earnings growth ratio (‘PEG ratio,’) I envisage AWS being valued at 9x sales or $800 billion in market value. I appreciate that many readers have lost interest in the e-commerce area due to the elusive earnings, but I’m curious how many readers are regular users of the site. It is critical not to confuse a lack of earnings owing to investments with a lack of profitability due to poor business ideas. Consider that AMZN’s ability to invest nearly infinite amounts of capital at high ROI into its e-commerce operations is a clear positive, as most growth companies eventually reach a point where they are unable to reinvest incrementally more capital and must instead demonstrate growing profit margins. I recognize that this viewpoint may not be popular in an atmosphere that is currently focused on short-term gains.
Consider what AMZN has accomplished in the field of e-commerce. It has established an unequaled logistical network, allowing it to deliver packages, often on the same day. It has a positive reputation among customers, thanks in part to the ease of return and the aforementioned rapidity of delivery. Because of the enormous number of consumers, it provides an appealing marketplace for vendors. This is a significant network effect, and it is unclear how a rival can compete on all three fronts at the same time. AMZN built significant advantages over several decades, making any future competition face a costly battle. While Wall Street appears to have given up on this segment’s long-term profitability, I remain optimistic because the company continues to expand its advantages in this area. Prior to the pandemic, AMZN was producing 4% to 6% margins in its North American sector, significantly greater than the 1.2% margin announced this quarter. Its international segment comprises numerous countries that are still in the early phases of development and require significant investment to build out infrastructure. We can value the e-commerce industry at $440 billion if we assume a 5% long-term net margin for e-commerce activities and a 20x earnings multiple. Despite the modest assumptions, combining these two elements already yields a market value near the current stock price. If we instead assume 18% CAGR and a 2.0x PEG ratio for AWS and 7% long-term net margins and 25x earnings multiple for e-commerce, we get $1.2 trillion for AWS and $770 billion for e-commerce, for a total value of about $2 trillion. Given the company’s propensity to drive margin expansion for as far as the eye can view, the latter estimate appears more reasonable, albeit not still conservative. Somewhere between these two projections gives a potential gain of roughly 50% over the following 12 months.
What are the main dangers? I feel my projected PEG ratios are pretty cautious, but the growth and margin assumptions remain risky. It is likely that AWS growth will never revert to even the 15% prediction I considered modest. It is probable that AMZN is unable to achieve margin expansion in its e-commerce activities, maybe due to inflation or the fact that delivery speed is a minor consumer want. If AWS grows just 10% with a 30% long-term net margin assumption, and the e-commerce businesses have a 3% long-term net margin and trade at only 15x earnings, the estimated value falls to $583 billion, signaling a significant downside. That exercise reveals something important: AMZN is not “deep value,” as Meta Platforms (NASDAQ:META) were trading in late 2022. However, I believe Amazon stock is undervalued in relation to its excellent quality, as this is the type of stock that can drive long-term margin expansion and deserves premium values like typical consumer staple stocks (which, I may add, trade at PEG ratios in the 3x to 4x range). I reaffirm my strong buy recommendation.
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