Amazon is a great stock with lots of potential. It's producing massive cash flows and has potential for greater growth and profits with AWS and Advertising (aside from e-commerce). The stock is currently 19% undervalued, but is one of the most expensive it's been in recent history. The stock is a HOLD for me, and would buy on dips. #notfinancialadvice
Is it too late?
Today we take a look at AMZN stock. This thing has gone on a tear lately – 8% in the last week! Primarily due to the cancellation of the $10bn JEDI deal between the Pentagon and Microsoft (putting Amazon back in the picture). I honestly think that's unwarranted speculation. I do think that traders are potentially getting in before Q2 earnings looking for a nice swing. But, as always, let's look at the long-term fundamentals to see the stock is worth buying today.
How does Amazon make it's money?
Surely you know of the online retailer Amazon.com. But, Amazon.com, Inc. (AMZN) is in fact a pretty large company with it's hands in a lot of places. The first step is to understand what these pieces are. As per their Q1 2021 earnings release, here's the breakdown:
- Online Stores (i.e. Amazon.com) - 49%
- Third-party Seller Services (i.e. Amazon.com) - 22%
- AWS - 12%
- Subscription Services (i.e. Prime) - 7%
- Other (i.e. Advertising) - 6%
- Physical Stores (i.e. Whole Foods) - 4%
Naturally, as you can see, most of the revenue is still being driven by Amazon as an online retailer. That business has grown 44% YoY in Q1, which is still carrying the boost from COVID. Q2 2022 should be the time where those YoY growth numbers began to slow. In fact, analysts expecting a 29.40% YoY revenue growth in Q2 2021 – which is aligned with my thoughts – gives me some comfort.
Amazon had a long journey to get to where it is today. In fact, it starting from the dotcom boom and bust, Amazon always had some hype. However, it was known in its early days for selling just books, music and videos online – which was a pretty big deal back then! It had a lot hype, but lost 90% from its ATH during the dotcom bubble. It took nearly 10 years to reach those levels again. But keep in mind, most internet companies since then just never made it. Kind of sounds like where blockchain and crypto are today!
Apart from the massive ecommerce operation it's built over the years, Amazon took a huge pivotal step into cloud computing. Amazon Web Services (AWS) was a home run led by current CEO (and Jeff Bezos' successor) Andy Jassy. It was the right time and right place as cloud computing is still a rapidly going market, with high margins. In fact, in the last quarter (Q1 2021), AWS made up nearly 50% of Amazon's operating income!
The coronavirus has further boosted Amazon's growth as the world accelerated its shift to ecommerce away from brick-and-mortar retail. It's been a fascinating journey for Amazon, to say the least.
Where is Amazon headed?
I see the post-Bezos era of Amazon having a focus on two main areas (aside from their ecommerce operations): Cloud Computing (AWS) and Advertising. Although Microsoft is showing a higher growth rate, AWS has a huge lead in the cloud computing market which is forecasted to grow 18% CAGR to 2026.
Aside from AWS, the other area that I see Amazon having huge potential in, is Advertising. This doesn't get nearly the attention it deserves in my opinion. Advertising revenues are essentially what created two other tech giants, Facebook and Google. Amazon has yet to scratch the surface of the potential they can achieve with advertising. The more they become the ecommerce authority (more than they already have) the stronger their advertising power – namely in search and display. I highly doubt this is factored into any valuation model for Amazon today.
What is Amazon worth?
To value Amazon today, I started with forecasting its revenues and operating income from its three segments – North America, International, and AWS – which you can see below.
The Google Sheet version of my working papers are available for premium subscribers, if you would like to make a set of your own assumptions. It's incredibly valuable for someone looking to plug their own numbers.
With my assumptions, which I go into more detail on my YouTube video, I (very conservatively) got to a fair value per share of $4,420 – which represents a 19% upside to the stock price of $3,720 today; meaning Amazon stock is undervalued. This is the equivalent of a near 12% IRR.
Now, before we jump into buying Amazon stock, I always want to warn you that you simply can't rely on one valuation model. When you zoom out and take a look at the history of AMZN stock and the state of the market today, it's clear to see there it is trading at a huge premium right now (what isn't?). That's the biggest risk I see with the stock right now. When we look at the Price to FCF ratio, AMZN is currently trading at 72x. This is the highest level it's been since the 2008 financial crisis.
Some other risks worth noting:
- regulatory risks (i.e. antitrust legislation) which Biden is clearly prioritizing
- Amazon's leadership under Jassy (i.e. without Bezos' vision)
- Competition from Google and Facebook in terms of both ecommerce and cloud computing
Factoring in the fair value I calculated above, I've also considered a more reasonable Price to FCF ratio and Price to Sales ratio based on history. There is a chance we may never see those prices, but there is a chance we do. I wouldn't overlook a potential black swan event in our horizon, so I am ready with dry powder. With a 45x Price/FCF ratio and a 2.5x Price/Sales ratio taking a 50% weighted average on my target (the rest going to the Fair Value) I arrive at a price target of $3,900. Keep in mind, my calculations are very conservative and this doesn't factor any potential innovations or entries into other markets. I believe Amazon is a great company and a great long-term hold, however I do think the stock is fairly priced right now. But, I don't like a "fair price". I like getting deals. And, I do think if you're patient enough, the deals come around 😉 The stock is a HOLD for me.
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