3 Reasons Why Amazon Bears Are Wrong

Amazon (AMZN) is a widely discussed stock, with both the Amazon bulls and bears usually taking sanguine positions. Personally, I think that an investment in Amazon carries above-average risk. However, the upside potential in the stock can more than compensate for those risks over the long term.

Let's take a look at three particularly relevant arguments among Amazon bears and try to explain why those arguments are ultimately no reason to stay away from the stock.

1. Valuation Is Unreasonable

When looking at Amazon through ratios such as price to earnings, it's easy to make the case that the stock is egregiously overvalued. The trailing price to earnings ratio stands at a stratospheric 91 times earnings as of the time of this writing.

On the other hand, current earnings numbers are not truly reflecting the company's underlying earnings power. Amazon is aggressively investing in all kinds of growth projects, and this naturally takes a big toll on both current earnings and free cash flows.

However, operational profitability metrics show that the company is thriving and profits are growing at a faster rate than revenue over the long term. The chart below shows the evolution of revenue, cash flow from operations, and EBITDA over the past decade.

AMZN Revenue (TTM) data by YCharts

Amazon stock has never traded at cheap valuations, but a high growth business doesn't need to be purchased for a cheap price in order to produce attractive returns.

Current valuation levels are in line with historical standards for Amazon over the past five years when looking at price to sales, enterprise value to EBITDA, and price to operating cash flows.

AMZN PS Ratio (TTM) data by YCharts

It is important to note that Amazon has produced massive returns from those valuation levels. Even after falling by more than 20% from its highs of last year, Amazon has gained 32.4% annually in the past five years, nearly double the 16.78% produced on average by companies in the specialty retail category, based on data from Morningstar.

If Amazon can sustain rapid revenue growth and increasing margins going forward, this will provide a double boost to earnings, since earnings will increase due to both larger sales and a bigger percentage of sales retained as profits. This would mean that current earnings are not telling the whole story regarding future earnings potential, making valuation far more attractive than it seems to be at first sight.

As long as Amazon continues generating vigorous growth and increasing profitability levels, then current valuation should be no impediment for the stock to continue rewarding investors with attractive returns.

The PowerFactors system is a quantitative investing system available to members in my research service, "The Data Driven Investor." This system basically ranks companies in a particular universe according to quantitative return drivers such as financial quality, valuation, fundamental momentum, and relative strength.

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Disclosure: I am/we are long AMZN. I wrote this article myself, and it expresses my own opinions.

Disclaimer: I wrote this article myself, and it expresses my own opinions. I am not ...

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David Reynolds 1 year ago Member's comment

Arguments well put. I'm with you on $AMZN.