Amazon's Blowout Quarter: It Is Not Too Late To Buy

However, anchoring is a powerful and well-documented bias. It is very human to believe that the company could be overvalued when you see the stock price rising exponentially. For many investors, both individual investors and professionals, psychological biases such as anchoring can be very hard to overcome.

Imagine for a second that you are a professional fund manager who has missed the epic rally in Amazon for considering the stock overvalued over the past several years. In that situation, it is very likely that you are now going to stick with your position and say that the stock is even more overvalued than before, even if you could probably see things differently if you looked at Amazon stock with fresh eyes. The ability to change your mind can be enormously beneficial, but it is a rare ability that only the best investors have.

The price to earnings ratio is simply misleading because Amazon is investing massive amounts of money on future growth opportunities, so current earnings as reflected by accounting standards do not reflect the company's true earnings generation capabilities. In cases like this, cash flows are a much more clear reflection of business fundamentals.

Valuation Is Not Unreasonable At All

In the case of Amazon, the stock price is increasing, but so are the company's cash flows. Operating cash flow increased 42% last quarter to $51.2 billion for the trailing twelve months, compared with $36 billion for the trailing twelve months ended June 30, 2019.

Based on these numbers, Amazon stock is currently trading at a price to operating cash flow ratio of around 30. Considering that cash flows are growing at full speed, this valuation is not unreasonable at all.

Even more interesting, a sum of the parts valuation for Amazon can highlight the fact that the stock is far cheaper than it seems to be at first sight.

Amazon Web Services is facing increasing competition, but revenue still grew 29% last quarter, and operating income expanded by 58%. Due to scale advantages in AWS, Amazon is enjoying an expansion in profitability in this segment, and operating income reached 31% of revenue last quarter.

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Disclosure: I am/we are long AMZN, FB, GOOG.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no ...

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Roger Keats 1 year ago Member's comment

Enjoyed this article, good read

Angry Old Lady 1 year ago Member's comment

I sometimes thing there will be no end to how high #Amazon can go! $AMZN