Now Is The Right Time To Buy Amazon
Winning investment ideas don't need to be too complex or sophisticated. Leonardo Da Vinci is credited for saying that simplicity is the ultimate sophistication. Buying a high-quality business for an attractive valuation can produce outstanding returns over the long term, and this is clearly the case when it comes to Amazon (AMZN) stock at current levels.
A Long Consolidation
The chart below shows the evolution of Amazon stock price in comparison to the company's revenue. The stock price and revenue tend to move in the same direction over the long term, but the relationship is not linear or straightforward. Interestingly, the stock price has been lagging behind revenue growth in recent quarters.
Data by YCharts
Amazon stock is currently trading at levels it first reached in June of 2018, so the stock has been consolidating in a sideways range for a year and a half. This is probably due to the fact that the company has received plenty of criticism from politicians on both sides of the spectrum, ranging from President Donald Trump to Bernie Sanders and Elizabeth Warren.
The stock market hates uncertainty, and regulatory risk is always hard to measure or quantify. These kinds of considerations are also magnified by media coverage, as they tend to attract lots of attention from the public.
However, investors should not miss the forest for the trees, the fundamental picture remains intact, and Amazon looks like an attractive purchase at current valuation levels.
Value And Growth
Amazon reinvests most of its profits and cash flows for further growth, so traditional valuation metrics such as price to earnings don't really reflect the company's true underlying earnings power.
Looking at indicators such as price to operating cash flow and enterprise value to EBITDA, Amazon stock is trading at ratios around 25. This is hardly excessive for such a strong growth business, and the valuation levels are, in fact, near the low end of the historical range.
Data by YCharts
Offering a similar perspective, the price to sales ratio was above 4.8 in 2018 and now it is coming down to 3.4. This is more than reasonable considering the company's growth rates, and it even looks very attractive in comparison to other successful players in the industry. As a reference, Alibaba (BABA) has a price to sales ratio of 9, while Shopify (SHOP) has a much higher price to sales ratio of 32.
Data by YCharts
Granted, these kinds of companies are fairly unique when it comes to their risk profiles and their growth potential. But the point is that Amazon is materially cheaper than both Alibaba and Shopify, even if the comparison is not completely straightforward.
Wall Street analysts are expecting revenue growth to considerably slow down in the years ahead. The table shows the average revenue estimates from Wall Street analysts and the implied price to sales ratios based on those estimates.
Looking at these numbers, it's hard to argue against the fact that Amazon is trading at fairly reasonable valuation levels, even when incorporating expectations for slowing growth in the future.
Fiscal Period Ending | Revenue Estimate | YoY Growth | FWD Price/Sales |
Dec 2019 | 279.15B | 19.86% | 3.18 |
Dec 2020 | 331.06B | 18.60% | 2.69 |
Dec 2021 | 387.62B | 17.08% | 2.29 |
Dec 2022 | 448.08B | 15.60% | 1.98 |
Dec 2023 | 508.31B | 13.44% | 1.75 |
Dec 2024 | 578.45B | 13.80% | 1.54 |
Dec 2025 | 657.89B | 13.73% | 1.35 |
Dec 2026 | 692.09B | 5.20% | 1.28 |
Dec 2027 | 759.47B | 9.74% | 1.17 |
Dec 2028 | 793.33B | 4.46% | 1.12 |
Source: Seeking Alpha Essential
Some kind of deceleration is a very reasonable assumption because growth usually slows down as a company gains size over the years and its main markets start reaching maturation. However, Wall Street numbers could be too conservative when considering that Amazon still has enormous room for expansion in the long term.
U.S. online retail is the company's most mature market, yet e-commerce still accounts for only 11.2% of total retail sales in the U.S. The lines between online and physical stores will continue getting blurred in the years ahead, and no company is better positioned than Amazon to benefit from such a massive growth opportunity.
Source: US Census Bureau
Amazon is barely giving the first steps in international markets, and it has enormous potential for sustained growth in areas such as Amazon Web Services, advertising, and digital content. The company has multiple growth engines with abundant opportunities for growth, which increases the probability that Amazon will outperform Wall Street growth expectations over time.
Amazon is also expanding into new areas with exciting potential, and it could make big inroads into businesses such as B2B. According to estimates from Bank of America, the total addressable market for e-commerce B2B could reach $1.4 trillion by 2021, which is nearly double the firm's estimated $761 billion market for consumer e-commerce.
The numbers from RBC Capital Markets are quite promising for investors when considering both the addressable markets in different areas and the levels of penetration in different segments.
- RBC calculates that Amazon's online retail platform has a $20 trillion TAM and is only 10% penetrated.
- AWS reportedly has $1 trillion in TAM and is also only about 10% penetrated.
- Advertising could be worth another $1 trillion, with penetration of around 30%.
- RBS calculates that business supplies could be a $5 trillion opportunity with a current penetration level of 10%.
These kinds of estimates obviously carry a large margin of error, and the numbers should be taken as broad approximations as opposed to accurate estimates. But the main point is that Amazon is still benefitting from huge growth opportunities in the years ahead.
In simple terms, Wall Street analysts are forecasting a material deceleration in growth for Amazon, and the stock is quite reasonably valued for that scenario. Even better, there is a considerable chance that Amazon's growth rates will exceed Wall Street expectations, which would mean that the stock is really much cheaper than what the numbers are currently reflecting.
Sum Of The Parts Valuation
There have been growing discussions regarding the possibility that Amazon should be broken apart into its different segments. Chances are that this won't happen any time soon. Nevertheless, when analyzing the company's value from a sum of the parts perspective, the numbers look quite interesting.
According to research data from Cowen, AWS revenues could reach $36.1 billion this year, growing by 31% annually and reaching $140 billion in 2024. Under these assumptions, AWS alone would be worth $506 billion. Offering a similar perspective, the analysts at Morningstar calculate that AWS is worth $550 billion as a standalone business.
Amazon, as a whole, has a market capitalization value of $889 billion. If AWS alone is worth $500 to $550 billion, investors are currently paying $335-389 billion for the rest of the business, which sounds like a major bargain.
Looking at the different segments and their estimated valuation, Morningstar reaches a fair value estimate of $2,300 per share for Amazon, which represents a healthy upside potential of 28% versus current levels.
Source: Morningstar
This is quite an ironic situation, one of the main risk factors weighing on the stock price is regulatory uncertainty due to all the criticism that Amazon has received from politicians of both parties in recent years. Like usually happens, investors seem to be overreacting to this risk, and regulatory pressure will not derail Amazon from its long-term growth trajectory.
Even more interesting, Amazon would arguably be worth more as a combination of different businesses with their own individual valuations in comparison to current valuation levels for the company as a whole.
The Bottom Line
Amazon is a fundamentally sound business, the company owns one of the most powerful brands in the world, and it has an unparalleled logistics and distribution network setting it apart from other players in online commerce. Massive-scale provides cost advantages in both e-commerce and cloud computing, generating an additional layer of competitive strength for the business.
The company has had its fair share of flops when it comes to new products, but management has proven an exceptional track record of successful innovation and sustained growth over the long term.
Due to aggressive investments for growth, profit margins are thin and volatile, which can create volatility around the stock price on a quarter to quarter basis. Besides, the political noise affecting Amazon could get louder over the coming months.
But those risk factors are already well reflected in the stock price, and Amazon looks like a good opportunity at current valuation levels. Overall, the risk and reward trade-off for investors in Amazon looks clearly attractive going forward.
Disclosure: I am/we are long AMZN, BABA.
Disclaimer: I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business ...
more