High inflation and rising interest rates are threatening to tip the U.S. economy into a recession, as investors have become increasingly pessimistic about the situation. Those concerns have made Amazon even harder to deal with. The decline in its share price has been the worst in the past decade.
There is a once-in-a-decade buying opportunity.
The cost structure of its retail business is the center of the bear case. The Amazon brand is synonymous with online shopping but retail is a very low margin industry.
It is the case for Amazon. The company frequently spends a lot of money on shipping and fulfillment.
The situation has deteriorated due to high inflation. Discretionary consumer spending has slowed and that has led to disappointing financial results. The company had negative free cash flow of $26 billion on a trailing-12-month basis.
There is no immediate danger since Amazon has $59 billion in cash and short-term investments. It would put more downward pressure on profitability and free cash flow if the company had to take on more debt. Bears think that is a reason to avoid the stock.
Cost pressures on its retail business should be less when inflation is normalized. Amazon's fastest-growing segments have higher margins than retail and will become more profitable in the future.
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The bull case for Amazon focuses on the company's strong position in three growing markets. Amazon will account for 40% of online sales in the US this year, giving it more market share than Walmart. Amazon is better positioned to take advantage of the secular shift to online shopping than its competitors, and global e-commerce sales are expected to grow at a faster rate than the rest of the world.
The popularity of its online marketplace has led to Amazon becoming a digital advertising powerhouse. Amazon is the most popular starting point for U.S. consumers when they are searching for a product, according to a new report. It makes Amazon a good ad partner. Amazon nearly led the world in ad revenue growth last year, but the company is now the fourth- largest advertiser.
That has a lot of consequences. Digital advertising is growing quickly and is more profitable than retail. Even though Amazon hasn't provided specific operating metrics, investors can assume that the company is in the same ballpark as Google.
The leader in cloud computing is Amazon Web Services. The next-closest cloud vendor, Microsoft Azure, has an operating margin of around 30%, but the next-closest cloud vendor, Amazon Web Services, has an operating margin of twice that. According to Fortune Business Insights, the cloud computing market is expected to increase 20% annually to reach $1.7 trillion by 2029, and that's thanks to Amazon Web Services.
With Amazon's strong presence in three large and growing markets, investors have good reason to believe that sales will average double-digit growth over the next several years. Amazon should become more profitable over time, as it is growing faster than its retail segment.
The three-year average of 3.8 times sales is a discount to the current share price of 1.8 times sales. The company is poised to deliver double-digit sales growth over the long term.
The three-year average for shares is roughly in line with the current one. As Amazon's high margin segments account for a bigger chunk of revenue, the multiple should fall quickly.
This growth stock is a great buy, and investors should take advantage of it.
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