AMZN stock has hit its all-time high. Can Amazon.com, Inc stock continue to rally?
Amazon.com, Inc (NASDAQ:AMZN) has been one of the greatest generators of shareholder wealth ever. Amazon stock has returned around 60% over the last one year, 360% over the last five years and an astounding 2100% over the last ten years. The eye-popping performance of the stock has made its founder and CEO, Jeff Bezos, one of the richest people in the world, with a current net worth of $74 billion. While the stock has faced many hiccups, it has been able to bounce back each time. Recently, the company reported a miss on the top line, following which the stock sold off 3%. However, the stock has gained almost 5% since then, reaching its all-time high of $847.27 on Friday. The question is whether Amazon stock will continue to go up or not?
Why value investors avoid Amazon.com stock.
First, let's look at the risks. Amazon is an expensive stock with slowing revenue growth, high debt, high reinvestment need and low-profit margins. These were the main reasons why most of the value investors missed the Amazon party. And they are likely to stay away from AMZN stock for now. Amazon stock is currently trading at a PE (ttm) ratio of 173! While the forward PE ratio is much better, it's still very high at 84x 2017 earnings. Even the PEG ratio which takes into account earnings growth is at 3.02. A PEG ratio above 1 indicates that the stock is overvalued.
For the most part of its existence, the company has churned out losses year after year. Even now, Amazon's net margin is a paltry 1.7%. And on top of that, the company has a huge amount of debt. According to the company's latest 10K filing, Amazon has around $20.2 billion in debt and $19.2 billion in shareholder equity, giving it a debt to equity ratio of 1.04. High leverage adds considerable risk to the stock. More importantly, given its current size, Amazon will not be able to maintain its tremendous revenue growth going forward. For a richly valued growth company, a slowdown in revenue growth could have serious consequences for the stock. Case in point, the stock market reaction after the recent earnings. Amazon reported a beat on both operating profit and earnings per share. However, the stock sold off 3% because of the miss on revenues.
Amazon still has strong growth potential.
But in spite of the risks mentioned above, Amazon stock could still go higher due to multiple tailwinds. Firstly, the eCommerce business will continue to grow at a healthy rate over the next few years. The company has also been making huge investments in fast growing markets like India. Also, continued innovation will improve the company's margin in the eCommerce segment. The first place where Amazon is looking to cut its cost is shipping. In 2016, Amazon's shipping cost increased by 38% to $16.17 billion, around 7 times its net income. Amazon is currently investing into drone technology and looking at having its own fleet for transporting goods, which is likely to reduce shipping costs substantially, in the long run, improving its profitability.
Amazon Web Services (AWS), the fast growing high margin segment will be the main profit driver for Amazon in the coming quarters. AWS reported a revenue of $12.2B in 2016, up 55% from 2015. Amazon currently has the largest market share in the cloud computing space, with AWS accounting for a 33.8% global market share. Its nearest three competitors Microsoft, Google and IBM combined accounted for only 30.8% of the market share according to recent data reported by Canalys. AWS contributes disproportionately high profits to Amazon's total profits due to its higher operating leverage. In 2016, AWS contributed $3.1 billion of Amazon's overall operating income of $4.1 billion. With AWS continuing to grow faster than other segments, its profit margins are likely to improve.
Fast growing "high margin" revenues like prime subscription and advertising will be another catalyst. Amazon generated $9.3 billion in high-margin revenues in 2016. Based on Amazon's retail subscription services of $6.4 billion in 2016, Morgan Stanley believes that Amazon has 65 million prime subscribers worldwide. Prime subscribers not only provide subscription revenues (almost $5.8 billion) but also tend to spend much more than regular customers on Amazon's eCommerce platform. Increasing advertisement revenues is another tailwind as they have much higher margin. With the volume of voice searches likely to grow rapidly over the coming decade, Echo and other Alexa devices will be a strong growth driver for its advertising segment.
Can Amazon stock continue its strong rally?.
Like the stocks of most fast-growing companies, AMZN stock is a high risk-reward stock. Any slowdown in growth could tank the stock while continued growth could drive the stock higher. For now, Amazon stock has more of tailwinds than headwinds. With strong tailwinds, Amazon stock is likely to go higher in the long term. Amazon stock currently has a consensus buy rating from Wall Street. Guggenheim's analyst Robert Drbul has a price target of $950 on Amazon stock.
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