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Investment Thesis
by Amazon (NASDAQ:AMZN) AWS is not enough to save this investment thesis. Even though Amazon has seen a lot of it go down, I believe that most of Amazon, its retail business ends up reporting losses and not supporting a strong multiple in the stock.
Meanwhile, although the AWS segment has proven to be very resilient so far, I believe that as businesses struggle in this global environment, this will lead to AWS’s near-term growth prospects also slowing down.
All in all, I don’t believe that paying 51x next year’s EPS numbers reflects Amazon’s intrinsic value. This is a high multiple for what is being offered today.
Business Secular Growth
Secular growth stories have worked so well for so long that we stopped to examine under the hood. A friend of mine calls this investing style the ”it doesn’t matter until it matters” style.
And we are all guilty of this. I know I am. We look for information that matches and confirms our views. Although we like to hear other points of view, we do so as long as it is not misguided too far from our own beliefs.
However, in the end, we are looking for more information that allows us to increase our confidence in our own perspective. we do not real look for more rounded information, to build a more accurate mosaic. The brain is not designed that way. Our brain is designed to know whether an animal is coming to hunt us or not. Our survival path is binomial. There is too little space for nuances.
Furthermore, the problem here is that in an era of 0% interest rates, any business that does not invest for growth is doing a disservice to its shareholders. And that vision is more than enough to reward investors. Investing for growth, while being marginally profitable makes a lot of sense.
But like anything that starts out as resoundingly positive at first, investors tend to take those ideas to extremes.
What’s Happening Now?
Amazon has two main segments, its retail business, and its AWS business. I will discuss them one at a time.
work of the author
Amazon’s retail segment makes up about 84% of its total business mode. Within it, there is a very powerful business, Amazon’s advertising business.
Amazon’s advertising business is amazing. This is a high-margin business. Furthermore, any brand looking to carve out a business on Amazon is almost forced to pay for advertising or else it will be relegated to the back pages on Amazon where few customers are interested. -busy search. And while it’s easy to identify the moat of Amazon’s advertising business, we’re only talking about 7% of Amazon’s total business.
Because of this, I’d argue that 70% of Amazon is actually played, that’s the yellow section of the pie at the top.
This is the 70% of Amazon that is currently struggling to make a profit. So, from an investment perspective, investors are apparently willing to look past its lack of profitability, as Amazon continues to grow at more than 20% CAGR.
But now, even the staunchest shareholders would struggle to admit that Amazon will return to growing at 20% CAGR. That won’t happen, for now.
There is a massive cost of the lifestyle crisis. Not only throughout Europe and Canada, but also in the US. In general, shoppers are more likely to compare products on cost before looking on Amazon.
In other words, does Amazon offer consumers a significantly higher value proposition, because today’s consumers are being squeezed? I don’t believe that is accurate.
With this framework in mind, let’s now turn our focus to AWS.
Placing a Fair Multiple on AWS
AWS is the crown jewel. Less than 20% of Amazon’s total revenue is AWS. That’s an area of resilient growth. However, we have seen evidence from a broad spectrum of enterprise businesses, that the sales cycle is now beginning to lengthen.
For evidence to back up this assertion, we can look at Salesforce’s (CRM) Investors Day or ServiceNow’s (NOW) recent results. Businesses are not immune to underlying economic pressures.
So, this is the main question that investors need to answer, can AWS continue to grow at 30% CAGR in the coming year?
Or maybe it is AWS took a step forward much of its future growth and is now entering a period of slowing earnings growth rates? Or could Azure (MSFT) and Google Cloud (GOOG)(GOOGL) affect AWS’s ability to grow at 30% CAGR in the coming year?
Also, even if AWS’s margins are able to remain stable in the face of rising inflation, can AWS have a 25% operating margin?
All things considered I don’t believe AWS is worth more than a $700 to $800 million market cap. For this, I assume that AWS’s operating income will grow by 2023 to $30 billion and I put a 25x multiple on its operating income. I hope you agree that is a very fair assumption.
AMZN Stock Valuation — 51x EPS Next Year
Next, the problem is compounded because Amazon’s valuation simply leaves investors with no room for potential surprises. As I mentioned throughout, I believe Amazon’s near-term earnings will negatively surprise investors.
However, at least I allow myself some room for a margin of error, and agree to that Analysts’ EPS estimates were correctthere is absolutely no justification for Amazon to be priced at 51x EPS next year.
AMZN EPS consensus
Additionally, of most mega tech names, Amazon seems to be the one where analysts have the most significant changes to their EPS estimates. So, with this in mind, it is likely that these EPS estimates have now come down to a more measured level.
And then, we circle back again, are investors justified in paying 51x in EPS next year when Amazon’s top line is growing at less than 20% CAGR?
The Bottom Line
The mark of an open mind is not to let your ideas become your identity. If you define yourself by your opinions, questioning them is a threat to your integrity. (Adam Grant)
Adam Grant has this habit of making the complex sound simple. It’s always very easy to see the writing on the wall when we break away from our position. But we become steadfast in our views because we too are easily identified with our stocks as a reflection of who we are!
I believe that Amazon’s Q4 2022 guidance could be a negative surprise to investors, especially if its AWS business does not live up to expectations.