As Amazon (NASDAQ:AMZN) prepares to unveil its Q2 results on July 25, investors are grappling with the question of whether the e-commerce and cloud giant remains an attractive investment. Despite concerns about its valuation following a 54% surge in share price over the past year, Amazon continues to present compelling reasons to maintain a bullish outlook. In this analysis, we delve into three key bullish signals supporting the stock’s long-term investment thesis, alongside one bearish factor that could impact future returns. Nevertheless, my stance on AMZN stock remains optimistic.
Promising Signal #1: Strong Growth Across Diverse Segments
Amazon’s growth momentum spans across all its segments. In Q1, the company exhibited impressive growth in Retail, Advertising, and Amazon Web Services (AWS), signaling no signs of slowing down. Let’s examine each segment individually.
The Retail Segment
Amazon’s Retail business continues to flourish due to its vast product selection and competitive pricing. North American sales surged 12% year-over-year in Q1 to $86.3 billion, while International sales grew 11% in constant currency to $31.9 billion. Efforts to attract third-party sellers have bolstered Services revenues by 16%, increasing the third-party unit mix to 61% in Q1.
From a profitability standpoint, Amazon’s North American segment witnessed a 557% surge in operating income to nearly $5 billion, boasting an operating margin of 5.8%. The International segment also marked a significant improvement, with $903 million in operating income compared to a $1.23 billion loss the previous year. These robust figures defy concerns over sustainable profitability, hinting at consistent profitability ahead with continued margin expansion.
The Advertising Segment
Amazon’s Advertising revenue soared by 24% year-over-year in Q1, driven by strong performance in sponsored products and improved relevancy and measurement capabilities. The segment appears poised for further growth as Amazon persists in its innovation efforts, especially in Prime Video ads.
Amazon Web Services (AWS)
AWS, Amazon’s high-growth cash cow, witnessed a 17.2% year-over-year revenue increase in the previous quarter, up from 13.2% in the quarter before. This acceleration in an increasingly competitive cloud landscape underscores the segment’s pivotal role as a growth catalyst moving forward, especially with the expected uptick in companies leveraging AI technologies.
Promising Signal #2: Technological Innovations and AI Advancements
Amazon’s technological innovations, particularly in artificial intelligence (AI), serve as a key driver of its investment outlook. Given its massive scale, these advancements are poised to accelerate its growth and cement its dominant position at the intersection of retail, cloud computing, and AI.
Notably, Amazon’s AI capabilities within AWS are remarkable, generating substantial revenues through offerings like SageMaker, which streamline data processes, experiment management, model training, and developer productivity.
For example, Perplexity AI, an AWS customer, achieved a 40% faster model training rate using SageMaker. Another instance is NatWest Group (NYSE:NWG), a U.K.-based bank that reduced its AI project time-to-value from 12-18 months to under seven months. These innovations position Amazon at the forefront of the AI race, given its extensive AWS client base.
Promising Signal #3: Surge in Free Cash Flow
The substantial increase in Amazon’s free cash flow stands out as the third and arguably strongest bullish catalyst propelling the stock’s rally. Operating income margins, as noted earlier in the retail and AWS segments, continue to rise. Coupled with the company’s moderated capital expenditures (CapEx) that saw just a 5% increase in Q1, Amazon’s free cash flow has been skyrocketing.
Amazon has generated record free cash flow of $50.1 billion over the past four quarters, a significant turnaround from a $3.3 billion outflow the previous year. Forecasts anticipate this explosive growth to persist, with consensus estimates projecting free cash flow to reach $62.0 billion, $78.8 billion, and $102.2 billion in 2024, 2025, and 2026, respectively. Such substantial projected growth is poised to uphold Amazon’s bullish sentiment.
The Singular Bearish Concern to Consider
Amid the compelling bullish factors discussed, a single bearish aspect to bear in mind revolves around Amazon’s valuation, which appears lofty, even when factoring in Wall Street’s optimistic free cash flow projections. After the stock’s extended rally over the past year, it is currently trading at 33.6 times and 26.4 times this year’s and next year’s free cash flow, respectively, figures that are considerably high by industry standards.
If Amazon manages to live up to Wall Street’s projections and sustains its attractive free cash flow growth expectations in the years ahead, the current valuation could find some justification. However, failure to meet these expectations could prompt a significant contraction in valuation, affecting investor returns.
Analyst Consensus on AMZN Stock
Despite its prolonged uptrend, Wall Street upholds a Strong Buy consensus rating on Amazon. This consensus is backed by 42 unanimous Buy ratings assigned within the past three months. With an average Amazon stock price target of $221.70, the anticipated upside potential stands at 10.85%.
If you’re deliberating on which analyst insights to follow for trading AMZN stock, the top-performing analyst for the stock over a one-year period is Rob Sanderson from Loop Capital Markets, boasting an average return of 36.06% per rating and a 94% success rate.
In Conclusion
Amazon is on the cusp of revealing its Q2 results, showcasing sustained growth across its Retail, Advertising, and AWS realms. With notable profitability enhancements and AI innovations driving its momentum, coupled with the potential for escalating free cash flow in the foreseeable future, Amazon seems poised for continued success.
However, caution should be exercised regarding the stock’s valuation, which currently stands at premium levels. Wall Street’s lofty expectations, if unmet, could lead to a substantial downside for the stock.