After Earnings, Is Amazon Stock a Buy, a Sell, or Fairly Valued?

Amazon AMZN released its first-quarter earnings report on April 30. Here’s Morningstar’s take on Amazon’s earnings and the outlook for its stock.

Key Morningstar Metrics for Amazon

• Fair Value Estimate: $193.00
• Morningstar Rating: 3 Stars
• Morningstar Economic Moat Rating: Wide
• Morningstar Uncertainty Rating: High

What We Thought of Amazon’s Q1 Earnings

• Results were nicely ahead on the top and bottom lines. Many positive trends from the last several quarters continued, with notable improvement in Amazon Web Services demand and additional cost savings arising from fulfillment and cost to serve. Revenue guidance was a little light vs. the consensus, while operating profit was in line.
• Generative artificial intelligence is now a multi-billion-dollar run-rate business. Amazon will ramp up capital expenditures in 2024 to meet demand. We think Amazon is one of several obvious winners in AI, so we don’t think investors will have a problem with additional investment based on demand.
• AWS accelerated with larger and longer deals. Customer focus has moved from containing costs to moving new workloads to the cloud. Changes in the useful life of servers helped boost gross margins.
• Amazon is executing well in the core e-commerce business. Improvements in fulfillment are boosting margins and improving delivery times. Increased delivery speed means more frequent purchasing for Prime members. The regional hub model with eight US regions is doing well. Management believes there is plenty of opportunity, with US consumers trading down and looking for deals. European consumers have been more impacted by geopolitical events.
• Advertising performed well again, up 24% year over year. Sponsored ads remain the big driver, but the recent launch of ads on Prime Video represents a nice opportunity over the next several years.
• Strong quarterly performance has pushed Amazon’s shares meaningfully higher over the last year, and as such, we see only a modest upside to our fair value for investors.

Fair Value Estimate for Amazon Stock

With its 3-star rating, we believe Amazon’s stock is fairly valued compared with our long-term fair value estimate of $193 per share, which implies a 2024 enterprise value to sales multiple of 3 times and a 2% free cash flow yield. We think multiples are less meaningful for Amazon, given the ongoing heavy investment and rapid scaling that depresses its financial performance. However, we expect it to significantly increase free cash flow as it matures.

Read more about Amazon’s fair value estimate.

Economic Moat Rating

We assign Amazon a wide moat based on network effects, cost advantages, intangible assets, and switching costs. The company has been disrupting the retail industry for more than two decades while emerging as the leading infrastructure-as-a-service provider via Amazon Web Services. This disruption has been embraced by consumers, driving change across the industry as traditional retailers have invested heavily in technology to keep pace. Covid-19 has accelerated this change, and given the company’s technological prowess, massive scale, and relationship with consumers, we think Amazon has widened its lead, which we believe will result in economic returns well over its cost of capital for years to come.

We believe Amazon’s retail business has a wide moat. It has network effects associated with its marketplace, whereby its many buyers and sellers continually attract more buyers and sellers. It has a cost advantage tied to purchasing power, logistics, vertical integration (proprietary brands, owned delivery, and so on), and a negative cash conversion cycle. And the business possesses intangible assets associated with technology and branding.

We also believe AWS is a wide-moat business. It has high customer switching costs, a cost advantage associated with economies of scale whereby few competitors can keep up with Amazon’s investment pace, intangible assets arising from semiconductor and facility development, and a network effect associated with a marketplace for software created to make AWS work better.

Amazon’s burgeoning advertising business has a narrow moat, in our view, based on intangible assets from its proprietary data on hundreds of millions of users, as well as a network effect again focusing on buyers and sellers meeting in the largest available venues.

Read more about Amazon’s economic moat.

Financial Strength

We believe Amazon is financially sound. Revenue is growing rapidly, margins are expanding, the company has an unrivaled scale, and its balance sheet is in great shape. In our view, the company’s marketplace will remain attractive to third-party sellers, as Prime continues to tightly weave in consumers. We also see AWS and advertising driving overall corporate growth and continued margin expansion.

Read more about Amazon’s financial strength.

Risk and Uncertainty

Amazon’s Uncertainty Rating is High. Despite being an e-commerce leader, the company faces a variety of risks.

Amazon must protect its leading online retailing position, which can be challenging as consumer preferences change (especially in the wake of covid-19, as they may revert to prior behaviors) and traditional retailers bolster their online presence. Maintaining an e-commerce edge has pushed the company to make investments in nontraditional areas, such as producing content for Prime Video and building out its transportation network. Similarly, the company must maintain an attractive value proposition for its third-party sellers. Some of these investment areas have raised investor questions in the past, and we expect management to continue to invest according to its strategy, despite periodic margin pressure from increased spending.

Read more about Amazon’s risk and uncertainty.

AMZN Bulls Say

• Amazon is the clear leader in e-commerce and enjoys unrivaled scale to continue to invest in growth opportunities and drive the very best customer experience.
• High-margin advertising and AWS are growing faster than the corporate average, which should continue to boost profitability over the next several years.
• Amazon Prime memberships help attract and retain customers who spend more with Amazon. This reinforces a powerful network effect while bringing in recurring and high-margin revenue.

AMZN Bears Say

• Regulatory concerns are rising for large technology firms, including Amazon. Further, the firm may face increasing regulatory and compliance issues as it expands internationally.
• New investments—notably in fulfillment, delivery, and AWS—should dampen free cash flow growth. Also, Amazon’s penetration into some countries might be harder than in the United States due to inferior logistical networks.
• Amazon may not be as successful in penetrating new retail categories, such as luxury goods, due to consumer preferences and an improved e-commerce experience from larger retailers.

This article was compiled by Leona Murray.