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Is Amazon Undervalued?

As the retailer hits a profitability inflection point, we're increasing our fair value estimate of the shares, writes Morningstar's R.J. Hottovy.

We also have greater confidence in the North American segment's ability to deliver operating margins in the mid-single-digit range, with segment margins of 5.1% driven by gross margin expansion (a byproduct of Prime memberships, which we now peg at around 44 million) but also greater fulfillment and marketing expense efficiency. Though it still posted an operating loss, there are also signs that Amazon's international operations are also building a foundation for profitable growth through accelerating general merchandise sales, international Prime memberships growing faster than the U.S., and increased third-party sales.

We believe the second quarter represents a key inflection point with respect to Amazon's margin expansion story while reinforcing the network effect, intangible asset, and cost advantage sources behind our wide moat rating. We're raising our fair value estimate to $600 from $440 as we recalibrate the trajectory of our longer-term margin expansion outlook. We previously assumed GAAP operating margins would grow to 4.5% by 2019, but now believe 6.5% GAAP operating margins are achievable over that timeframe based on the company's strong competitive positions in AWS and North American e-commerce as well as early indications of international success.

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About the Author

RJ Hottovy

Sector Strategist
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R.J. Hottovy, CFA, is a consumer strategist for Morningstar Research Services LLC, a wholly owned subsidiary of Morningstar, Inc. He is responsible for consumer discretionary and staples research. He has covered the consumer sector as an analyst and director of global consumer equity research for Morningstar since joining the company in 2008, and specializes in a broad range of consumer categories including restaurants, footwear and apparel retailers, consumer electronics retailers, fitness clubs, home improvement and furnishing retailers, and consumer product manufacturers.

Before joining Morningstar, Hottovy was a director and senior stock analyst for Next Generation Equity and an analyst for William Blair & Co., specializing in a wide range of retail and consumer product companies. He also spent two years at Deutsche Bank, covering waste management, water utilities, and equipment rental stocks.

Hottovy holds a bachelor’s degree in finance and a second degree in computer applications from the University of Notre Dame, where he graduated magna cum laude. He also holds the Chartered Financial Analyst® designation and is a member of the CFA Institute and the CFA Society of Chicago.

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