Raising Our Amazon Fair Value Estimate

Some critics may point to a deceleration in North America margins (3.5% versus 5.1% last quarter, but also a 300-basis-point gain versus a year ago) and an international business that is still in the red. However, the third quarter is typically Amazon's weakest ahead of the holiday season. Based on gross margin gains (up 500 basis points to 33.9%) and current investment trends, we're comfortable calling for 200 basis points of North America operating margin improvement to 6% in the fourth quarter. Additionally, many international markets are starting to demonstrate Prime adoption and third-party sales trends consistent with the maturation curve in the United States, suggesting operating margins can build to the low- to mid-single-digit range over time.

Based on the strength of AWS (which appears well on its way to 30%-plus segment margins), greater confidence in North America segment profitability, and improving international margin visibility, we plan to raise our fair value estimate to $700 per share from $600. Our model previously assumed GAAP operating margins would grow to 6.5% by 2019, but we now believe 7.0%-plus is achievable. There is always a risk to these estimates if Amazon embarks on a major investment cycle, but we're comfortable with this risk, given recent capital discipline and investments more directly aligned with the core commerce and AWS platforms.

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