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Why We Raised Amazon’s Fair Value

Why We Raised Amazon’s Fair Value

Even the most ardent Amazon bear would have a hard time finding negatives from its second-quarter update, as Amazon Web Services, advertising services, third-party sales, and Prime memberships are each contributing to an increasingly visible long-term cash flow story.

With greater visibility for some of Amazon's highest-margin categories, we now think 8% operating margins are achievable over the next five years (assuming top-line growth in the low to mid-20s) and plan to raise our fair value estimate to $2,200 from $1,900.

Accelerating revenue growth for web services is getting a lot of attention. However, we believe it's North American retail operations that should have investors' attention, as its network effect--the primary source behind our wide moat rating--is starting to manifest in more stable profitability.

As in previous quarters, we think advertising services are among the primary reasons Amazon continues to come in above its quarterly operating profit goals, reinforcing its importance as a distribution platform for sellers, which should continue over the foreseeable future.

We also think third-party sales and increased Prime member engagement are contributing to the margin upswing, which should persist through new logistics options for sellers while Prime members take advantage of new benefits like Whole Foods and Amazon Music, which have positive member pricing implications.

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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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