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

Amazon AMZN is set to release its first-quarter earnings report on April 30. Here’s Morningstar’s take on what to look for in Amazon’s earnings and stock.

Key Morningstar Metrics for Amazon

• Fair Value Estimate: $185.00
• Morningstar Rating: 3 stars
• Morningstar Economic Moat Rating: Wide
• Morningstar Uncertainty Rating: High

Earnings Release Date

• Tuesday, April 30, after the close of trading

What to Watch for In Amazon’s Q1 Earnings

• Amazon Web Services: AWS grew 13% year over year last quarter, which was an acceleration from the 12% growth in each of the two previous quarters. We’re looking for modest acceleration again. Management believes the workload optimization efforts have ended. Microsoft is seeing similar trends and making similar comments.
• Advertising: Given price increases and the inclusion of ads in Prime Video, we’re expecting another strong quarter in advertising. Advertising grew 26% year over year in the third quarter and 27% year over year in the fourth. We’re not expecting acceleration, but we think growth somewhere in the mid-20% range would be good—even a little lower would not be problematic.
• Retail: Retail overall was ahead last quarter, and we expect solid results. It’s the largest category for the company, but the one investors seem to overlook the most. Trends appear to be slowly improving, which we expect to continue in the near term. Most of the profitability improvements for the company overall have stemmed from improvements in retail operations.
• Profitability: Profitability has been the biggest positive development over the last several quarters. Operating profits have been guided ahead of expectations, and then Amazon delivers upside to that. We think Amazon’s profitability improvements have been remarkable, and that there is room for further improvements. The regional hub model has yielded both cost savings and improved delivery speeds. Management has already identified improvements that can be to the regional hubs, even as it continues to attack other margin improvement vectors. We also note that more immediately, shipping rates, fuel prices, and a more rational labor environment contributed to margin upside in the quarter. Strength in high-margin advertising was also a tailwind, and it should remain so in 2024 and beyond as ads make their way into Amazon’s streaming portfolio.
• Artificial Intelligence: Any data points or discussion would be interesting and timely. We continue to believe Amazon is well-positioned in generative AI, and that it should benefit as the technology adoption gains steam. Management believes generative AI can add tens of billions of dollars to revenue over the next several years.

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 $185 per share, which implies a 2024 enterprise value to sales multiple of 3 times and a 3% free cash flow yield. We think multiples are a little less meaningful for Amazon, given its ongoing heavy investment and rapid scaling that depresses financial performance. However, we expect the company to significantly grow its free cash flow as it matures.

We believe the firm’s critical growth drivers over the medium term will be AWS and advertising. Since these segments earn materially higher margins than the rest of the business, we also expect them to drive margins higher over time. Over the next five years, we project AWS growing at a 15% compound annual growth revenue and advertising growing at an 18% CAGR. In total, Amazon should grow at an 11% CAGR through 2028. We model GAAP operating margin expanding from 6% (actual) in 2023 to nearly 10% in 2028 as the company grows into its expanded footprint and optimizes its substantial investment in transportation.

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. Amazon has been disrupting the traditional retail industry for more than two decades while emerging as the leading infrastructure-as-a-service provider via AWS. This disruption has been embraced by consumers and has driven change across the entire industry, as traditional retailers have invested heavily in technology to keep pace. Covid-19 accelerated these changes, and given its technological prowess, massive scale, and relationship with consumers, we think Amazon has widened its lead, and that this will result in economic returns well over its cost of capital for years to come.

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 marketplace will remain attractive to third-party sellers, as Prime continues to tightly weave consumers to Amazon. We also see AWS and advertising driving overall corporate growth and continued margin expansion.

Read more about Amazon’s financial strength.

Risk and Uncertainty

We believe uncertainty around Amazon is high, and that 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 since covid-19, as consumers 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 it enjoys an unrivaled scale to continue investing 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 logistic 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.