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Pros and Cons to Buying Amazon Stock

Pros and Cons to Buying Amazon Stock
15 Sep 2019

Should you buy Amazon stock? It’s a question many investors might be asking themselves as shares of the online retailer approach all-time highs.

AMZN has been rocketing higher in recent years due largely to a long series of earnings beats as it quickly made the transition from an intermittently profitable company to one of the most impressive large-cap earnings growth stocks out there.

Primarily responsible for that: the growth of its cloud division Amazon Web Services (AWS). Impressive growth in Prime subscribers and blowout sales of Alexa-enabled devices haven’t hurt, either.

AMZN stock has risen 21% so far in 2019 and 457% over the last five years.

Those are clearly exceptional returns; here’s a quick look at the dynamics of Amazon’s business and an overview of the pros and cons to buying Amazon stock.

Amazon Stock at a Glance

Bezos, who started the e-commerce company as an online bookseller in the 1990s, has been in aggressive growth mode ever since. He never cared much about making a profit each year but focused intensely on pleasing the customer, and in doing so, building market share.

More than 20 years later, the market share has followed, and so have profits. In 2018, Amazon reported revenue of $232.9 billion, up 31% from the year before.

The vast majority of Amazon sales are generated on its increasingly dominant eponymous online shopping platform, which currently sells almost every product you can imagine. Sellers can pay extra to use Fulfilled by Amazon (FBA) — Amazon warehouses, packs and ships their products, which are also eligible for Prime two-day shipping.

Amazon Prime, its $119 per year subscription service with perks, including two-day shipping, an online streaming video service, photo storage and discounts on select company products, has an estimated 105 million members in the U.S. alone.

Alexa, its virtual assistant technology, comes standard in the company’s Echo line of smart speakers, which have sold by the tens of millions worldwide.

Pros to Buying Amazon Stock

Like other ridiculously successful Silicon Valley companies Facebook ( FB), Netflix ( NFLX) and Alphabet ( GOOG, GOOGL), Amazon is a founder-run company. But even compared to the enviable track records of those names, Bezos’s leadership is exceptional.

Bezos has built a culture that ignores the myopic quarter-to-quarter mindset of Wall Street, doing everything with an eye to the long term. He believes “current” earnings were actually earned due to decisions three to five years ago.

His obsession with customer service is now a core part of Amazon’s ethos — as is his ruthlessness. And if there were any doubt, Bezos is also the largest single owner of Amazon stock, so his interests are clearly aligned with shareholders.

The second big advantage to owning AMZN stock is, simply put, the company’s willingness, desire and ability to disrupt an extraordinarily wide range of industries. started as a disruptor, forcing brick-and-mortar booksellers out of business due to its scale, lower overhead and convenience. It didn’t take long for Amazon to push from hawking books to all sorts of product categories — toys, electronics, clothes, tools, you name it.

The e-commerce giant’s ambitions continued to evolve, and in 2017 it surprised Wall Street by acquiring organic foods grocer Whole Foods for $13.4 billion. It offers its own branded credit card and is considering moving seriously into retail banking.

Amazon is also building out its own delivery service and working on drone technology that could one day rival UPS ( UPS) and FedEx ( FDX). A partnership with Berkshire Hathaway ( BRK.A, BRK.B) and JPMorgan Chase & Co. ( JPM) aims to disrupt health care, though it’s not clear exactly how yet.

The third and final “pro” to buying AMZN stock — aside from all the implied pros that come from the dominant company and ruthless culture Bezos has built — is AWS, Amazon’s cloud computing business.

Yet another one of the company’s bold ventures into new frontiers, Amazon shares owe a huge debt to AWS for their otherworldly performance in recent years.

Think about it this way: It wasn’t until 2018, a full 24 years after its inception, that Amazon’s retail operations reached the margins and scale needed to consistently turn a profit. But AMZN had been able to break even or turn a modest profit for years by then, and for one reason: AWS.

In 2017, Amazon’s global retail revenue was $160.4 billion, on which it generated and operating loss of $225 million. But Amazon actually boasted more than $4 billion in operating profits that year. How? AWS, which generated operating profits of $4.3 billion on just $17.5 billion in revenue.

That fast growing and high margin segment of Amazon allows the company to invest so heavily in logistics, smart speakers, e-readers, original content for its streaming video service, and so on. And it’s pretty helpful when it comes to competing on price, too.

AWS is also expected to be the testing grounds for future huge opportunities for growth, particularly artificial intelligence and machine learning.

Cons to Buying Amazon Stock

Sometimes there’s a problem with having a few really impressive strengths. It’s the age-old concept of the double-edged sword. The Achilles’ heel.

Arguably Amazon’s two biggest competitive advantages are its CEO, Bezos, and its AWS division.

Bezos, 55, seems healthy and should have plenty of gas left in the tank. But the founder risk associated with Amazon shares is very much present: as much as any thriving company in the world, Amazon’s success and ability to constantly stay a step ahead of competitors is a result of one person’s vision and leadership.

Brilliant as Bezos is, he’s not immortal. One wayward bus and shareholders could be left owning an awesome business that suddenly forgets the things that made it great.

Then there’s Amazon Web Services. AWS is still tops in the cloud computing industry by a pretty large margin, but Microsoft’s ( MSFT) Azure is routinely growing far faster than AWS, though from a smaller base. Microsoft doesn’t break out revenue for Azure, just its growth rate, but competition is clearly heating up, and it’s not impossible to see AWS with stagnant or slightly declining market share in two or three years.

Adding more bells and whistles to AWS is the only way to defend against this; without differentiation cloud computing can be considered a commodity service sold on price. And Google Cloud, Alibaba ( BABA) Cloud, and competitors like IBM ( IBM) could eventually spell an end to AWS’s meteoric margins.

A few other non-trivial issues that should concern the cautious investor debating whether they should invest in Amazon stock: the stock’s valuation, and the increasingly likely risk of regulation.

Knowing how to properly value Amazon has always been tough, but a $900 billion company trading at 54 times forward earnings is unprecedented. And U.S. regulatory agencies recently came out and admitted they were looking at a handful of big tech companies. Amazon was one of them.

The Bottom Line on Amazon Stock

Amazon’s one-of-a-kind CEO Jeff Bezos is in the same league as Steve Jobs. He’s built a company with a culture that’s so customer-centric that it practically has a mandate to be disruptive and ruthless.

And AWS, a result emblematic of the company’s resolve to innovate, is a cash cow financing future innovations and investments, creating a self-perpetuating, accelerating process Bezos refers to as a “flywheel.”

Still, the main issue with AMZN stock in essence is this: The market seems to be pricing the company as if its current strengths won’t weaken and its future execution will be perfect. The future, of course, is unpredictable.

Capitol Hill is increasingly wary of big tech, and as Amazon’s size gives it monopoly-like power in certain spaces, regulators are taking notice. So are some of Amazon’s most important business partners — UPS recently announced it was going to stop delivering packages for the e-tailer. Amazon is investing billions in its own shipping and delivery network that includes planes, truck fleets, and shipping vessels, and UPS doesn’t want to help a future rival grow.

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Amazon stock is expensive, no question. But U.S. antitrust actions haven’t packed a punch in decades.

While AMZN probably isn’t the stock to buy for conservative retirees seeking stability, long term investors who know they can handle volatility should definitely own some Amazon shares.

Bezos didn’t become the world’s richest person on accident — he’s the single best allocator of capital in the world right now, which means he’s seldom unprepared for future opportunities and challenges.

To this end, Bezos’ determination to build a culture of customer obsession and innovation should insulate Amazon when, eventually, Bezos is no longer around.

By John Divine

Source: Yahoo Finance UK