Surging Profits Will Keep Amazon Stock on a Winning Path
05 May 2019
Amazon stock could double over the next several years, thanks to a big upswing in profits
Shares of Amazon (NASDAQ:AMZN) continued on their torrid run higher in 2019 after the technology giant reported first-quarter numbers that smashed profit expectations. Specifically, profits came in more than 50% above expectations and doubled year over year. Amazon stock popped in response, and is now up 30% year to date.
This big rally in Amazon stock is far from over.
Broadly speaking, the growth narrative at Amazon over the past several years has been centered around robust revenue growth and massive market share expansion in huge secular growth markets. That narrative ultimately powered Amazon stock significantly higher.
Now, over the next few years, the narrative at Amazon will be one centered around robust earnings growth and massive margin expansion on an already huge revenue base. Ultimately, that narrative will keep Amazon stock on a winning trajectory, despite what will likely be decelerating revenue growth.
Profits Are SurgingOverall, then, surging profits will keep Amazon stock on a winning path both in 2019, and over the next few years. As such, now isn’t the time to sell Amazon stock. Instead, AMZN stock remains a long term buy-and-hold stock.
There are two important things to know about Amazon right now. First, revenue growth is slowing after years of super-charged revenue growth. Two, profits are finally ramping after years of muted profit growth.
On the first point, Amazon’s robust revenue growth trajectory is finally losing some momentum, and that is totally natural. For several years, Amazon was the only runaway train in the e-commerce market. Now, every retailer is pivoting to the digital channel. Amazon’s market share is falling, and growth rates are coming down. Amazon’s online stores sales growth rate was just 12% last quarter, versus 20%-plus a few quarters ago, while third-party seller services growth was just 23%, versus 40%-plus a few quarters ago.
To be sure, not everything at Amazon is slowing. Although the e-commerce business is slowing down, Amazon Web Services and the digital ad business are not. But those businesses are significantly smaller than the e-commerce business. Thus, steady growth in those two segments isn’t enough to offset slowing growth in the e-commerce business, and overall revenue growth rates are falling. Net sales growth was 19% last quarter. A few quarters ago, it was at nearly 40%.
On the second point, Amazon’s profits are in the early innings of a multi-year surge. Context is important here. The e-commerce business is notoriously low margin. The cloud and digital ad business are high margin. Consequently, as the e-commerce business has slowed and the cloud and digital ad businesses have boomed, margins are dramatically expanded. Over the past few quarters, trailing twelve month operating margins have gone from 2.3% to 6.2%.
This has led to a huge surge in profits. This surge is far from over. The trend of slowing e-commerce growth and accelerating AWS and digital ad growth will persist for the foreseeable future. This dynamic will ultimately continue to produce huge margin expansion and robust profit growth for Amazon.
Huge Upside Potential Remains
Ultimately, robust profit growth creates a visible pathway for huge long term upside in AMZN stock.
In the big picture, there are three things going on here. First, Amazon is losing share in a 20%-plus growth, low margin e-commerce market. Second, Amazon is rapidly gaining share in a 10%-plus growth, high margin digital ad market. Third, Amazon is preserving market share in a 20%-plus growth, high margin cloud market.
Putting those three pieces together, it’s easy to see that Amazon projects as a healthy revenue grower over the next several years with powerful margin drivers. Realistically, I think Amazon’s revenues will grow at a 15% rate over the next several years, while operating margins will expand above 10% and towards 15%.
Modeling out those expectations, I think Amazon has an opportunity to do about $125 in earnings per share by fiscal 2025. Based on a big growth 30 forward multiple, that implies a reasonable 2024 price target for Amazon stock of $3,750. That is nearly double today’s price. As such, long-term upside potential in AMZN stock remains huge, mostly thanks to the company’s ability to ramp profits over the next several years.
Bottom Line on AMZN Stock
The revenue growth trajectory at Amazon is slowing. But, that doesn’t matter. This slowdown on the revenue growth front is accompanied by an acceleration on the profit growth front. This dynamic will persist for the foreseeable future. As it does, profits will surge higher, and that will power huge gains in Amazon stock.
By Luke Lango, InvestorPlace Contributor
Source: Investor Place