Opinion: Amazon’s stock price has slumped almost 34% this year. This money manager says it’s a steal and could surge 76% to $3,900 in 2 years


The stock market is a fun place – when big business sells, most people are not happy. Instead, they are frightening. This presents an excellent opportunity for long-term investors who keep their wits about them and triangulate between price and value.

While doing my own triangulations, today I find many technological stocks for sale, although in this market, as in any, I have to discriminate. Some in the group deserve a look, while others deserve to be crushed. The reason is simple: like companies in any other industry, most technology companies are doomed to failure, or at least mediocrity, by the fiercely corrosive nature of free market capitalism.

Only pit companies, to use Warren Buffett’s famous and accurate metaphor, can withstand the intense competition it generates.

For this reason, the key to unlocking successful technology investments remains the same as in all previous generations. We need to identify, buy, and maintain companies with competitive advantages that allow them to thrive while others languish.

Amazon AMZN,
-1.99%
is one of these companies. Down nearly 34% in 2022 through Monday, I think it represents an excellent long-term investment at Monday’s closing price of $ 2,216.21.

Here’s why:

Even the most skeptical will admit that Amazon has big, formidable trenches around its major companies. Its original business, e-commerce, accounts for almost 50% of all online retail traffic, and no one comes close to matching its combination of selection, price, and convenience beyond its extensive distribution network.

The company’s cloud platform, Amazon Web Services, has an equally dominant market share of outsourced computing. And while AWS’s main business is to rent “stupid servers,” it bundles that merchandise with a set of powerful software and analytics tools that are gradually integrated into customers’ day-to-day business processes. This gives AWS a Prime-like stickiness.

Therefore, the trenches of Amazon are beyond any reasonable doubt. The most notable question is: can they make money behind them? How much profit, exactly, can Amazon produce behind its castle walls? This is a tricky question, because your earnings history has been erratic.

Let’s get down to the easy part: Unlike mainstream e-commerce, AWS shows consistently healthy GAAP benefits. Last year, AWS made a 30% operating margin, in line with other capital-intensive technology-intensive companies operating on a large scale.

However, AWS has much more growth ahead of mature technology companies such as Cisco CSCO,
-1.13%.
Experts estimate that businesses spend only 10% -15% of their cloud computing budget today. Over the next generation, that figure could quadruple.

AWS made an operating profit of $ 18.5 billion last year. Although it will slow its historical growth rate from 35% to 20% over the next three years, AWS will earn more than $ 25 billion in after-tax revenue in 2024. Capitalize it in 20 times, a reasonable multiple for a higher business even in the current environment of rising interest rates, and produces a value of approximately $ 500 billion. Coincidentally, that’s about half of Amazon’s current market capitalization, minus its cash in hand.

The question then is: what is e-commerce good for? The answer depends on how much money e-commerce can earn.

After following the company for 20 years, I am convinced that e-commerce has the potential to earn about 10 times what it reported in 2021. To any reasonable person it should seem like a weird statement, so let me explain why this is rational . than magical thinking.

My first point is that Amazon has shown that it can produce profits more or less at will in e-commerce. You can catch the business that is growing behind your ditch and show abundant profits that would rival companies in the old economy. Instead, Amazon has decided that with so much more business than capturing, spending a dollar today and penalizing current profits will generate multiples of them in the future.

Amazon went public during the dot.com boom, and from 1997 to 2001 the company spent like crazy to build its e-commerce trench, producing $ 2 billion in cumulative operating losses. In the ensuing crisis, Amazon lost 80% of its stock market value. Accused by the capital markets, Amazon went into harvest mode between 2002 and 2007, producing margins of between 5% and 6% and nearly $ 2 billion in operating income.

E-commerce made 5% operating margins in 2009, and again in 2018 and 2019, but when the pandemic hit, Amazon went back into investment mode. It has doubled in 24 months the distribution infrastructure it took 24 years to build. No wonder he reported his first quarterly operating loss in six years earlier this month.

Those who worry about overloading should examine their head. Amazon’s network has doubled in two years, but its sales have grown “only” by 65%, leading to overcapacity. If Amazon’s e-commerce division grows by 10% to 15% a year, which is well below its historical rate, it will only take three to four years for the company to reach its full capacity. If sales approach their five-year historical growth rate of 20%, the problem will be resolved in two years, which led Bank of America analyst Justin Post to write correctly: “Growing existing compliance capacity can be a of the easiest problems for Amazon to solve in its history ”.

Still, given its recent decline in prices, market forces could again force Amazon to show higher profits as it did after the fall in dot com.

Read: Amazon is looking to cut costs after the first loss in seven years brought down stocks

Internal discomfort could also trigger such a move. Over the past two years, Amazon has given employees $ 22 billion worth of shares at the time of the grants, but the stock price has dropped during that time, and the bases will only be compliant for a long time.

My second point is that more than any other technology company, Amazon and its founder, Jeff Bezos, have shown that they know how to invest. They can be relied upon to offset current and future benefits. Unlike most tech entrepreneurs, Bezos began his professional life in a hedge fund. He is a big fan and student of Buffett, and understands the creation of value to the core.

Specifically, both Bezos and Buffett understand that it is smart to spend $ 1 today if there is a reasonable chance of earning more than $ 1 in the future.

Avid Reader Press / Simon & Schuster

In the late 1990s, Buffett lowered GEICO’s reported profits by spending hundreds of millions of dollars on marketing to gain new customers. I knew that spending would make GEICO seem less profitable in the present, but in the long run, it would bear fruit.

Bezos and Amazon behaved similarly. It is true that Amazon’s spending in its early days might just be called speculative, but those days are over. With huge pits around its e-commerce business, most of Amazon’s spending now involves widening and deepening its trench, throwing sharks and alligators into it, to use the colorful extension of Buffett’s metaphor.

Finally, Amazon has powerful profitability levers for pulling that it has only recently acquired. He took advantage of the fact that almost half of all e-commerce starts on his website in a $ 30 billion business that sells advertising on the site. The ad business is three times bigger than it was just three years ago, and the margins here are probably close to 100%.

In addition, most of what Amazon now sells on its website comes from third parties. When Amazon acts as a mere platform for other merchants, it avoids the biggest expense of a retailer: the products themselves. Driven by such developments, the gross margin on e-commerce, which is a good indicator of a company’s ability to drive operating profits, has gone from 25% to almost 40% over the last decade.

Amazon’s e-commerce business reported operating margins last year were 1.5%. Given the above, I think its latent earning power (which you could gain if you decide to go into crop mode) is about 15%.

AMAZON: EVALUATION

$ in millions

Operating

After taxes

Segment

Revenue 2024E

Margin

Income

Multiple

Value

Online retailer

295

6%

18

20x

301

Third party retail

137

15%

21

20x

350

Advertising

54

90%

48

20x

820

Physical stores

18

2%

0

20x

6

Subscriptions

43

0%

20x

TOTAL RETAIL SALE

547

16%

87

1,477

Cloud

107

30%

32

20x

514

TOTAL

Commercial value

1991

The actions

0.5

Value / share of 2024

$ 3,904

Price today

$ 2,215

The other way around

76%

As you can see in this chart, assigning reasonable multiples to each of your segments gets you a stock price of almost $ 4,000 in two years. That’s 75% to 80% north of where stocks are listed today, and why Amazon is one of the top positions in my portfolio and why I’m adding to it now in accounts that have money to implement.

Adam Seessel is the founder and investment director of Gravity Capital Management in New York and the author of “Where the Money Is: Value Investing in the Digital Age.”

Now read: With interest rates rising, it’s time to focus on MANG shares instead of FAANG, according to Jefferies.

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