Why we think Amazon stock is now a buy

Amazon remains the clear leader in e-commerce, and efforts to improve operations have paid off. The company is also a leader in public cloud services and is well positioned for all things AI – and these are all secular trends.

We weren’t as aggressive in the short term as the street, so the results and guidance were a little more in line with our thinking. Our estimated fair value increased from $2 to $195 based largely on the time value of money in our model. We don’t think the long-term story has changed and see the quarterly results as more noise.

E-commerce led the weakness in the quarter, which seems obvious given the pressure consumers are under with inflation. AWS has been strong and continues to accelerate, with new workloads moving to the cloud and generative AI driving relative strength. Advertising remains another bright spot, outpacing advertising growth at Meta Platforms ( META ) and Alphabet ( GOOGL ).

The following are the highlights of Dan Romanoff’s current outlook for Amazon and its stock. The full report and more of his coverage of Amazon is available here.

Morningstar Key Values ​​for Amazon Stock

• Estimated fair value: $195.00
• Morningstar rating: 4 stars
• Morningstar Economic Moat Rating: Lat
• Morningstar Uncertainty Rating: Medium

Estimated fair value for Amazon stock

With its 4-star rating, we believe Amazon stock is undervalued compared to our long-term fair value estimate of $195 per share, implying a multiple of 3x enterprise value on 2024 sales and cash flow yield free of 2%. We think the multiples are slightly less meaningful for Amazon, given the ongoing heavy investment and rapid scaling that is depressing financial performance. However, we expect the company to significantly increase its free cash flow as it matures.

In the long term, we expect e-commerce to continue to take away from retailers. Additionally, we expect Amazon to gain online share. We believe that in the medium term, covid-19 has attracted some demand by changing consumer behavior and better penetrating some retail categories that previously had not gained as much traction online, such as grocery, pharmacy and luxury goods. We believe Prime memberships and the benefits that come with them, along with selection, price and convenience, continue to drive the retail story. We also see international as a long-term opportunity in retail. We model total retail revenue growing at a compound annual growth rate of 8% over the next five years.

Read more about estimating Amazon’s fair value

Economic evaluation

We give Amazon a wide moat based on network effects, cost advantages, intangibles and switching costs. The company has disrupted the retail industry for more than two decades as it emerged as a leading infrastructure-as-a-service provider through Amazon Web Services. This disruption has been embraced by consumers, driving changes across the industry as traditional retailers have invested heavily in technology to keep up. Covid-19 has accelerated this shift, and given the company’s technological prowess, massive scale and relationship with consumers, we believe Amazon has extended its advantage, which we believe will result in economic returns well in excess of its cost of capital for the following years.

We think Amazon’s retail business has a wide moat. It has network effects associated with its marketplace, whereby many buyers and sellers continuously attract more buyers and sellers. It has a cost advantage related to purchasing power, logistics, vertical integration (own brands, owned delivery and so on) and a negative cash conversion cycle. And the business owns intangible assets associated with technology and branding.

We also believe that AWS is a business with a wide moat. It has high customer switching costs, a cost advantage associated with economies of scale through which few competitors can keep up with Amazon’s pace of investment, intangible assets from developing semiconductors and facilities, and a network effect associated with a market for software created to make AWS work better.

Amazon’s burgeoning advertising business has, in our view, a narrow moat based on intangibles from its proprietary data on hundreds of millions of users, as well as a network effect that refocuses buyers and sellers which meet in the largest available locations.

Read more about Amazon’s economic moat

Financial strength

We believe Amazon is financially sound. Revenues are growing rapidly, margins are expanding, the company has unparalleled scale, and its balance sheet is in great shape. In our view, the company’s market will remain attractive to third-party sellers as Prime continues to tightly knit consumers together. We also see AWS and advertising driving overall company growth and continued margin expansion.

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Risk and uncertainty

Amazon’s uncertainty rating is high. Despite being a leader in e-commerce, the company faces a variety of risks.

Amazon needs to protect its leadership position in online retail, which can be challenging as consumer preferences change (especially in the wake of covid, as they may revert to previous behaviors) and brick-and-mortar retailers strengthen their online presence. Maintaining an e-commerce edge has pushed the company to make investments in non-traditional areas, such as producing content for Prime Video and building out its carrier network. Similarly, the company must maintain an attractive value proposition for its third-party vendors. Some of these investment areas have raised questions from investors in the past, and we expect management to continue to invest according to its strategy, despite periodic margin pressure from rising expenses.

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AMZN Bulls say

Amazon is the clear leader in e-commerce and enjoys unparalleled scale to continue to invest in growth opportunities and deliver the best customer experience.

High-margin advertising and AWS are growing faster than the corporate average, which should continue to boost profitability over the next few years.

Amazon Prime memberships help attract and retain customers who spend more with Amazon. This reinforces a strong network effect while bringing recurring and high-margin revenue.

AMZN The bears say

Regulatory concerns are growing for big tech firms, including Amazon. In addition, the firm may face increasing regulatory and compliance issues as it expands internationally.

New investments – particularly in execution, delivery and AWS – should dampen free cash flow growth. Also, Amazon’s penetration in some countries could be more difficult than in the United States due to inferior logistics networks.

Amazon may not be as successful in breaking into new retail categories, such as luxury goods, due to consumer preferences and an improved e-commerce experience from larger retailers.