Amazon.com, Inc. (NASDAQ:AMZN) is in the headlines for its second annual Prime Day, so this seems as good a time as any to look at the bull and bear case on AMZN stock.
AMZN’s valuation and inconsistent profitability has been something that has dogged the stock since its earliest days, and those remain a part of the case against it. If you just look at some of the most basic valuations metrics, Amazon stock does indeed look extremely expensive, if not overpriced.
Bulls have always been able to counter this with AMZN’s long-term goals. The company is constantly in investment mode, purposely plowing earnings back into building the extant business and expanding into new ones. It’s this imperial ambition that makes AMZN so attractive to bulls.
Amazon Prime Day is an example of this. Sure, last year’s event generated a record day of sales for the e-commerce leader, but that’s not why it decided to do it again. It’s a marketing effort. The goal is to expand the membership rolls of the Amazon Prime, which is far more lucrative than the non-subscription way of shopping the site.
True, Prime is just one of Amazon’s highly credible growth strategies, but that doesn’t mean any of them have to work. Every company stumbles from time to time, and the ones with the highest valuations often fall the hardest.
Amazon stock is up roughly 70% over the last year and the valuation looks stretched by some traditional measures. Should investors wait for a better entry point? Or does it just not matter given the long game AMZN is playing?
To get a sense of whether AMZN is a good buy right now, let’s look at some of the pros and cons.
AMZN Stock Pros
Mega-Cap Growth. Amazon is a massive company with an astonishing growth rate. With a market capitalization of $360 billion, AMZN is just as big as — if not bigger than — Berkshire Hathaway Inc. (NYSE:BRK.A, NYSE:BRK.B), and it is larger than Johnson & Johnson (NYSE:JNJ) and General Electric Company (NYSE:GE). The difference is that AMZN has a projected long-term growth forecast of 50% a year. Those other giants poke along at 12% tops.
Battleship Balance Sheet. For all the handwringing over Amazon’s traditionally erratic profitability, the balance sheet and cash flow situations underscore how much this just doesn’t matter. As Moody’s points out, Amazon has an excellent liquidity profile, with almost $20 billion in cash and marketable securities at the end of 2015 against total debt of slightly over $20 billion. At the same time, it generated free cash flow of more than $8 billion. This company is safe despite its ambitious plans.
World Domination. The strongest part of the bull case on Amazon is that it already dominates the fast-growing e-commerce sector and has more than a foothold in other key markets of the future. From streaming media to the Internet of Things, AMZN has a purchase, and its position in cloud-based services is an accelerating driver of growth.
Amazon Stock Cons
Valuation. Amazon stock trades at about 75 times forward earnings. That’s not an insane premium for a company with a long-term growth forecast of 50%, but it can hardly be called a value stock. The danger comes from what happens if the market starts to question the growth trajectory. In that case, the multiple would come crashing down just like Apple Inc.‘s (NASDAQ:AAPL) did on iPhone anxiety.
Competition/Disruption. Amazon is fighting a war on many fronts against murderers’ row of opponents. Alphabet Inc‘s (NASDAQ:GOOG, NASDAQ:GOOGL) Apple, Netflix, Inc. (NASDAQ:NFLX) and Microsoft Corporation (NASDAQ:MSFT) are just some of its rivals for things like digital media and cloud services. Then there’s the unknown.
It seems unlikely that any upstart — or Wal-Mart Stores, Inc. (NYSE:WMT) — could dislodge AMZN in e-commerce just because of the infrastructure involved, but never say never in the tech space. Disruption is a way of life.
Little Room for Error. An investment in Amazon is all about deferred gratification but that doesn’t mean it can just print net losses whenever it wants. A string of those would surely turn the market off. And so it has to pay close attention to its very thin margins. When you have a net profit margin of 1%, it doesn’t take much to swing the bottom line to red from black.
The Verdict on AMZN
Amazon stock is a buy. The long-term growth story is just too compelling. This mega-cap is laughing at the law of large numbers like no other. E-commerce is still only a small part of total U.S. retail sales, and that alone makes a strong buy case for AMZN. But it’s the company’s disregard for the market’s quarterly nitpicking and truly strategic vision that makes it stupid to bet against.
As of this writing, Dan Burrows did not hold a position in any of the aforementioned securities.
