The seemingly uninterrupted bull run in Amazon.com, Inc. (NASDAQ:AMZN) stock has hit a bump. Amazon cleared $1,000 in late May on its way to an all-time high of $1,083. But Amazon stock now sits 9% below those highs.
A big bottom-line miss in the Q2 earnings report has sent AMZN stock tumbling of late. But, as has historically been the case, the dip presents a buying opportunity.
What’s important here isn’t Amazon’s profits in the second quarter of 2017. It’s what the company’s profits will be in the future. With no reason to see those future earnings coming down — in fact, expectations should increase coming out of the Q2 report — there’s no reason to expect the sell-off in Amazon stock to persist.
Analyzing Amazon Stock the Right Way
There’s probably nothing in the market I find more annoying than the constant snide chatter about Amazon’s valuation being the result of investors not “paying attention” or “not focusing on value”. There’s a reasonable bear case for AMZN stock, to be sure. But using a single metric like price-to-earnings ratio to criticize Amazon longs for “ignoring valuation” is lazy, short-sighted and hypocritical.
It’s true that AMZN isn’t terribly profitable at the moment. Operating margins in the first half were just under 4%. Compare that to Apple Inc. (NASDAQ:AAPL), whose EBIT margins were 27% in the first three quarters of its fiscal 2017.
But it’s equally true that Amazon shouldn’t be all that profitable at the moment. The company still has massive opportunities in multiple markets. International revenues are only about one-third of Amazon’s total sales, leaving plenty of room for growth. Adding customers to Amazon Web Services usually involves upfront costs — in exchange for high-margin, long-term recurring revenue. And a series of initiatives targeting various markets already dominated by major companies costs money as well.
Some of those efforts may not work — in fact, it’s almost certain that some will fail. But that’s OK: Amazon has failed many times before, as CEO Jeff Bezos himself has pointed out. And that’s no reason for Amazon to pull back on spend which should drive long-term shareholder value. Nor is there any reason for investors to ignore the impact of that upfront spending on current financials.
Amazon’s Amazing Growth
From that standpoint, the focus on profitability makes little sense. But it also misses another point. AMZN bears complain that Amazon stock has “defied reality” for two decades in part due to help from bullish analysts and investors. After all, those Amazon stock bulls ‘ignore’ the fact that the company never has been consistently profitable.
But the reason bulls aren’t focused on profitability yet is that Amazon’s opportunity — two decades after its IPO — still is that large. And its sales growth still is torrid. Amazon generated $136 billion in revenue last year — and it’s expected to grow sales another 24% this year.
That’s an absolutely incredible combination, and one that’s almost unprecedented. Only Alphabet Inc (NASDAQ:GOOG, NASDAQ:GOOGL) comes close and both its sales and growth are lower than that of Amazon. (Alphabet, too, is spending billions to drive that growth.)
The market might be wrong on AMZN stock, though I don’t think it is. But the argument that it’s not paying attention is simply silly. Amazon bulls aren’t just reading charts or paying silly earnings multiples based on the ‘greater fool theory’. They’re taking the long view.
Yes, AMZN Stock Is A Buy
And the long view still suggests that Amazon stock is a buy. Valuation is expensive, admittedly, even considering the potential for profit maximization down the line.
But investors should pay for quality, and Amazon is a quality business. Particularly in the U.S., it is deeply embedded in daily life. It’s likely by year end that over half of U.S. households will have a Prime membership. An increasing number of those households (mine included) use the Alexa voice control system.
A similarly growing number of businesses use AWS, which still has a huge lead on Microsoft Corporation (NASDAQ:MSFT) platform Azure. And its reach is only going to grow, as it continues to expand internationally, as it integrates its acquisition of Whole Foods Market, Inc. (NASDAQ:WFM), and as it continues to find new ways to generate revenue and — eventually — profits.
It’s true that Amazon isn’t particularly profitable right now. But the point is that it shouldn’t be. As long as the dollars being spent now are driving more in future profit — as appears to be the case — then Amazon is creating shareholder value. And below $1,000, I still don’t think that value is fully reflected in the Amazon share price.
As of this writing, Vince Martin did not hold a position in any of the aforementioned securities.