Shares of internet juggernaut Amazon (NASDAQ:AMZN) have had a strong 2019. In 2019, Amazon stock is up nearly 30%, on the back of improving macro and economic fundamentals, strong earnings reports, and the continued expansion of its business.
In the near-term, the rally of AMZN stock may need to take a breather. Investors had been pricing in multiple interest-rate cuts over the next several months. However, recent language from the Fed indicates that it will cut rates gradually. That means there will be only one cut this summer, and then the central bank will take a “wait-and-see” stance. As investors reset their rate-cutting expectations, growth stocks with valuations that have been boosted by low rates will retreat.
Amazon stock is in that category. But its struggles won’t last forever. Eventually, rate-cut noise will fade into the background, and Amazon’s long-term growth outlook will power AMZN stock higher.
In the big picture, AMZN is a mega-growth company on the verge of a profit breakout, thanks to the rapid expansion of its digital-ad business and the continued ramp of its cloud business. At the same time, worries about the risks facing AMZN stock are overblown.
The takeaway, then, is simple. Amazon stock may be weak over the next few weeks. But such weakness would be nothing more than an opportunity to buy into a stock that will go way higher in the long run.
The Reset of Rate-Cut Expectations Could Hurt Amazon Stock
Over the next few weeks, Amazon stock could retreat as investors reset their interest-rate cut expectations from multiple cuts in the pipeline to one cut.
It is important to understand that all equities are boosted by low real rates. Low rates do two things. First, they essentially wipe out the real returns of the bond market because the yield on risk-free instruments is cancelled out by inflation. That makes investing in equities more attractive than investing in bonds. Second, they increase the net present value of future profits. The discount rate on those future profits decreases because of depressed risk-free-return expectations. That increases the theoretical present value of equities.
As a result, low rates provide a lift to most stocks. They provide an especially big lift to growth stocks like Amazon. Growth stocks derive most of their value from future profits, so as the present value of those future profits increases due to lower rates, the overall value of growth stocks increases by a higher percentage than that of the average stock.
Consequently, as investors begin to anticipate fewer rate cuts than previously, all growth stocks, including Amazon stock, will face a headwind.
Other Risks Are Overblown
While a reset of rate- cut expectations does present a serious risk to AMZN stock in the foreseeable future, worries about other risks facing AMZN are grossly overstated, as these risks will not be material in the big picture.
Bears love to pound on the table about how rich the valuation of Amazon stock is. Yes, it’s rich, at 70-times forward earnings. But this company has shown a unique ability to consistently grow into its high valuation through sustained, robust revenue and profit growth. That’s why AMZN’s price-earnings multiple has consistently compressed over the past several years. Further, low rates are here to stay for the foreseeable future. Low rates help support the high multiple of AMZN stock.
Thus, valuation risks are overstated.
Bears also love to cite regulation risks as a reason to avoid Amazon stock. But Amazon is far from a monopoly. Instead, while the company is very large, it also operates in intensely competitive industries. On the retail front, there are Walmart (NYSE:WMT), Target (NYSE:TGT), and many more, all of whom are actually gaining ground on Amazon in the e-commerce world. Meanwhile, on the cloud front, there are Alphabet (NASDAQ:GOOG) and Microsoft (NASDAQ:MSFT), both of whom have cloud businesses which are very competitive with Amazon Web Services.
Thus, regulation risks are overstated.
The Long Term Growth Outlook of AMZN Stock Remains Compelling
The larger trends supporting AMZN stock remain highly favorable.
AMZN is still the world’s leading e-commerce company, with an e-commerce business whose revenue is increasing at a relatively steady, double-digit-percentage pace. Meanwhile, AMZN is also still the world’s leading cloud infrastructure company, with a cloud infrastructure business whose revenues are increasing at a steady 20%-plus pace and generating high margins.
At the same time, Amazon is rapidly expanding its high-margin digital-ad business, pushing forward into offline commerce, in the early stages of launching an e-pharmacy business, and quietly rolling out its own logistics network.
Putting all that together, Amazon’s top line can easily rise 15%-plus for the next several years. Thanks to the ramp of its high-margin cloud and digital-ad businesses, its profit growth looks well-positioned to be a lot higher than that.
That robust profit-growth trajectory should keep Amazon stock on a winning path for the foreseeable future.
The Bottom Line on AMZN Stock
Amazon is a rapidly growing company, and its outlook is relatively certain. That combination of strong growth and high visibility warrants paying a premium for AMZN stock. As a result, while AMZN stock may trade lower over the next few weeks thanks to a reset of rate-cut expectations, that weakness is nothing more than a longer-term buying opportunity.
As of this writing, Luke Lango was long AMZN, WMT, TGT, and GOOG.
