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Earnings Erase Key Doubts About Amazon Stock

Amazon (NASDAQ:AMZN) stock is back at the highs. A blowout fourth quarter earnings report last week sent Amazon stock up 7.4% and back above $2,000.

Earnings Erase Key Doubts About Amazon Stock
Source: Sundry Photography / Shutterstock.com

After the jump, investors might be tempted to take profits. This is an excellent business, but valuation, as always is the case with Amazon, looks stretched.

But the fourth quarter report is beneficial to Amazon stock for reasons that well go beyond a simple headline beat. It’s not just that Amazon beat expectations, but how the company did so that matters.

Meanwhile, valuation is much more reasonable when considering the factors at play, and after Q4 the long-term story here seems not just intact, but strengthened. I had long been a bull on Amazon before backing off last year amid short-term concerns; but last week’s earnings go a long way toward assuaging those worries.

A Headline Beat

Purely in terms of the broad numbers, the fourth quarter report looks bullish for Amazon stock. Revenue growth of 20.8% year-over-year was almost two points better than Wall Street expected. But it was profits that truly shone: earnings per share of $6.47 was a full $2.51 better than consensus.

Expectations aside, investors should take note of the numbers themselves. Again, Amazon grew revenue nearly 21% year-over-year off a base of over $72 billion. For the full year, sales increased $47.6 billion, which as total revenue would rank Amazon 66th in the Fortune 500, just behind Cigna (NYSE:CI) and Cisco Systems (NASDAQ:CSCO).

The list of companies driving that type of growth off that size a base is basically Alphabet (NASDAQ:GOOG,NASDAQ:GOOGL) and no one else. Even Alphabet’s revenue is barely half that of Amazon.

As for the criticism that Amazon isn’t profitable enough, its full-year operating margins came in at over 5%, roughly in line with those of 2018. The figure at Walmart (NYSE:WMT) is closer to 4%. Obviously, Amazon Web Services skews that comparison, but Amazon’s North America segment still posted margins in line with those of Walmart, per figures from the Form 10-K filed with the U.S. Securities and Exchange Commission.

This continues to be a stunningly impressive business, with literally historic revenue growth and solid profit margins. Obviously, that was true before the fourth quarter as well. But Q4 results do seem to quell two of the key risks that dogged Amazon stock heading into the report.

One-Day Shipping

In April, Amazon announced that it would offer free one-day shipping to its Prime customers. The move wasn’t expected to be cheap: Amazon forecast an impact to earnings of $800 million in the second quarter, which would balloon to an estimated $1.5 billion in the busier Q4.

To at least some extent, that decision weighed on Amazon stock for the rest of 2019. Shares did rally to $2,000 (briefly) in July, but a second quarter earnings miss led to a reversal. Amazon would stay stuck for several more months before perking up in December.

The issue wasn’t just a matter of one-time costs. With Walmart and Target (NYSE:TGT) driving accelerated revenue growth through their omnichannel efforts, the worry was that Amazon was spending a few billion dollars annually simply to keep pace. Amazon’s (mostly) online-only model long had seemed like an advantage against brick-and-mortar rivals. The convenience promised by the “whatever you want, however and wherever you want it” offerings from Target and Walmart threatened to turn that advantage on its head.

But Q4 suggests that those worries at least were somewhat overblown. Despite revenue above its own expectations, Amazon’s spending on one-day shipping still came in below its guided $1.5 billion. And while operating income in the North America segment did decline 16%, it fell just $351 million year-over-year.

In the context of well over $1 billion in higher shipping costs, and future savings as Amazon removes one-time expenses and increases shipping efficiency, that’s a manageable decline. It’s certainly nothing that suggests Amazon is losing its competitive edge. Rather, it now looks like, as management promised, the North American retail business will return to profit growth in 2020 and beyond.

Amazon Web Services

The other key risk for AMZN stock is related to the Amazon Web Services business. That cloud provider is a powerhouse, and a key part of the valuation for Amazon stock: last year, one analyst valued AWS alone at over $500 billion.

Concerns mounted in 2019. Weak margins in the third quarter raised fears of either market share losses and/or pricing pressure. Both fears made some sense. Competitors have been targeting the cloud space for years now. Microsoft (NASDAQ:MSFT) has established itself as a legitimate rival with Azure, but the likes of Oracle (NYSE:ORCL), IBM (NYSE:IBM), and Google continue to fight for the remaining market share. Rock-bottom pricing would seem one way to attract new customers, with hopes of then slowly adding to profitability over time.

Meanwhile, Amazon’s vast business itself seemed a competitive disadvantage. Would any retailer work with AWS, and in the process do business with an ostensible rival? What about streaming video and music companies like Netflix (NASDAQ:NFLX) and Spotify Technology (NYSE:SPOT)?

Here, too, Q4 results should calm investor nerves. AWS revenue grew a healthy 34% year-over-year to just shy of $10 billion in the quarter. All of Google Cloud — not just its Google Cloud Platform which competes with AWS — is generating $10 billion a year, according to Alphabet’s earnings disclosures this week.

As for AWS margins, they actually expanded year-over-year in Q4. And so the growth rate, the size of the revenue, and the margin improvement all suggest that business remains on track. Given the importance of AWS to Amazon stock, that unquestionably is good news.

The Risks to Amazon Stock

And so Q4 earnings seem to set a path for Amazon stock to finally hold new highs. But there are some risks here — one of which is the use of the word “finally” in the preceding sentence.

Amazon has been here before. A late-day fade in trading Friday marked the fourth time that Amazon stock had cleared a $1 trillion market capitalization intraday but failed to maintain that level at the close. (As of this writing, AMZN should hold $1 trillion in trading Monday.) This is also the fourth time that Amazon stock has cleared $2,000. The first came all the way back in early September 2018; each of the preceding trips to these levels have been brief.

Valuation too may play a role. At over 50x 2021 EPS estimates, Amazon stock remains expensive.

But those risks seem worth taking, particularly given that the broader, deeper worries raised by recent performance seem assuaged by Q4 results. AMZN stock isn’t cheap — but it shouldn’t be. And in the context of the billions of dollars being invested in areas like the grocery business, content, and one-day shipping, its underlying earnings power undoubtedly is far higher than reported earnings suggest.

As I’ve written before, if Amazon decided one day to become more profitable, it could do so instantly, and materially. Instead, it keeps investing in its business. Those near-term costs have long-term benefits, with one-day shipping looking like another wise investment.

Short-term trading may well be choppy, particularly in a suddenly volatile broad market. But AMZN has rewarded investors who have rode out past bouts of volatility, and I expect it will do so again.

More broadly, focus on valuation and short-term risks is a good way to lose sight of the unbelievably attractive business underneath. That’s what I did myself heading into Q4 — and it’s a mistake I don’t plan to make again.

As of this writing, Vince Martin has no positions in any securities mentioned.


Article printed from InvestorPlace Media, https://investorplace.com/2020/02/earnings-erase-key-doubts-amazon-stock/.

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