Amazon (NASDAQ:AMZN) shares have fallen more than 15.5% since the beginning of September when it reached $3,531 per share. AMZN stock still looks undervalued, as I pointed out in my article last month, even though I was too early on my assessment.
In that article, I argued that AMZN stock was worth at least $3,775 per share. That is more than 25% above its current prices. I stand by that estimate today, as I feel that the underlying reasons for the forecast are still in place.
In fact, I have raised my target price slightly since estimates for the company’s fourth-quarter sales have risen. My new target price is $3,779.57.
Free Cash Flow Drives Everything
My forecast is based on the company’s powerful free cash flow (FCF). Amazon likes to review its performance each quarter based on its last 12 months (LTM) FCF. And as I pointed out in my last article, Amazon uses a slightly different definition of FCF, whereas I use the traditional one.
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You can see in the chart at the right that Amazon is expected to make $35.4 billion in LMT FCF at the end of Q4.
This will be more than 63% higher than the prior year. This is based on its historical operating margin and FCF conversion margins.
I use this to value AMZN stock. The way I do this is to apply an FCF yield analysis.
For example, taking $35.4 billion and dividing it by 1.86% (the FCF yield), the market value is $1.897 trillion. Assume 502 million shares outstanding and the per-share value is $3,779.57.
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You can see the relationship between the FCF yield assumed and the estimated stock price in the chart at the right.
Now obviously if the FCF yield set by the market is a higher number, then the per share target price would be lower.
In this chart, I assume that as FCF continues to grow, especially given the company’s margins, the yield will be well below 2%. That is how I came up with the estimate for $3,779.57 per share, as shown in the chart.
What Some Analysts Say About Amazon
RBC analyst Mark Mahaney has a similar price target, $3,800, and an “outperform” rating as of late July. Recently, Seeking Alpha pointed out that the analyst said its logistics network strategy could become a catalyst or tailwind for the stock.
At one point this summer, Barron’s magazine argued that Amazon should be the world’s most valuable stock. The author cited a report from Citi analyst Jason Bazinet who raised his target to $3,550 per share.
However, the magazine noted that the stock doesn’t usually trade above its average price target.
Not everyone is so sanguine about Amazon. A Barclays analyst was reported by Seeking Alpha as saying that mega-cap tech stock prices are now at “dot-com bubble levels” from the year 2000.
What to Do With AMZN Stock
The fourth quarter will clearly show an increase in FCF at Amazon. I believe that investors will warm up to the stock then when they realize that online shopping is taking a larger portion of overall Christmas sales.
For example, a recent article in the Financial Times shows, reviews of Amazon products are now so important that regulators in the UK are stepping in and getting involved.
Nevertheless, Amazon stock is likely to move higher as the market realizes that its FCF will continue to grow at very high rates. This is what supports its high FCF yield.
For example, my price target for Amazon stock of $3,780 represents a gain of some 25% over today’s price. Even if it takes two years to achieve that price, the compound annual gain will be 13.1% annually. For most people that represents a very decent ROI.
On the date of publication, Mark R. Hake did not have (either directly or indirectly) any positions in any of the securities mentioned in this article.
Mark Hake runs the Total Yield Value Guide which you can review here.
