When it comes to Amazon (NASDAQ:AMZN), the bull thesis can be summed up in one sentence: Amazon has a built a huge and unparalleled global e-commerce ecosystem, which it is now leveraging to build multiple, valuable tangential-business verticals. Furthermore, the sum of these verticals will power robust revenue and profit growth longer-term and drive Amazon stock meaningfully higher.
The core idea here isn’t hard to understand. Amazon is only scratching the surface of how much it can monetize each one of its 100 million U.S. Prime members. Right now, that includes revenue from Prime and Amazon.com sales. However, management has several expansive options at its disposal.
For example, Amazon can throw digital ads at those 100 million members. They can also sell them pharmaceutical goods, as well as create for them a logistics system. Later, management can outsource that system much like they did with Amazon Web Services. Plus, they can create a parallel offline business, sell more private-label brands, and create better streaming music and video services.
In other words, Amazon’s future opportunity to monetize its dedicated Prime membership base is enormous. Management realizes this, and they are doing everything possible to scale these opportunities. Some of them won’t pan out. Some of them will. The ones that do work will ultimately add billions of dollars of profits to Amazon’s bottom line. They will also serve as the fuel for the next leg higher in Amazon stock.
The most exciting of these new verticals? Digital ads. Considering Amazon’s wide reach and robust, unique consumer-data set, I reasonably think Amazon’s digital-ad business has the potential to double the company’s profits by 2025. If so, that massive growth will inevitably drive Amazon stock significantly higher.
Amazon’s Digital Ad Business Has Big Potential
Amazon is one of the most visited websites in the world. Depending on whom you ask, Amazon.com ranks anywhere from tenth to fifteenth place internationally. Excluding adult or China-based websites, Amazon.com is right behind Google (NASDAQ:GOOG), YouTube, Facebook (NASDAQ:FB) and Instagram. Yet, relative to those highly visited web peers, Amazon has a tiny digital-ad business.
The Google advertising ecosystem, including YouTube revenues, is projected to measure north of $100 billion in revenue this year. Analysts expect Facebook’s advertising umbrella, including Instagram revenues, to measure around $70 billion in revenue this year. Meanwhile, Amazon’s digital-ad sales will likely hit just $14 billion in 2019.
That’s relatively miniscule. Further, of the global digital-ad pie, industry experts forecast Amazon’s market share to reach merely 4% this year.
This will change dramatically over time. Amazon is just now getting serious about its digital-ad business. They have the reach (a popular website) and data (consumer-behavior profiles) to grow share quickly in this market. This is already happening. The Wall Street Journal reported that ad dollars are flowing in bulk from Google to Amazon, while eMarketer says that Amazon’s share in the U.S. digital-ad market will rise from around 4% in 2018, to approximately 7% by 2020.
Overall, then, Amazon has a clear trajectory to dramatically grow share in the secular growth global digital ad market over the next several years.
Digital Ad Growth Will Drive a Profit Surge
In the big picture, growth in the digital-ad business is important for Amazon stock because it will lead to a profit surge that will allow the stock to head meaningfully higher.
Based on steady, mid-single digit growth rates, the global media-advertisement market should grow to $1 trillion by 2025. Digital ad penetration should rise closer toward 65% by then, implying a $650 billion digital-ad market. It’s reasonable to assume Amazon takes home about 10% of this segment. That would give Amazon $65 billion in digital-ad revenue by 2025.
Facebook operates around 40% operating margins. Applying those same margins to Amazon, that would give Amazon’s digital-ad business $26 billion operating-profit potential by 2025. Taking out 20% for taxes and dividing by 500 million shares, that equates to north of $40 in earnings per share.
That’s a substantial number for this company. Amazon is projected to do less than $30 in EPS this year. Thus, assuming the e-commerce and cloud businesses fall completely flat over the next several years, this company should still be able to do about $70 in EPS by fiscal 2025. In reality, both those businesses will keep growing, and there will be additional catalysts from pharma, logistics, and offline retail.
All in all, then, $100-plus in EPS by fiscal 2025 is very, very doable. I actually think that number will pan out closer to $150. If so, Amazon stock won’t need a nosebleed multiple to justify a big price tag. Based on a growth average of 20x forward earnings, $150 in EPS by fiscal 2025 will support a $3,000 price tag for Amazon stock.
Bottom Line on Amazon Stock
The story at Amazon continues to play out in favor of the bulls. The company is aggressively expanding into higher margin businesses. These expansion efforts are fueling continued top-line growth, while simultaneously expanding margins. Profits are consequently roaring higher. This is allowing the multiple to compress, while still powering gains in the stock. In other words, Amazon stock is the quintessence of growing into a big valuation. Consequently, this stock remains a long-term buy-and-hold. The “growing into” phase is just starting.
As of this writing, Luke Lango was long AMZN, GOOG and FB.
