Amazon.com Inc (NASDAQ:AMZN) is one of the most iconic brands perhaps ever. Whether one loves it or hates it, everyone knows it and most people interact with part of its ecosystem daily. As an investment, there are many moving parts in the equation. Lately, these include supply chain woes and labor shortages, the prolific rise of Amazon Web Services (AWS), congressional hearings and legislation, union rumblings, the internet space race, valuation concerns, potential stock split, streaming wars, privacy regulations in Europe and elsewhere, consumer spending during the holiday season, a stake in Rivian Automotive (RIVN), and more! While these are fascinating developments, what investors really want to know is whether their money is safe and will grow with Amazon. So let's explore!
Is Amazon A Safe Investment?
In a previous article, I have strongly advocated for Amazon spinning off AWS and a third-party seller marketplace. Here I will take up for the other side (surprise!) and play devil's advocate, if you will. It may surprise some readers that I am now taking up for the other side, however the issue is not cut-and-dried in my view.
My reasoning for the spinoffs are fairly straightforward, and perhaps a bit basic. First, this would solve the company's problems with the FTC over monopolistic tendencies. By splitting the Marketplace from the direct ecommerce, the charges of unfairly poaching items and displaying direct products more prominently would no longer apply. Second, many investors, including myself, would jump at the opportunity to invest solely in the highly profitable AWS segment. The ecommerce business has much tighter margins, has broader competition, and therefore has never been highly profitable. AWS is just the opposite.
Shown below, AWS accounts for just 13% of sales, but has brought in 62% of operating profits during the first nine months of 2021. This is a highly efficient and profitable segment juxtaposed with the tight ecommerce division.
Table created by author with data from SEC filing.
The other side of this equation is that Amazon's tremendous ecosystem, taken as a whole, is extremely advantageous to the company, and therefore to investors as well. One segment is high volume, while the other is highly profitable. Having them linked provides for greater economies of scale. Having first-party and third-party sellers side-by-side drives traffic to the website. Amazon makes money on a purchase in either case.
The company also has tremendous cash flows which are greater when taken as a whole. This has allowed in the past for the development of an AWS. It could lead to even greater things in the future. The Project Kuiper space-based internet system is just one such example. The project would provide a low orbit satellite system to provide internet to underserved areas around the globe. There is serious competition in this new "space race" from companies like SpaceX with its Starlink system. The support of the Amazon ecosystem is a critical piece of the puzzle to win the race. Other initiatives include "walk out" technology, expanding the international footprint, Amazon One and Amazon Astro and Glow.
Another advantage of the company's ecosystem is that if one division is experiencing headwinds the company can still post profits on the strength of the entire enterprise. The fact that Amazon is diversified provides an excellent level of safety for investors.
Is Amazon Stock A Good Long-Term Investment?
Amazon stock remains an excellent equity for long-term investors despite short-term issues that dominate daily headlines. Due to increasing prices on variable costs, and the nature of the retail business, I prefer to examine the growth metrics from gross profit down. After all, if revenue rises simply because costs of raw materials are up and those costs flow through, then this is not a quality indicator. Instead, by using gross profit, we can see growth more accurately after removing costs of sales. Shown below, Amazon has seen tremendous growth in gross profits over the last five years. EBITDA has also grown quite well from just $12.3B in 2016 to well over $60B over the trailing twelve months (TTMs). Even better, the company has achieved growth consistently, year after successful year.
Chart created by author with data from Seeking Alpha.
Operating income and diluted EPS are also on the rise.
Chart created by author with data from Seeking Alpha.
There are short-term headwinds to the ecommerce business, which will be discussed below, however the long-term trends are intact and show no signs of receding. Any slowdown in ecommerce due to reopening should be offset in terms of profits by the growth of AWS. The pandemic has likely changed many consumer habits as well. Many consumers who used Amazon ecommerce from necessity will likely continue to do so long after current macroconditions change.
Amazon Stock Forecast
In the short term, Amazon is dealing with several major macroeconomic issues that will likely materially impact results. First, the country is dealing with serious labor challenges. These have caused problems hiring and retaining employees. The cost of doing business in this environment is higher wages and hiring bonuses in many cases.
Higher wages economy-wide also serve to increase spending power of many of Amazon's core customers. This increases consumer spending as a whole. While the initial wages increases and bonuses paid at Amazon may hurt margins, in the long run we could see some positives as well. Shown below is the change in disposable income and personal spending over the last five years in the United States.
The more likely outcome, however, is that most wage increases will be swallowed up by inflation and economic disparity will continue unabated.
There are also consistent rumblings about unionizing the Amazon workforce. This will likely continue. Recently, workers in Staten Island have withdrawn a petition to vote for unionization.
Amazon has been spending heavily on facilities, technology, and workers in order to stay ahead of the curve. The company seems to recognize that one should invest, rather than cut, its way out of these headwinds. This is evidenced below by the increased capital expenditures and decreased free cash flow over the last several quarters.
And we have grown our global headcount by 628,000 employees in the past 18 months and are recruiting for more, including more than 150,000 in the U.S. to support Q4 seasonal demand. This demand for labor has recently coincided with the shortage of available workers, particularly in the United States. It began in Q2, but it really started to impact our operations and cost structure in Q3.
It's led to wage increases and sign-on incentives, as companies compete for workers, as well as inconsistent staffing levels in our operations. In addition, disruption to the global supply chains and inflation in the cost of materials such as steel and services such as trucking have also raised our cost of operations. We estimate the cost of labor, labor-related productivity losses, and cost inflation to have added approximately $2 billion in operating costs in Q3, particularly in August and September.
Our Q4 guidance range anticipates that these costs will approach $4 billion in Q4 as we see a full quarter's impact of these effects and a higher seasonal unit volume. Specifically in Q3, we saw nearly $1 billion of inflationary pressures, primarily tied to wage increases and incentives in our operations. Our average starting wage is now over $18 per hour, with an additional $3 per hour depending on shifts in many locations and sign-on bonuses that can be up to $3,000.
-Brian Olsavsky, CFO on Q3 earnings call.
Short-term these issues will affect the bottom line negatively. In the long-run these issues will spur innovation and the investments in technological efficiencies, committed workers, and facilities will pay off in spades.
So, some of the things that we continue to be excited about and do a lot of work on are things like the Just Walk Out Technology, that's been in our Amazon Go stores and is now moving into some over Amazon Fresh stores. Just really eliminates, again, one of those things that people may not realize is such a hassle or deterrent to shopping, waiting in line, and eliminating something has really been possibly received by customers as they use that technology.
Another one, just as you enter these stores, there's technology we have now in a little over 70 of our physical retail stores like Amazon one, which is a contactless way for folks to enter stores using their palm to identify. So that's in retail stores and Whole Foods stores. And so, keep looking for us to roll that out. -Brian Olsavsky, CFO on Q3 earnings call.
The stock has reacted generally positively to Q3 earnings. It looks as if investors who overreacted to the "disappointing" Q2 earnings did not want to make the same mistake after Q3. The chart below is annotated with the earnings release dates.
While Amazon's share price went on a tear during the pandemic, the EV to EBITDA ratio remains reasonable. Shown below, the company is trading at 25 times EBITDA on a forward basis. This is in the high end of the range, but certainly not euphoric. This is basically the same forward multiple as Microsoft (MSFT).
According to YCharts, the EBITDA estimates for 2022 average to over $86B as shown below.
If a long-term investor assumes a very conservative 20% compound annual growth rate in EBITDA thereafter, Amazon would achieve nearly $180B in 2026. Were it still valued at 25 times EBITDA, the market cap would reach $4.5T or 2.5 times what it is today in five years.
Amazon's stock may dip in the short-term due to the macroeconomic issues above. The reduction in free cash flow could spook a short-term investor. Or perhaps due to an unfavorable development with the FTC and congress. Could a whistleblower come forward similar to what happened with Meta (Facebook) (FB)? It's possible. The Board of Directors could also decide to split the stock, which would likely give it a short-term boost. All of this is just noise.
Whatever happens over the next several months, the long-term trends are still intact. Revenue, gross profit, and EBITDA are rising steadily and consistently. Diluted earnings per share are doing the same. Margins may constrict in Q4 2021, however should also bounce back shortly thereafter. Amazon, possibly because of its expansive ecosystem, is an excellent long-term investment.
This article was written by
If you are a medium to long-term investor looking for an analysis of equities focused on cash flow, growth, and other critical metrics from a financial professional who knows financial statements inside and out, consider giving me a follow.While I am Tech-focused, I have a diversified portfolio, including growth and value equities, REITs, and dividend stocks. I like to use options for income and risk management when the opportunity arises.I have over 15 years of experience in the market. I am a practicing CPA; however, I have learned about investing more from avid reading, market watching, experience, and of course, making mistakes over the years. Also, am an admitted Excel junkie.I believe Benjamin Franklin when he said: "An investment in knowledge pays the best returns," and Warren Buffet that "The most important quality for an investor is temperament, not intellect." I am constantly learning and focusing on long-term goals - even when the market misbehaves.Thank you very much for reading, and please feel free to leave me a message in the comments or send a private message.All the best!
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Now, let's dive into the concepts used in the provided article about Amazon:
Amazon's Ecosystem and Moving Parts:
- The article mentions various factors influencing Amazon's investment landscape, including supply chain issues, labor shortages, the rise of Amazon Web Services (AWS), congressional hearings, legislation, union activities, the internet space race, valuation concerns, potential stock split, streaming wars, privacy regulations, consumer spending during the holiday season, and a stake in Rivian Automotive.
Investment Safety and Growth Considerations:
- The author explores the safety and growth potential of investing in Amazon. They initially discuss the idea of spinning off AWS and a third-party seller marketplace as a solution to FTC concerns. The profitability of AWS is highlighted, contributing significantly to operating profits despite accounting for only 13% of sales.
Advantages of Amazon's Ecosystem:
- The article emphasizes the advantage of Amazon's integrated ecosystem, combining a high-volume ecommerce segment with a highly profitable AWS segment. The synergy between first-party and third-party sellers is noted, driving traffic to the website. The article also mentions Amazon's diverse initiatives, such as Project Kuiper, "walk out" technology, international expansion, Amazon One, Amazon Astro, and Glow.
Long-Term Investment Analysis:
- The author argues that despite short-term challenges such as labor issues and supply chain disruptions, Amazon remains a strong long-term investment. They examine growth metrics, including gross profits, EBITDA, operating income, and diluted EPS, over the last five years.
Short-Term Challenges and Innovation:
- Short-term challenges, including labor issues, wage increases, inflation, and disruptions to global supply chains, are discussed. The author suggests that these challenges could lead to innovation and technological efficiencies in the long run.
Stock Performance and Valuation:
- The article analyzes Amazon's stock performance in reaction to Q3 earnings and notes that the company's EV to EBITDA ratio remains reasonable. The forward multiple is compared to that of Microsoft. The author provides an optimistic forecast for Amazon's market cap in the next five years.
Conclusion and Author's Position:
- The article concludes that Amazon's stock may face short-term fluctuations due to macroeconomic issues, but the long-term trends in revenue, gross profit, and EBITDA remain positive. The author expresses confidence in Amazon as an excellent long-term investment. The analyst discloses a beneficial long position in Amazon and asserts that the article reflects personal opinions.
In summary, the article provides a comprehensive analysis of Amazon's current challenges, strengths, and future prospects, offering insights for potential investors.