Investment Evaluation
Amazon.com, Inc. (NASDAQ:AMZN) shares have experienced an astounding 88% surge in 2023. This dramatic rise has set off a frenzy of expectations within the stock. Upon careful reverse discounted cash flow (DCF) valuation, it becomes evident that the current stock price necessitates Amazon to achieve an ambitious 16% sales growth, coupled with a 10% operating margin over the next decade. Such aspirations seem overly optimistic, given the trade-offs between margin improvement and volume growth. Besides, Amazon faces fierce competition in e-commerce and cloud businesses, tempering potential multiple expansions. Hence, my recommendation is to assign Amazon a Hold rating at this juncture, as market expectations appear overly exuberant.
Robust Performance and Macroeconomic Uncertainties
Amazon has posted robust sales and profit growth, buoyed by strong holiday spending and an optimistic outlook for the current quarter, backed by heightened interest in AI technology. However, the recent deceleration in consumer demand raises concerns, as weakening retail sales are indicative of broader economic frailties that could impede Amazon’s growth trajectory. Such trends bear critical vigilance, for they have direct implications on Amazon’s sales momentum. The reverse DCF model underscores the precariousness, as markets anticipate a ~16% top-line growth in the coming years. Any further consumer spending downturn could significantly impact Amazon’s valuation, resulting in compressing multiples.
Amazon’s heavy investments during the pandemic led to an overinvestment situation as growth slowed, causing a decline in its share price. However, the subsequent rebound, with an 88% appreciation in 2023, can be attributed to the company effectively leveraging its excess capacity to drive sales and operating margins. The key question here is the profitability of Amazon’s overall business, where managing costs and leveraging capacity can propel long-term margin growth.
Regarding Amazon’s e-commerce dominance and the potential of its ad business, it is foreseeable that the company will continue to capture market share due to its robust competitive advantage. However, the real game changer lies in AWS, where the company’s market position and strong secular trends could drive substantial sales and profitability in the years ahead. Yet, all these prospects are currently built into the stock price, suggesting limited room for further expansion.
Expressing Market Expectations Through Valuation
It is prudent for investors to discern prevailing market expectations embedded in the stock price. Hence, my reverse DCF model illuminates that Amazon will continue to incur significant capital expenditures, although at a moderated pace, given the ongoing capacity leverage. Besides, the company’s negative cash conversion cycle is likely to endure, with cash tied to operations hovering around 2% of sales. Overall, these factors underscore the weight of market expectations and the need for a cautious investment approach.
