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The Nasdaq Composite has nosedived into a bear market this year, as investors have become increasingly pessimistic about high inflation and rising interest rates, both of which threaten to tip the U.S. economy into a recession. But those concerns have hit Amazon (AMZN 1.64%) even harder. Its share price has plunged 52%, marking its sharpest decline at any point in the past 10 years.
Here’s what investors should know about this once-in-a-decade buying opportunity.
The bear case for Amazon centers on the cost structure of its retail business. The company operates the most-visited online marketplace in the world, and the Amazon brand is undoubtedly synonymous with online shopping, but retail itself is a very low margin industry.
That is especially true for Amazon. The company operates a massive logistics network, and it regularly spends a tremendous amount of money on shipping and fulfillment.
High inflation has made the situation much worse. Discretionary consumer spending has slowed and operating expenses have soared over the past year, and that dynamic translated into disappointing financial results. Revenue increased just 10%, earnings dropped 58%, and the company reported negative free cash flow of $26 billion on a trailing-12-month basis.
That said, Amazon has $59 billion in cash and short-term investments on its balance sheet, so there is no immediate danger. But if the company is forced to take on additional debt in a rising interest rate environment, it would put even more downward pressure on profitability and free cash flow. Bears see that as a reason to avoid the stock, but there are two problems with that argument.
First, economic headwinds are temporary, meaning cost pressures on its retail business should ease to some extent when inflation eventually normalizes. Second, Amazon is set to become more profitable in the coming years because its fastest-growing segments come with much higher margins than retail.
Image source: Getty Images.
The bull case for Amazon focuses on its strong position in three growing markets: e-commerce, cloud computing, and digital advertising. Retail may come with low margins, but Amazon will account for 40% of online sales in the U.S. this year, giving it more than five times the market share of its closest rival, Walmart. That means Amazon is still better positioned to capitalize on the secular shift to online shopping than its competition, and global e-commerce sales are expected to grow at 13% annually to reach $15 trillion by 2030, according to Ameco Research.
Better yet, Amazon is becoming a digital advertising juggernaut, due in large part to the popularity of its online marketplace. When U.S. consumers are searching for a product, Amazon is the most common starting point, even more common than Alphabet‘s Google Search, according to eMarketer. That makes Amazon a valuable ad partner for brands. In fact, the company is now the fourth-largest advertiser on the planet, and Amazon nearly led the world in ad revenue growth last year.
That has big implications. Digital advertising is a massive industry that is rapidly approaching $1 trillion, but it is also far more profitable than retail. Amazon has yet to provide specific operating metrics, but Google regularly achieves an operating margin over 30% in its ad business, so investors can reasonably assume Amazon is in the same ballpark.
Additionally, Amazon Web Services (AWS) is the clear leader in cloud computing, another quickly growing industry with high margins. In fact, AWS currently holds twice as much market share as the next-closest cloud vendor, Microsoft Azure, and it regularly achieves an operating margin around 30%. That means AWS is poised to be a powerful growth engine in the coming years, as the cloud computing market is expected to increase at 20% annually to reach $1.7 trillion by 2029, according to Fortune Business Insights.
Given Amazon’s strong presence in three large and growing markets, investors have good reason to believe sales will average double-digit growth for years to come. Better yet, Amazon should become more profitable over time, as AWS and advertising services are growing more quickly than its retail segment.
With that in mind, shares currently trade at 1.8 times sales, a discount to the three-year average of 3.7 times sales. That is a bargain price for a company poised to deliver double-digit sales growth over the long term.
Also noteworthy, shares currently trade at 81.8 times earnings, roughly in line with the three-year average. But that multiple should fall quickly as Amazon’s high-margin segments account for a bigger chunk of total revenue.
That’s why this growth stock is a screaming buy, and investors should jump on the opportunity before it passes.
John Mackey, CEO of Whole Foods Market, an Amazon subsidiary, is a member of The Motley Fool’s board of directors. Suzanne Frey, an executive at Alphabet, is a member of The Motley Fool’s board of directors. Trevor Jennewine has positions in Amazon.com. The Motley Fool has positions in and recommends Alphabet, Amazon.com, Microsoft, and Walmart. The Motley Fool has a disclosure policy.
*Average returns of all recommendations since inception. Cost basis and return based on previous market day close.
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