As Amazon (NASDAQ:AMZN) prepares to post its Q2 results on July 25, investors are questioning whether the e-commerce and cloud titan still presents a compelling investment opportunity. Despite worries regarding its valuation following a 54% increase in share price over the past year, Amazon continues to offer strong reasons to maintain a bullish stance. In this article, we will look into three key bullish signals supporting the stock’s long-term investment case, along with one potential risk that could impact future returns. Regardless, I remain bullish on AMZN stock.
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Bullish Signal #1: Robust Growth Across Segments
The first, more general, bullish catalyst that Amazon stock enjoys is that its growth remains strong across all segments. In Q1, the company demonstrated remarkable growth momentum in Retail, Advertising, and Amazon Web Services, with no indications of deceleration. Let’s examine each segment separately.
The Retail Segment
Amazon’s Retail business continues to thrive thanks to an ever-expanding selection and low prices. North American sales increased 12% year-over-year in Q1 to $86.3 billion, while International sales grew 11% in constant currency to $31.9 billion. Efforts to attract third-party sellers boosted the third-party unit mix to 61% in Q1, increasing Services revenues by 16% as well.
Profitability-wise, Amazon’s North American segment’s operating income rose 557% to nearly $5 billion, with an operating margin of 5.8%. The International segment improved significantly, with $903 million in operating income compared to a $1.23 billion loss last year. Historically, Amazon’s retail segment raised concerns about its potential for sustainable profitability. Yet, these numbers defy such worries, indicating consistent profitability ahead following a rather extended margin expansion.
The Advertising Segment
Amazon’s Advertising revenue increased by 24% year-over-year in Q1, powered by robust performance in sponsored products and enhanced relevancy and measurement capabilities. This segment appears poised for further growth as Amazon continues to innovate, particularly with its Prime Video ads.
Amazon Web Services (AWS)
Amazon’s high-growth cash cow, AWS, saw its revenue increase by 17.2% year-over-year in the previous quarter, up from 13.2% in the previous quarter. The segment’s acceleration in an increasingly competitive cloud environment is quite commendable. It also underscores its importance as a growth driver moving forward, as we will likely see a rising number of companies leveraging AI technologies, which will grow their cloud needs.
Bullish Signal #2: Technological Innovations and AI Integration
The second bullish catalyst driving Amazon’s investment case is its technological innovations, particularly in artificial intelligence. Given the company’s massive scale, these advancements are poised to accelerate its growth and solidify its dominant position at the crossroads of retail, cloud computing, and AI.
Amazon’s AI capabilities in AWS are particularly noteworthy, generating multi-billion dollar revenues through offerings like SageMaker, which streamlines data preparation, experiment management, model training, and developer productivity.
Take Perplexity AI, for instance, an AWS customer that has achieved a 40% faster model training rate using SageMaker. Another example is NatWest Group (NYSE:NWG), the U.K.-based bank that has cut its time-to-value for AI projects from 12-18 months to under seven months. Such innovations position Amazon to be at the forefront of the AI race, especially given its already wide AWS clientele.
Bullish Signal #3: Free Cash Flow Skyrockets
Amazon’s surging free cash flow is the third and likely strongest bullish catalyst currently contributing to the stock’s rally. As I briefly noted when discussing the retail segment’s results, Amazon’s operating income margins are on the rise. This also holds true for its AWS segments. Combined with the company moderating its (CapEx), which rose by just 5% in Q1, its free cash flow has been surging.
For context, Amazon has generated record free cash flow of $50.1 billion over the past four quarters, a terrific turnaround from a $3.3 billion outflow the previous year. In the meantime, Wall Street expects that this explosive growth in free cash flow is set to persist. Consensus estimates see free cash flow reaching $62.0 billion, $78.8 billion, and $102.2 billion in 2024, 2025, and 2026, respectively. Such huge anticipated growth should keep fueling Amazon’s bullish sentiment.
The One Bearish Concern to Keep In Mind
Besides the three strong bullish catalysts I just went through, there is one bearish catalyst to keep in mind that could hamper Amazon’s future total returns. The stock’s valuation, in particular, seems very rich, even when applying Wall Street’s explosive free cash flow assumptions. Following Amazon’s lengthy rally over the past year, the stock is now trading at 33.6 times and 26.4 times this year’s and next year’s free cash flow, respectively. These multiples are objectively hefty by any comparable measure.
If Amazon actually meets Wall Street’s expectations and maintains equally attractive free cash flow growth expectations in the years ahead, the current valuation could be somewhat justified. Should Amazon fail to keep pace, however, the stock could experience a significant valuation contraction, hampering investors’ prospects.
Is AMZN Stock a Buy, According to Analysts?
Despite the stock’s prolonged rally, Wall Street maintains a Strong Buy consensus rating on Amazon. This is based on 42 unanimous Buys assigned in the past three months. At $221.70, the average Amazon stock price target suggests 10.85% upside potential.
If you’re unsure which analyst you should follow if you want to buy and sell AMZN stock, the most profitable analyst for the stock (on a one-year timeframe) is Rob Sanderson from Loop Capital Markets, with an average return of 36.06% per rating and a 94% success rate. Click on the image below to learn more.
The Takeaway
Amazon is gearing up for its Q2 results, displaying sustained growth across its Retail, Advertising, and AWS segments. Further, the company showcases strong profitability improvements and technological advances in AI that should keep powering its growth and potentially result in surging free cash flow in the coming years.
That said, investors should remain wary about the stock’s valuation, as its forward multiples seem particularly rich. Wall Street is pricing in tremendous expectations, which, if not met, could lead to notable downside for the stock.
