Big-Tech Investment Series - Amazon

Finally, brethren, whatever things are true, whatever things are noble, whatever things are just, whatever things are pure, whatever things are lovely, whatever things are of good report, if there is any virtue and if there is anything praiseworthy—meditate on these things.

Philippians 4:8

I have a trait passed down within my family that I’d like to not have, a short temper. As I’ve gotten a little older, I’ve realized that the primary catalyst to unlocking this temper is negativity. My thoughts and perceptions are powerful in generating actions for what I say and do. Philippians 4:8 teaches me to meditate on what God views as the priority traits of life; truth, nobility, justice, purity, loveliness, goodness, virtuosity, and praiseworthiness to have the right frame of mind. Believe me, it's a daily battle.

When it comes to investing, psychology and emotions are big factors that influence decision-making. A lot of times the pressures of Wallstreet influence short-term trading actions and a vicious versus virtuous cycle can quickly emerge due to frustrations and angst. Keeping a sound mind and focusing on primary goals, objectives, and realistic expectations can be the difference maker to maintaining focus, versus falling apart.

The next company in the Big-Tech investment series is Amazon, Inc. (AMZN).

Key Takeaways for Retail Investors

• AMZN is not overvalued but neither does the company offer any significant upside potential based on current valuation.

• The company remains at the forefront of the cloud market via AWS and is the clear leader for third-party seller services; these services are key growth drivers along with advertising and subscription services.

• The 1P side of AMZN’s business will continue to grow, but at a slower rate than earlier in the company’s business cycle.

• AMZN continues to invest substantially in its infrastructure needs versus paying out dividends and buying back stock which affords it to remain growth oriented.

• AMZN like other Big-Tech peers has been brought into the monopoly investigation focus, and there is risk of the company being broken up at some point.

This series began with Netflix, Inc. (NFLX) and Apple, Inc. (AAPL) as both companies are overvalued with NFLX being the most extreme. Microsoft Corporation (MSFT) was the last Big-Tech company covered and is more modestly overvalued. Pivoting to AMZN, the company has traded more consistently with its historical trends. While one could argue that enterprise value to sales is at a peak, operating cash flow is clearly within range. Most Big-Tech leaders are trading 20-25 times operating cash flow per share and AMZN finds itself right in the middle of this valuation level.

AMZN’s gross margin has been a focal point to the company’s success from a Wallstreet perspective. In the early days, fulfillment operating expenses were lumped with the company’s cost of sales. Since only including cost of sales to equate to gross margin, AMZN has witnessed a clear improvement that has only continued over time. This has been a clear benefit from AMZN’s diversification into numerous operating segments with higher margins. Despite this improvement, AMZN’s operating cash flow margin has consistently fluctuated near the 10 percent level with only the pandemic era and inflationary environment leading to peak margins.

Looking at AMZN’s cash flow margins more closely we see the company was witnessing improvement from 2010 to 2019 (a nearly 40 percent increase). During the pandemic era and higher inflationary environment, AMZN has witnessed both benefits and challenges. The substantial increase in e-commerce (nearly 40 percent penetration against retail sales in the U.S), led to inflated operating cash flow for AMZN in 2020. This was followed by more erratic cash flow performance in the next two subsequent years due to AMZN’s increasing imbalance due to volatility, and increased investments to grow capacity. The rapid increase in inflation benefited AMZN similarly to the first year of the pandemic due to AMZN’s scale, and the expectation is for the company’s operating cash flow to gravitate toward the 15 percent or higher margin.

The correlation of AMZN’s cash flows and jump in total cash and investments during the pandemic illustrates how AMZN has greatly benefited overall. AMZN’s total cash and investments peaked at $100 billion. Despite this seemingly dropping to sub-$90 billion, AMZN’s substantial investments into both fulfillment and server infrastructure was enabled greatly during these volatile times.

AMZN clearly views itself still as a growth-oriented company. This is very different from companies like AAPL and MSFT who pay out dividends and institute significant stock buyback programs. Even NFLX has now instituted its own stock buyback program. AMZN on the other hand has not spent nearly the same amount on acquisitions as a company like MSFT, and the company has only bought back stock four times over the past 17 years.

Both AAPL and MSFT have witnessed substantial growth from their services revenue segments; AMZN is no different. For the foreseeable future AMZN’s revenue growth will continue to benefit from its services segments. Products sales that are predominantly connected to AMZN’s 1P e-commerce business will still be poised to grow at a slower pace than earlier in the company’s business cycle.

Aside from AMZN’s online and physical stores segments, everything else is related to its services segments. Clearly, third-party seller services and AWS are the core drivers of this growth. AMZN continues to witness increasing performance for both its advertising and subscription services as well. For AWS, Alphabet, Inc. (GOOG) discloses its cloud business separately and generates about 39 percent of AMZN’s AWS. While MSFT doesn’t explicitly disclose its comparable Azure cloud information, there are ample publicly available sources breaking down cloud market share. AMZN typically trends to near a 30 percent market share, while MSFT has seen a jump from sub-15 percent to the 20 percent level, and GOOG continues to remain just above 10 percent.

When it comes to AMZN’s third-party seller services, the core driver as many already know is the company’s 3P gross merchandise sales. Third-party seller services have improved strongly as a portion of AMZN’s 3P GMS increasing from just above 24 percent to the 30 percent level more recently. AMZN like other Big-Tech companies is leveraging its core business to expand and diversity its revenue streams. While the company doesn’t have the same cash flow margins as AAPL or MSFT, or GOOG or Meta Platforms, Inc. (META) for that matter, but with over $100 billion in operating cash flow, AMZN is a formidable cash cow generator.

Final Thoughts

Over the next five years, AMZN has a real shot at becoming the first company in history to generate $1 trillion in revenue, a truly amazing feat. Despite this, I do expect that the company’s operating cash flow margin will contract towards 15 percent versus stay closer to 20 percent. When considering the financial model at 25 times operating cash flow per share, this puts a potential annualized return over the mid-term at 7-8 percent.

AMZN is strongly tied to macro trends and broader market indices. Lately, there has been some push-pull between Big-Tech and small- and mid-cap growth stocks. If inflationary pressures do indeed return with the new administration, Big-Tech will see the spotlight return.

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