Amazon (AMZN) is one of the most valuable mega-cap companies on the Nasdaq. The firm commands a high premium valuation because of its demonstrated record of consistent sales growth. However, it almost always appears grossly overvalued when using earnings-based valuation methods.
The company relied on reinvesting most of its profits into the business. This strategy allowed Amazon to expand faster while minimizing its tax burden. As a result, traditional measurements of value often fail when applied to Amazon. Thus, several valuation metrics deserve close examination to accurately gauge the difference between market valuation and Amazon's business fundamentals.
- Traditional measurements of value often fail when applied to Amazon.
- The sales growth rate is a better guide to Amazon's corporate health, with 30% per year being typical.
- Amazon Web Services, the company's internet cloud infrastructure, is a primary driver for the company's sales growth.
- The operating profit margin at Amazon went up substantially between 2014 and 2019.
- Amazon's high price-to-earnings ratio does not mean the stock is going to crash, but it does make shares more volatile.
Amazon's Sales Growth Rate
According to the company's annual report, Amazon's consolidated yearly sales growth rate was 2% in 2021 compared to 38% from the year prior. This figure includes North American, global, and Amazon Web Services sales.
Amazon Web Services, the company's internet cloud infrastructure, is an increasingly important business for Amazon. Its experience running one of the top sites on the internet allowed Amazon to start AWS long before most competitors arrived. Developers and enterprises can run their online operations on Amazon Web Services for a monthly fee. AWS, as it's commonly known, is the fastest-growing source of revenue for Amazon, netting 37% of sales in 2021. Compare that to North American and global sales of 18% and 22% in 2021, respectively.
The company continues to make many capital investments each year, mostly using cash flow from operations. This leaves little cash for anything else, which means that all eyes are on growth. Besides being at the forefront of e-commerce retailing,
Amazon also runs a publishing platform for authors and publishers. The company takes a sales cut from every book it helps to sell. The firm began as an online bookseller, and Amazon is still growing its book business.
Amazon's Profit Margin
Most companies focus on their bottom line earnings and profits. At Amazon, it was all about the top-line revenue story. The company believes that by increasing market share, it can eventually leverage economies of scale to lower costs.
Once it has a high market share, Amazon can also exercise some pricing power over customers. Critics claim that the company must eventually start showing more profits and eventually pay dividends. Amazon may not be able to sustain its sales exuberance forever.
Amazon's operating profit margin hit 2.5% in the fourth quarter of 2021. The company's operating margin was negative as early as 2014. Part of the increase in the operating margin is due to the rapid growth of Amazon Web Services. Web services are generally a much higher margin business than retail, so we can expect higher profit margins going forward. The other explanation is that Amazon is running out of areas to reinvest its profits.
Traditional Valuation Metrics
Because the market has valued Amazon stock solely on its growth potential, conventional valuation metrics for Amazon often look high. Keep in mind, though, that Amazon's price-to-earnings (P/E) ratio does not mean the stock is going to crash, but it does make shares more volatile.
The company's P/E ratio was 25.93 in 2021. According to estimates, the company's P/E ratio for 2022 is expected to be 121.74 and 53.85 in 2023. As a standard of comparison, Apple (AAPL) had a price-to-earnings ratio of 21.27 in 2022. The tech giant's estimated P/E ratio for 2023 is expected to be 21.02.