The first three months of 2022 have been an interesting time to invest in stocks. I’m glad we’ve seen some of the scum coming out of certain areas of the market, but I think we still have a long way to go. I was quite cautious at the start of the year, but there are still some stocks that I find interesting. Amazon (AMZN) is one such stock. I sold most of the big tech holdings in late 2021 to early 2022, but I plan to hold onto my Amazon shares for a long time.
I have read and listened to several different sources on investing and the economy, but I think we are going to continue to see significant inflation, supply chain issues, and several other issues with our economy. I know everyone has noticed that gasoline prices, food prices and rents are skyrocketing in real terms. I’m not interested in using the CPI (which is still high even if manipulated) as we see true inflation in the double digit range.
When it comes to things in the Consumer Discretionary (XLY) sector, I think Amazon is in a unique position. If we go into a recession, will people still buy Tesla (TSLA) electric vehicles? Will Lowe’s (LOW) and Home Depot (HD) see continued growth if we see a slowdown in construction and renovation activity? Will people still spend $8 on a Starbucks (SBUX) coffee? Maybe, but I think Amazon is a unique value proposition for its customers and will be able to retain its Prime members in virtually any economy.
Amazon stands out from the big tech companies for several reasons. I like the diverse business segments in attractive areas, from the dominant e-commerce platform in North America, to a streaming segment that rivals Netflix (NFLX) and the crown jewel of Amazon Web Services. The second reason is a valuation that remains reasonable in my opinion. I plan to hold my stock for a long time because I think Amazon is an awesome company with a history and culture of innovation. I won’t predict the short-term direction of the stock price, but I think long-term investors who prefer to own individual stocks should own a bit of Amazon.
A 20:1 split
I’m going to be perfectly honest in saying that I don’t care about the share price on any of my stocks. I’m more focused on market capitalization and company valuation, but I can understand arguments on both sides of the stock split argument. More cash, easier access to options trading, and making it easier for employees and their stock options makes sense. However, it doesn’t actually change the value of the company, even though the stock split announcement sent shares up more than 10% after hours on the day of the announcement. Some speculated that the company would be included in the Dow Index (DJI) after the split. I wouldn’t be surprised if the company was included soon after the split ended.
Amazon is the leading e-commerce company in North America. Over the past two decades, they have grown from an online bookstore to so much more. They now account for over 40% of e-commerce sales in the United States. This is an impressive moat around the business, and they have spent huge sums of money building the necessary infrastructure to support the e-commerce segment. To be fair, the margins on this segment aren’t huge, but the e-commerce segment is the biggest reason people pay for Prime memberships. I know many people order items weekly from Amazon, and Two-Day Delivery allows members to regularly order anything from books to big-ticket items like a TV.
Personally, I’m addicted to the Vikings series on Prime Video right now, but there are plenty of other movies and series on Prime Video worth watching. I understand that the streaming segment might be an afterthought for many investors, but I think investors shouldn’t overlook the impact of having a content service like Prime Video. I know it’s tough when the e-commerce business is massive and AWS has the huge revenue growth and margins it does, but I think the streaming business is an attractive part of Amazon for the next decade.
E-commerce and streaming are two businesses that are poised for continued growth over the next decade, but AWS is the high-margin glue that holds the whole company together. This is where most operating profit comes from, and the segment has seen impressive revenue growth over the past two years. This is the part of the business that gets people excited when looking at the long-term future of the business. AWS has a large share of the cloud market, and I think we’ll see them continue to have a large part of this extremely important sector.
For anyone who has taken the time to read Amazon’s 10-K, you may notice that the cash flow statement is the first financial statement presented. All the other companies whose financial statements I read first had the income statement or the balance sheet. This shows that the company has prioritized cash flow, something founder Jeff Bezos has mentioned many times in the past.
Amazon is currently valued at just under 28x cash flow, which is just above the average cash flow multiple of 27.2x. I think 25x cash flow is a reasonable valuation and you’ll see the cash flow multiple tracks the 27x average quite closely. Fast Graphs predicts a cash flow explosion over the next two years, which could lead to impressive returns for investors. Even though the cash flow multiple compresses to 15x, investors are still eyeing double-digit returns due to the projected growth.
The company has been splurging on capital spending over the past two years. Some Wall Street analysts say it’s going to end soon, but I think they’re missing the point. Sure, increased capital spending hurts overall short-term profitability, but that’s never been a top management concern. They focus on providing the best experience to their customers and increasing cash flow. As long as the company can continue to invest capital in the growth of the company, I am happy to be part of it as a shareholder.
Amazon isn’t your typical tech giant that’s been buying up stock as fast as it could for years. Their last repurchase authorization was $5 billion as of 2016. They only repurchased $2.1 billion of this authorization. Along with the 20-to-1 split, the company announced a $10 billion buyout. This will replace the old authorization. This is a small buyback for a company the size of Amazon, and unlike some companies, I’m confident they won’t buy back shares at any price. I have mixed feelings about the buyout, but I think they have the balance sheet to start returning capital to shareholders.
Amazon is a company that has created significant wealth for investors and impressive services for their customers. I think the company will be the best big tech company to own in the next two years. They just announced a 20-to-1 split and a $10 billion buyout, which could be a sign of things to come for investors. The company has three operating segments (along with several equity investments) that are at or near the top of the category. I think investors with a long time horizon can buy Amazon under $3,000 and expect attractive returns going forward.
Valuing Amazon has always been tricky, and many analysts and investors have claimed it was overvalued for over a decade. Despite this fact, Amazon has largely outperformed the market reaching a market capitalization of $1.4T. I chose to use cash flow instead of earnings because the company has always focused on cash flow and the earnings multiple has proven ineffective in the past as a valuation metric for the company. We’ll see where things go, but I think Amazon is a great company at a fair price. Investors can expect continued revenue growth and gain exposure to three growing operating segments by buying shares of Amazon. I think Amazon certainly qualifies as a fantastic company at a fair price, and I look forward to being a shareholder for a long time.
I would be fascinated to hear your thoughts. Feel free to leave a comment below.