One of the most common criticisms Amazon.com, Inc. (Nasdaq: AMZN) shareholders have heard throughout the stock’s meteoric rise is that the company’s lackluster profits don’t justify its $720 billion market capitalization.
However, as Amazon continues to pour cash into expanding its highest-margin businesses, long-term investors may soon witness unprecedented earnings growth.
According to MKM Partners analyst Rob Sanderson, Amazon deserves the type of trust the market is placing in the company by pricing its stock at a forward price-earnings ratio approaching the triple digits. While most investors primarily think of Amazon as an e-commerce company, Sanderson says its Amazon’s high-margin cloud services and advertising businesses that will be responsible for the lion’s share of its earnings growth over the next four years.
In 2017, combined revenue from Amazon Web Services and Amazon advertising grew 43 percent. The two businesses now account for 36 percent of total revenue, up from just 23 percent in 2016. These two high-growth, high-margin areas are mostly responsible for the 2 percent increase in Amazon’s gross margins in 2017, Sanderson says. In fact, Amazon’s gross margins are now up 10 percent since 2013.
Sanderson says Amazon’s heavy investments and shifting business mix are paving the way for a massive expansion of profits in the next several years. Amazon reported diluted earnings per share of just $6.15 in 2017, but Sanderson has raised his 2022 EPS forecast for Amazon from $66 to $78.
“Lower tax assumptions represent $8 of the $12 revision, higher revenue drives another $8 and lower margin and mix assumptions are a $4 per share drag in our EPS power scenario,” Sanderson says. “We continue to think AMZN is the best growth story of all the mega-caps over the very long term.”
Amazon shareholders have been rewarded handsomely for their long-term patience over the past decade, a phenomenon that GBH Insights head of technology research Daniel Ives says will continue.
“Near term, there is a major focus on significant investments around fulfillment, Prime, Echo/Alexa, AWS, and integrating the Whole Foods acquisition into the fold, which could depress margins over the next few quarters,” Ives says. “Amazon has a unique window of opportunity to double down on its consumer and enterprise initiatives for 2018 and drive significant growth/cash flow for the coming years.”
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