Why Amazon's Stock Surge is Just the BeginningAmazon has delivered an impressive performance this year, with its stock appreciating over 20%. Many analysts believe this is just the beginning of a much larger upward trend.
Amazon's business model is undergoing a significant transformation, presenting a unique opportunity for investors. Here are three key insights that make a compelling case for buying Amazon stock now.
Resurgence in Amazon Web Services' Growth
Amazon Web Services (AWS), the company's cloud computing division, is experiencing a strong resurgence. AWS allows clients to rent computing space and run workloads over the cloud, a popular strategy that enables customers to scale computing power as needed. This is particularly relevant as many companies are developing AI models to enhance their operations.
Despite sluggish demand for AWS in 2023 compared to competitors like Google Cloud and Microsoft Azure, the outlook is improving. Amazon's significant investment in Anthropic, a generative AI startup, has equipped AWS with advanced AI tools. CEO Andy Jassy highlighted this in Amazon's Q1 conference call, stating, "We see considerable momentum on the AI front where we've accumulated a multibillion-dollar revenue run rate already."
This positive development is reflected in the financial results. In Q1, AWS saw a 17% year-over-year increase in net sales and an 84% rise in operating income. Another growth catalyst is the end of the optimization trend. Last year, companies focused on cost-cutting, including optimizing cloud computing spending. With this trend now complete, AWS is benefiting from new workloads, rather than declining revenue from reduced workloads.
AWS remains Amazon's most profitable segment, which is crucial for its success. However, other areas of the business are also starting to contribute significantly.
Amazon's Accelerating Cash Generation
While AWS has long been profitable, Amazon's commerce divisions haven't always shared that success. The company had to recover from significant investments in its supply network in 2021 and 2022, which affected its North American division. Additionally, Amazon's international operations have historically been unprofitable, but this is starting to change. In Q1, the international segment posted its first profitable quarter since 2021.
This turnaround has significantly bolstered Amazon's cash generation, which is now gaining momentum.
In the past 12 months, Amazon has generated $50.1 billion in free cash flow (FCF), a stark contrast to the $3.3 billion FCF outflow in Q1 of the previous year. The trends associated with this FCF are equally encouraging.
Historically, the first quarter is weak for Amazon due to high spending in Q4. This pattern results in a relative peak at the start of each new year, followed by a significant decline. This occurred again in 2024, but notably, this was the first year in recent memory that the drawdown did not result in a negative FCF. Additionally, the Q4 peak was the highest it has ever been.
This indicates that Amazon's cash flows are improving and sustainable, which is a positive sign for investors. As Amazon's cash flows increase, the company could initiate a dividend or start repurchasing stock, benefiting long-term investors.
Amazon is Still Below Its Average Valuation
Despite Amazon's significant cash flow growth and improvements across its business, the stock is still undervalued based on its price-to-sales (P/S) ratio. Traditional valuation metrics centered around earnings aren't as useful for Amazon yet, but the P/S ratio indicates that Amazon is valued at levels seen during the post-COVID demand drawdown and before that in 2018.
This suggests that the stock isn't overvalued and could be a reasonable purchase today.
Considering Amazon's growth prospects and increasing FCF, Amazon is an excellent buy right now. There are still many aspects of Amazon's business poised for transformation, and investors will benefit from buying and holding it for the long term.
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