Guru Peter Lynch is famous for his investment principle "invest in what you know.” The idea’s central message is uncomplicated: invest in the companies whose products and services are important to your life, which you use regularly. A prime example of this approach is Amazon.com Inc. (AMZN, Financial), a company deeply entrenched in the lives of millions of people.
Amazon's omnipresence and business exposure
Amazon.com's omnipresence is evident, ranging from its online retail platform to its Kindle e-readers, Fire TV, Echo speakers, Ring doorbells and a myriad of services like Amazon Prime, media, music and grocery stores. Moreover, Amazon Web Services has established itself as a world leader in cloud computing services, serving an ever-growing number of businesses.
The company's expansive consumer and business exposure has led many investors to believe in its continued dominance and substantial future profitability. Consequently, Amazon has become a challenging stock to bet against, solidifying its position as one of the world's most valuable companies.
Business performance and future potential
However, a closer examination of Amazon's business performance paints an intriguing picture. Although the company's revenues are dominated by its retail and consumer businesses, most of its profits come from its highly profitable AWS operations. This dichotomy raises questions about the overall quality of it as a business, especially when considering metrics like return on capital employed.
Supporters of Amazon's long-term prospects argue that focusing on its current financials misses the bigger picture. The company's emphasis on extensive investments for growth means its current earnings do not accurately reflect its future potential. The view is that once these investments bear fruit, the company's profits will soar to new heights.
Challenges and optimism
Despite this optimistic view, Amazon faces challenges, as evidenced by its recent performance relative to the S&P 500 Index. Additionally, the company is encountering headwinds in its North American retail business, primarily due to increased costs from investing heavily in its fulfilment assets during the Covid-19 pandemic. While these investments have added costs, the company is now focusing on optimizing its vast network by creating regional hubs to reduce traveling distances and lower customer service costs, potentially leading to improved retail margins.
It is essential to recognize that while Amazon's international business is currently loss-making, certain regions like the U.K. and Germany are profitable. As newer territories mature, they are expected to follow a similar trajectory to the U.S. business, which took nine years to break even.
Amidst these challenges, the grounds for optimism lie in Amazon's subscription and advertising revenues. Subscription services like Amazon Prime, Amazon Music and Audible offer predictable cash flows that leverage the company's fixed overheads, potentially leading to increased profits. Similarly, its advertising business has been growing steadily and shows no signs of slowing down, with ample potential for further growth and profitability.
Amazon Web Services
Another crucial aspect of Amazon's prospects lies in its cloud computing division, Amazon Web Services. Some investors worry about a potential slowdown in AWS's growth as companies might be becoming more cautious in the short term about information technology spending, which could have been a cause for Microsoft Corp.'s (MSFT, Financial) lower-than-expected quarterly revenue guidance given last week.
However, Amazon's ongoing efforts to help customers save money through its services and the increasing long-term trend of the adoption of cloud-based infrastructure by businesses indicate continued growth potential for AWS. With approximately 90% of global information technology spend still on-premises, there remains significant room for migration to the cloud.
A recent advertising campaign named “Data Full Throttle” by AWS and Formula 1 demonstrates what AWS is all about and its power and potential.
AWS's role in the future of cloud infrastructure
Longer term, AWS is investing quite a bit in capturing the cloud infrastructure business of the unicorns of tomorrow through its AWS Activate startup program, which provides free tools, resources, content and expert support for software startups. An informal survey of several software startups I know, which are using big data and artificial intelligence, shows they prefer the AWS Activate platform over those offered by Microsoft Azure, Alphabet's (GOOG, Financial) Google Cloud and Alibaba (BABA, Financial) thanks to the more generous cloud storage and compute credits on offer. The idea is that once a software startup builds its back end with AWS, it becomes difficult to switch, thereby giving it a strong pipeline for future cloud revenues and an important insight into current and future software trends.
One AWS service software engineer told me they appreciate Amazon SageMaker, which builds, trains and deploys machine learning models for any use case with fully managed infrastructure, tools and workflows. Machine learning is a subfield of artificial intelligence, and while AWS is not quite in the same league as Microsoft and Alphabet when it comes to AI, they are quite close and at least as commercial, which, as investors, is what we really care about.
Expansion
Further, Amazon's entrepreneurial spirit continues to drive its expansion. Recently, the comany increased its presence in the U.S. health care market with the acquisition of One Medical, a company providing affordable basic health care services. Moreover, Amazon launched the Project Kuiper initiative, aiming to provide internet access to underserved consumers and businesses worldwide through a low-orbit satellite service.
Valuation
While Amazon's shares may not seem cheap from a price-earnings perspective, across a broader range of valuation metrics, the stock is not expensive. Indeed, the GF Value shows the stock as significantly undervalued.
The company also has a very strong GF Score of 94 out of 100. Its continued growth potential remains its most enticing factor. My prediction of rapid profit growth in the years ahead should justify the current share price. There is also potential for improving margins as various business segments scale up.
Conclusion
In conclusion, Lynch’s investing idea advocates for investing in companies that play a significant role in our daily lives, a concept that applies to Amazon, for me at least. Despite challenges and skeptics, the company's vast presence and strategic investments in subscription and advertising revenues, cloud computing and diverse ventures make it a compelling prospect for patient, long-term investors.
The company is expected to report earnings after the market closes on Aug. 3.
