Key Takeaways
- Amazon’s investment case is pivoting from a narrative of pure top-line growth to one of operational efficiency and significant free cash flow generation, driven by margin expansion in its retail and AWS segments.
- The re-acceleration of AWS growth, fuelled by corporate demand for generative AI infrastructure, confirms its status as the primary driver of profitability, though this requires substantial ongoing capital expenditure.
- The North American retail segment has achieved impressive profitability, transforming from a perennial cash drain into a solid contributor, thanks to logistics optimisation and the high-margin advertising business embedded within it.
- While valuation appears demanding on a simple price to earnings basis, a comparison against peers on a free cash flow yield and EV/EBITDA basis suggests a more reasonable picture, contingent on sustained margin improvement.
- Persistent regulatory challenges, particularly the ongoing FTC lawsuit in the United States, and intense competition in both cloud and e-commerce remain the most significant structural headwinds.
An observation from the analyst TheLongInvest on social media highlighted a long-held bullish projection for Amazon, questioning whether investors have the conviction to maintain their positions. This sentiment taps into a broader market consensus, yet the underlying drivers supporting such a view have undergone a profound transformation. The rationale for holding Amazon is no longer solely about its relentless pursuit of market share; it has evolved into a more nuanced story of operational leverage, margin expansion, and prodigious cash flow, particularly as the business finally demonstrates profitable scale across its core divisions.
The Pivot to Profitability
For decades, Amazon operated as a study in deferred gratification, reinvesting virtually all operating cash flow back into the business to fuel growth. This “growth at all costs” model conditioned investors to prioritise revenue expansion over profitability. However, the narrative has shifted decisively. The post-pandemic era has seen a management team intensely focused on cost discipline and efficiency, particularly within its sprawling fulfilment network. The results are now becoming undeniable in the financial statements.
The most compelling evidence of this change is the company’s generation of free cash flow (FCF). Over the twelve months ending in the first quarter of 2024, Amazon generated an impressive $50.1 billion in FCF, a dramatic reversal from an outflow of $3.3 billion in the prior year. This is not a fleeting anomaly but the outcome of a deliberate strategy to regionalise its logistics network and refine its cost structure. For a company of Amazon’s scale, achieving this level of operational leverage signals a new phase of maturity.
Deconstructing the Pillars
While the market often views Amazon as a single entity, its future rests on the distinct but interconnected performance of its two main pillars: cloud computing and retail. Both are currently experiencing critical, positive shifts.
AWS: The Second Act Begins
After a period of decelerating growth that caused some unease in the market, Amazon Web Services (AWS) is re-accelerating. In the first quarter of 2024, AWS revenue grew 17% year over year, a notable uptick from previous quarters. This resurgence is directly linked to the burgeoning demand for generative AI, with enterprises requiring vast computational power for training and running large language models. AWS, as the established market leader in cloud infrastructure, is a primary beneficiary of this technological wave.
The division’s profitability remains immense, posting a 37.6% operating margin in its most recent quarter. However, this growth comes at a cost. Amazon’s capital expenditures are rising significantly to build out the necessary data centres and acquire the specialised chips required for AI workloads. This capital intensity is a key variable for investors to monitor, as the return on that invested capital will determine future FCF growth.
Retail: No Longer Just a Loss Leader
Perhaps the most underappreciated part of Amazon’s evolution is the newfound profitability of its retail operations. The North American segment, once known for razor-thin or negative margins, delivered $5 billion in operating income in Q1 2024. This success is twofold. First, the aforementioned logistics overhaul has structurally lowered the cost to serve customers. Second is the growing contribution of Amazon’s advertising business. By selling sponsored placements to third-party sellers, Amazon has created a very high margin revenue stream that flows directly from its retail platform, fundamentally altering the segment’s profit profile.
A Question of Valuation
Despite the operational improvements, a frequent criticism levelled at Amazon is its seemingly high valuation. On a forward price to earnings basis, it trades at a significant premium to Alphabet and at a similar level to Microsoft. However, a PE ratio can be a deceptive metric for a company like Amazon that is still heavily investing for growth and has significant depreciation charges.
A more holistic view emerges when comparing it with peers across a range of metrics. The table below provides context, using data from the most recent trailing twelve months where applicable.
| Metric | Amazon (AMZN) | Microsoft (MSFT) | Alphabet (GOOGL) |
|---|---|---|---|
| Forward P/E Ratio | ~37x | ~36x | ~22x |
| Price / Sales (TTM) | ~3.1x | ~13.4x | ~6.5x |
| Operating Margin (TTM) | ~8.5% | ~44.6% | ~30.7% |
| Free Cash Flow Yield (TTM) | ~2.6% | ~2.2% | ~3.4% |
The data reveals a more complex picture. Amazon’s operating margin still lags its peers significantly, highlighting the room for expansion that bulls anticipate. Its FCF yield is now competitive, a direct result of its recent operational discipline. The valuation hinges on the belief that Amazon can continue to expand these margins towards the levels of its big tech rivals, which, if successful, would make the current price appear more reasonable.
Unavoidable Headwinds
No investment of this magnitude is without risk. The primary headwind for Amazon remains regulatory scrutiny. In September 2023, the U.S. Federal Trade Commission (FTC), along with 17 states, filed a sweeping antitrust lawsuit alleging that the company uses monopolistic practices to stifle competition in its marketplace. An adverse outcome could force structural changes to its business model, particularly regarding how it treats third party sellers and integrates services like its advertising and logistics. This is not a background risk; it is a direct and ongoing legal challenge.
Competition also remains fierce. In cloud, Microsoft’s Azure is a formidable challenger, often leveraging its deep enterprise relationships to win AI contracts. In retail, the rapid ascent of platforms like Shein and Temu presents a new type of threat at the low end of the market, potentially pressuring Amazon’s market share among price sensitive consumers.
Conclusion: The Nature of the Hold
Returning to the initial question of whether to “hold still,” the answer requires an appreciation for the evolving nature of the investment. Holding Amazon today is not the same proposition as it was five years ago. It is less a speculative bet on revenue growth and more an investment in a company demonstrating significant operating leverage and cash generation. The long term bull case is no longer hypothetical; it is being written in the quarterly earnings reports.
As a final hypothesis, the market may eventually be forced to re-rate Amazon’s retail segment entirely. If the combination of marketplace fees, advertising revenue, and subscription services continues to drive retail margins higher, the segment may start to be valued less like a low margin retailer and more like a high margin digital platform. Should that perception shift occur, the impact on Amazon’s overall valuation would be substantial, providing the upside that long term holders are anticipating.
References
@TheLongInvest. (2024, October 29). [Long term projection on Amazon stock]. Retrieved from https://x.com/TheLongInvest/status/1852081697329664503
Amazon. (2024, April 30). *Amazon.com Announces First Quarter Results*. Amazon Investor Relations. Retrieved from https://ir.aboutamazon.com/news-release/news-release-details/2024/Amazon.com-Announces-First-Quarter-Results/default.aspx
Federal Trade Commission. (2023, September 26). *FTC Sues Amazon for Illegally Maintaining Monopoly Power*. Retrieved from https://www.ftc.gov/news-events/news/press-releases/2023/09/ftc-sues-amazon-illegally-maintaining-monopoly-power
Palmer, A. (2024, April 30). *Amazon Web Services growth accelerates as AI demand picks up*. CNBC. Retrieved from https://www.cnbc.com/2024/04/30/amazon-web-services-aws-earnings-q1-2024.html
The Motley Fool. (2024, May 1). *Will Amazon Be a $5 Trillion Stock by 2030?* Retrieved from https://fool.com.au/2024/05/01/will-amazon-be-a-5-trillion-stock-by-2030/
