“Buy Amazon” isn’t the world’s biggest stock-picking cliché, but it’s close. There are 49 analysts who cover the shares, and 47 of them are positive, with two neutral, according to FactSet. Only Alibaba Group Holding of China and ICICI Bank of India boast more endorsements.
And after a record-setting run-up, Amazon’s stock isn’t obviously inviting. A $1,000 stake at the close of the stock’s first day of trading in 1997 has turned into more than $950,000. The shares today, at $1,875, go for 69 times projected 2020 earnings.
Still, buy Amazon.com (ticker: AMZN). The stock price looks sensible when compared with free cash flow, which is swelling quickly. Some growth initiatives are only now paying off. Don’t expect a 35% gain this year, as Amazon has averaged, compounded, since going public. But don’t rule it out, either.
Amazon’s reputation for operating near break-even has long been outdated. Founder Jeff Bezos has emphasized free cash flow over accounting earnings from the start, and Amazon has generated free cash since 2002. The company has tended to invest much of that cash for growth, and the result is that earnings have been positive only since 2014, and only meaningfully so since 2018. Now the numbers are reaching escape velocity.
When 2019’s results are released, Wall Street expects Amazon to report that revenue increased by 20%, to $279.1 billion; that earnings rose slightly, to $10.4 billion; and that free cash flow ballooned by 28%, to $24.9 billion. In 2020, free cash flow is expected to expand even faster, by 36%, to $34 billion.
Within five years, the consensus view is that Amazon will become the biggest free cash generator in America, passing some companies that aren’t exactly standing still, like Apple (AAPL) and Microsoft (MSFT). The simplest reason is that Amazon’s investment spending can’t keep up with its growth rate forever.
Amazon launched Prime in 2005, with its free two-day shipping for members, and vast opportunities for the company to put capital to work building speedier infrastructure. Not long after, Amazon Web Services went into cloud computing, another path for investment. Both ventures have proved to be lucrative, with Prime spurring increased spending by shoppers, and AWS yielding generous profit margins.
Last year, Amazon said that it would spend to shorten free Prime shipping to a single day. There are early signs of that paying off, too. Cowen analyst John Blackledge estimates that Prime membership grew 13% during the fourth quarter, versus a year earlier. That compares with 3% growth a year ago and would be the third straight quarter of acceleration.
Now, consider another of Amazon’s growth initiatives: advertising. A recent search for “men’s tennis rackets” on Amazon.com yielded editorial recommendations and a racket listing labeled “Amazon’s Choice.” But nothing was more prominently displayed than the three sponsored racket listings near the top—except for the paid ad for portable nets just above them.
Advertising doesn’t require vast investments in fleets and data farms, and it looks like another boon for Amazon’s growth. Ad revenue will rise 36%, to $17.6 billion, in 2020, and by 2025 will top $46 billion, predicts Cowen’s Blackledge. Assuming a 35% operating margin for the business, he estimates that advertising and AWS will together account for 90% of operating income this year.
That has important implications for shareholders. First, it bodes well for the competitiveness of a store when it doesn’t have to rely on its retail margins for the bulk of profits. Second, the advertising ramp provides another rich source of funds to invest in growth. Third, with Amazon passing the anniversary of its spending boost for Prime one-day, it is unclear that it will need that extra spending. As things stand, growth in capital expenditures is expected to decelerate from over 25% last year, to 16% this year, to under 10% in 2021.
Among 10 analysts who have estimated Amazon’s free cash flow out to 2021, the lowest says $32.7 billion, the highest says $57.5 billion, and the average is $43.7 billion. Out to 2024, there are only three estimates, averaging $82.8 billion. Apple, in comparison, is expected to produce close to $63 billion in free cash during its current fiscal year through September.
If distant estimates for Amazon are feasible, or even if they are only moderately overblown, the stock could continue outperforming. At less than 30 times estimated 2020 free cash flow, it is cheaper than the shares of Visa (V), Nike (NKE), or McDonald’s (MCD). From here, 20% annual gains for the next three years could leave the stock priced at a humbler 25 times free cash flow.
A government crackdown against powerful tech titans is a risk, but Amazon may have a better “who me?” defense than some of the others. Its market share in the public cloud is less than half, and falling, as Microsoft and others catch up. In e-commerce, more than half of its sales are from third-party merchants who pay to use its services. And in online advertising, it’s a pipsqueak next to Alphabet (GOOGL) and Facebook (FB).
All told, Amazon is popular with stockpickers for good reason. It’s not too late to join the crowd.
Write to Jack Hough at firstname.lastname@example.org