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Amazon’s Profits Are About to Surge — Here’s Why

Luke Lango

Over the past several years, the biggest knock against Amazon (NASDAQ:AMZN) stock has been valuation. The bears keep saying that the valuation is too rich and that, when growth slows, Amazon’s day of reckoning will come. Despite these persistent bearish calls for a cliff-dive in Amazon stock, all the stock has done over the past several years is go higher, mostly because growth hasn’t slowed.

Amazon’s Profits Are About to Surge -- Here’s Why

Source: Shutterstock Over the past 5 years, shares are up more than 400%.

Bears won’t throw in the towel just yet. At 65 times forward earnings, Amazon stock still isn’t cheap by traditional standards — and there are signs that growth is slowing in the company’s core e-commerce business now. As a result, bearish calls for a big Amazon stock correction may grow louder in 2019.

But make no mistake about it, the bears will throw in the towel soon — likely within the next five years. Why? Because over the next five years, the robust revenue growth narrative at Amazon will finally be accompanied by an equally robust margin expansion and profit growth narrative. This will create a surge in Amazon’s profits, which will allow the stock to grow into its valuation, and head higher while the valuation compresses to more reasonable levels.

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Indeed, within the next five years, I think Amazon’s profit surge will enable AMZN stock to trade at $3,500-plus prices, with just a 25 forward price-to-earnings multiple.

Consequently, I believe the next five years for Amazon stock will be defined by a profit surge that silences bears, creates bulls and broadly reaffirms that this stock has the long-term firepower to more than grow into its valuation.

Profit Growth Initiatives Galore

Everywhere you look at Amazon, there are signs that this company is on the verge of a huge multi-year upswing in profits. Consider the following:

  • Amazon’s low-margin e-commerce business has started to slow, and is now growing at a low double-digit rate. Meanwhile, Amazon’s high-margin cloud business is growing at a 40%-plus rate, and the high-margin digital advertising business is growing at a triple-digit rate.
  • Within the low-margin e-commerce business, Amazon is driving traffic away from CRaP, or “can’t realize a profit”, items in an effort to boost retail margins.
  • Also within the low-margin e-commerce business, Amazon is rapidly expanding its private-label business. This business has higher margins than the traditional e-retail business, and also has a long runway for growth ahead.
  • On the brick-and-mortar front, Amazon is shuttering what are presumably very low-margin pop-up kiosk stores.
  • Within the digital advertising segment, Amazon is making a big mobile-ad push, specifically on the video front. Video ads have among the highest margins in the digital ad world and, thus, will be additive to Amazon’s already high digital ad margins.
  • Within the cloud segment, Amazon continues to grow at a robust pace, including recently scoring big all-in wins from Lyft and Gogo (NASDAQ:GOGO). So long as this segment continues to outpace the e-commerce segment, margins will head higher.
  • Amazon’s yet-to-be-launched logistics business, much like the cloud and digital advertising businesses, should be additive to margins. Traditional logistics giants UPS (NYSE:UPS) and FedEx (NYSE:FDX) operate at high-single-digit operating margins, versus Amazon’s aggregate mid-single-digit operating margin.

Overall, Amazon is oozing with profit growth potential — and all of this potential will likely materialize within the next five years.

Amazon Stock Can Grow Into Its Valuation

If Amazon’s profits surge thanks to the aforementioned margin expansion tailwinds and initiatives, then Amazon stock won’t need a big multiple to trade north of $3,500 in the future.

Here’s the math. Revenues this year (2019) are expected to grow 18% to $275 billion. Next year, they are expected to rise another 18% to $325 billion. Over the subsequent five years, robust expansion in digital advertising, cloud, logistics, pharmacy, offline retail, and private label should keep aggregate revenue growth around 15%. That would put 2025 revenues at around $650 billion.

Over the past two years, ramp in the cloud and digital advertising businesses, coupled with increasing scale in the e-retail business, has driven operating margins from narrowly above zero, to over 5%. Into 2025, similar dynamics will unfold at a roughly equivalent pace, implying that 15% operating margins are achievable by 2025.

A 15% operating margin on $650 billion in revenues implies operating profits of nearly $100 billion. Taking out 20% for taxes, that equates to a net profit opportunity of nearly $80 billion by 2025. Based on a big growth average 25 forward multiple — the sort of multiple Facebook (NASDAQ:FB) and Alphabet (NASDAQ:GOOG) have — that implies a market cap of $2 trillion by 2025.

Assuming 550 million fully diluted shares, that’s a price tag north of $3,500.

In other words, thanks to multiple profit-growth tailwinds and initiatives, Amazon stock has an opportunity to hit $3,500-plus prices within the next several years, while only needing a growth average multiple to do so.

Bottom Line on AMZN Stock

The biggest knock against Amazon stock over the past several years has been the stock’s out-sized valuation.

This headwind won’t last much longer.

Over the next several years, Amazon’s profits will surge, and as they do, Amazon stock will grow into its valuation. Bears will be silenced. Bulls will gain more control. And Amazon stock will head materially higher.

As of this writing, Luke Lango was long AMZN, FB, and GOOG. 

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