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Online Advertising Could Move the Needle for Amazon Stock

Thomas Niel

Amazon (NASDAQ:AMZN) stock has traded around the $1800 per share mark for the past month. With a nearly $900 billion market cap, it’s tough to imagine above-average growth can continue. But is the party over? The stock likely won’t see the big moves of years past. But advertising could be the key to sustaining growth.

AMZN

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While Amazon stock is by no means cheap, the company continues to have runway.

Let’s take a closer look at Amazon stock, and see if it is a buy today.

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New Frontiers for AMZN Stock

Retail remains Amazon’s biggest business. But services offer better margins and growth potential. Online store sales grew 16% in the second quarter of 2019. But the company’s biggest growth drivers were third-party seller services (25% sales growth), subscription services (37% growth), and Amazon Web Services (37%). AWS continues to be Amazon’s cash cow. As I wrote on Aug. 7, AWS generates a majority of Amazon’s operating income.

But online advertising could be a future cash cow. Amazon’s “other” segment (which encompasses their online advertising business) generated $3 billion in sales last quarter. This was a 37% boost year-over-year. Amazon’s ad business is still small fry compared to giants Alphabet (NASDAQ:GOOG, NASDAQ:GOOGL) and Facebook (NASDAQ:FB). But long term, it could be a threat to both rivals.

Business Insider summed it all up earlier this year. Their report, “The Rise of Amazon Advertising,” includes many finds that are music to investors’ ears. Amazon’s ad revenue growth has slowed in recent quarters. But the company has just gotten started. Beyond display ads on Amazon.com, AMZN could grow their ad business across their online video properties.

Amazon won’t steal Google and Facebook’s business anytime soon. But a pivot towards advertising would boost Amazon’s operating margins. Let’s compare the operating margins of AMZN against Alphabet and Facebook. Amazon’s earnings before interest, taxes, depreciation, and amortization margins are 13.1%. Alphabet’s EBITDA margins are 29.3%. Facebook has EBITDA margins of 42.7%.

The growth of Amazon’s online ad business would help sustain earnings growth. Sustained earnings growth justifies the current valuation of Amazon stock. Speaking of valuation, let’s take a look and see how AMZN stock stacks up to its peers.

AMZN Trades at Higher End FAANGs

Amazon has specific competitors in the retail space. However, comparing the stock to its FAANG peers offers other insights into valuation. FAANG is an acronym for Facebook, Amazon, Apple (NASDAQ:AAPL), Netflix (NASDAQ:NFLX), and Alphabet’s Google.

Compared to Alphabet, Apple and Facebook, AMZN stock trades a high valuation. AMZN’s forward price-to-earnings ratio is 54.3. Its enterprise value/EBITDA ratio is 27.5. Here are the corresponding valuations for Amazon’s cheaper FAANG peers:

  • Alphabet: forward P/E of 21.2, EV/EBITDA of 16.2
  • Apple: forward P/E of 16.4, EV/EBITDA of 12.3
  • Facebook: forward P/E of 19.7, EV/EBITDA of 17.9

Of the FAANG stocks, AMZN trades at the second-highest valuation. Only Netflix trades at richer multiples. NFLX has a forward P/E of 51.3, and an EV/EBITDA ratio of 69.2. But NFLX is priced for perfection. Amazon is no slouch when it comes to online video. They are in a stronger position than Netflix. Netflix needs to pay more to sustain its subscriber base. Amazon can easily absorb higher programming costs. Prime video is a loss leader for Amazon. But it keeps more users in the Amazon echosphere, driving retail sales. It also offers a ready-made audience for advertisers.

But does Amazon want to bet the ranch in a content arms race? Media conglomerates such as Disney (NYSE:DIS) could edge out both with their own streaming services. Amazon may be content focusing on the middleman aspect of video streaming. Distributing streaming services and collecting a piece of the revenue is another potential cash cow area.

Bottom Line: Amazon Richly Valued, But Has Runway

Amazon stock is richly valued. It trades at the higher band of FAANG stock valuation. But the current multiples applied to AMZN stock could be justified. AMZN is maxing out in retail. But there are plenty of frontiers it could explore. Amazon likely won’t reach number one in online advertising. But gaining third place to Google and Facebook would still generate significant revenue. With services providing high margins, Amazon could continue to drive earnings growth. Above-average earnings growth will sustain the current valuation.

Amazon stock remains a solid opportunity. The current valuation may be rich. But the company is in a better position than FAANG rivals like Netflix. AMZN stock likely won’t see big gains like in the past. But for investors entering today, it should definitely be on your radar.

As of this writing, Thomas Niel did not hold a position in any of the aforementioned securities.

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