If you’re an Amazon (AMZN 2.73%) investor, you’re likely feeling cheery this holiday season. Share prices of the tech giant have soared 76% through mid-December, easily beating the 23% rally in the S&P 500 this year.
It might seem outlandish to think Amazon stock will have another strong year after outperforming at that fantastic level in 2023, but don’t discount that real possibility. There are at least three good reasons to believe you haven’t missed the market-beating gains from Amazon stock just yet.
Many tech companies, including Apple, are shifting away from a focus on selling products and moving toward marketing services. Services have higher profit margins, after all. Compare Microsoft’s 42%-plus operating margin to Apple’s 30% figure for some illustration of that difference. And services provide more stable income because they tend to be subscription-based.
Amazon is moving quickly in Microsoft’s direction. Its services unit — anchored by Amazon Web Services (AWS) and things like its merchant advertising business and Prime subscription sales — now accounts for nearly 60% of total revenue. It is expanding at a much faster pace than e-commerce sales, too, suggesting that it will be an even bigger part of the company over time. As a result, Wall Street is starting to look at — and value — the stock as less of an e-commerce retailer and more of a tech services giant.
Since its inception, Amazon has famously prioritized growth over short-term net earnings, to the consternation of many investors. That broader approach hasn’t changed, but management is now more focused on finding balance. There’s no reason why this massive business can’t deliver strong earnings even while investing aggressively in areas like artificial intelligence (AI) and its global delivery network.
You can see proof of that shift in areas like free cash flow, which was $21 billion over the past full year compared to a $20 billion outflow in the prior-year period. Operating income was $24 billion in the first nine months of 2023, up sharply from about $10 billion a year earlier.
Expectations for further gains in these metrics are key reasons why Amazon stock has done so well lately. Management predicted in late October that Q4 operating earnings will land between $7 billion and $11 billion, up from $3 billion last year.
The best news is that there’s room for Amazon’s stock valuation to continue rising in 2024. Shares are priced at less than 3 times annual sales even factoring in the 2023 rally. That compares well against other tech giants like Apple (8 times sales) and Microsoft (12 times sales).
Sure, Amazon isn’t nearly as profitable as these companies. Its 5% operating margin is closer to what you might see from a retailer like Walmart than what tech investors are accustomed to. Yet that rate is improving right now and has a good chance of expanding toward double-digit percentages in 2024. Amazon’s surging cash flow trend is a clear signal that earnings will be rising in the next few years. Investors are likely to see solid returns if they own the stock and simply go along for that ride.
