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On Wednesday last week, March 09, 2022, Amazon (NASDAQ:AMZN) announced a 20-for-1 share split as well as a $10 billion share buyback authorization. Split adjusted trading is expected to begin on June 03, 2022. And while the stock market obviously considered the stock split as being extremely bullish (the stock jumped about 10% after hours following the news and closed about 5% higher the next trading day), we all know it has no impact on the fundamental business – we will get to that.
Right now, Amazon is trading about 22% below its previous all-time high and aside from the 95% decline following the Dotcom bubble, this is one of the steepest corrections for Amazon in its 25-year history and it is the steepest correction since 2018 for the stock. And this is certainly justifying the question if Amazon is a good buy at this point. Interestingly, the stock is trading almost for the same price as one year ago, when my last article was published, and I considered Amazon to be just a “Hold” and – spoilers – Amazon is still not a “Buy” in my opinion.
When looking at the trailing twelve months numbers, we see growth rates slowing down in the last few quarters. Like many other retailers, Amazon could report extremely high growth rates during the pandemic, and it is not surprising, that these growth rates were not sustainable, and we are seeing a slowdown again.
But when looking at the results for fiscal 2021we see still impressive growth rates many other businesses won’t reach. In fiscal 2021, the company generated $469.8 billion in sales and compared to fiscal 2020 when the company generated $386.1 billion in sales it is resulting in 21.7% year-over-year growth. When looking at operating income, we see an increase of 8.6% year-over-year from $22,899 million in fiscal 2020 to $24,879 million in fiscal 2021. However, when looking at the bottom line, diluted earnings per share increased from $41.83 in 2020 to $64.81 in 2021 – an increase of 55.0% YoY.
When looking at the different segments, it was once again the AWS segment, that contributed the most to growth. Net sales increased from $45,370 million in 2020 to $62,202 million in 2021 – resulting in 37.1% year-over-year growth. And the segment is still responsible for the biggest part of operating income (75% of total operating income) and operating income for the segment increased 37.0%. And we can also point out, that net product sales increased only 12.0% year-over-year (resulting in $241.8 billion in sales) while net service sales increased 34.0% year-over-year (resulting in $228 billion in sales).
Last week, Amazon announced a 20-for-1 stock split and this is the fourth stock split since Amazon’s IPO in 1997 and the first since 1999. In my honest opinion, a stock split is not worth mentioning as it makes no difference in investing. When the numbers are adjusted in June, we must become familiar with a stock that is trading for $150 and earnings per share being around $3 – but the fundamental business is the same, the stock should not be worth more or less. Some contributors – like Mott Capital Management – are even arguing, that the stock split (and share buyback) is only a distraction.
However, this is obviously not the way the market sees it – the stock jumped 10% following the news. Amazon is following stock splits of mega-cap companies Alphabet (GOOG) in February 2022 or Apple (AAPL) and Tesla (TSLA) in 2020 and every time investors seemed to be euphoric about the stock split. And obviously, companies that announced a stock split on average rose 25% over the next 12 months compared to 9% for the S&P 500 (SPY). But the question remains unanswered if the stocks would have performed in a similar way without the split and when considering, that usually companies split the stocks that are performing quite well (and saw stock prices increasing), this is not surprising.
And I will not deny that the stock split can have some positive effects. First, the stock is now more affordable for retail investors, which could lead to buying from people, which could not afford an Amazon stock before. And – even more important – Amazon could now be included in the Dow Jones Industrial Average (DIA), which could be a tailwind for the stock price as ETFs and other funds must buy the stock.
In my opinion, investors should not really think about stock splits, but rather try to answer the question if Amazon can continue to grow with a high pace. These are the rather tricky questions: For how long can a company, that is already generating close to $500 billion in sales continue to grow with a high pace? Can Amazon also turn its “International” business profitable? Can Amazon generate a positive free cash flow again? And Amazon is certainly one of the companies that needs to grow with a high pace in order to be fairly valued right now.
Analysts are still very optimistic that Amazon can grow its earnings per share with a high pace. While analysts are expecting earnings per share to decline in fiscal 2022, they are expecting growth rates between 25% and 56% for the years between fiscal 2023 and fiscal 2027. This is resulting in a CAGR of 25.96% until fiscal 2027.
And while we could argue that analysts are probably a bit too optimistic, there are many different ways Amazon can continue to grow:
And although we can expect high growth rates for Amazon in the years to come, we must assume that growth will gradually slow down over the years and decades to come. And one hint, that growth rates might slow down is the share buyback program.
Amazon also announced a $10 billion share repurchase program authorization and while this may sound like a lot, it is only enough to repurchase about 0.7% of the outstanding shares and won’t have much impact on earnings per share. And while Wall Street analysts see the share buybacks as rather positive, I don’t know if this is necessarily true for Amazon. Analysts are arguing that the share buyback announcement could be a sign, that Amazon is moving past the peak of its capex cycle – which could be true. In the last four quarters, Amazon spent $61.1 billion on capital expenditures and generated even a negative free cash flow for the first time in more than a decade.
And when looking at Amazon’s balance sheet, the company can afford share buybacks. Right now, Amazon has $48,744 million in long-term debt and compared to a total stockholder’s equity of $138,245 million this is resulting in a D/E ratio of 0.35. But Amazon also has $36,220 million in cash and cash equivalents on its balance sheet and $59,829 million in marketable securities and this is enough to repay all the outstanding debt and still have cash left over for share buybacks (or potentially a dividend?).
In my opinion, share buyback programs are rather indicating that growth rates will decline further. Share buybacks make sense when a company can’t use the cash in a better way (and the preferred way is to generate future growth for the business). And while the timing for share buybacks seems reasonable – after all, the stock declined more than 20% – we still must question if Amazon’s stock is actually cheap right now (or at least fairly valued).
We could start by looking at the price-free-cash-flow ratio to get a feeling how “expensive” the stock is. However, free cash flow is negative right now and therefore the P/FCF doesn’t offer any useful insights. Instead, we can look at the price-earnings ratio and the current P/E ratio seems to be rather low compared to the last few years. My first impulse was to call this the lowest P/E ratio ever for Amazon, but that is actually not true. For example, in 2005 and during the Great Financial Crisis, the stock was trading for a lower P/E ratio (and in early 2005, Amazon was trading only for 23.65 times earnings).
In the last five years, Amazon was trading for a P/E ratio as much as 300 in late 2018 and the P/E ratio then constantly declined to 45 right now. This is clearly below the average P/E ratio of 220 (since 2004 when Amazon became profitable) and below the 5-year average P/E ratio of 123.
When looking at the price-earnings ratio, we can state, that Amazon is cheap like it hasn’t been in a long time. But that statement doesn’t include the possibility, that growth will slow down and that the stock was always extremely expensive – and maybe still is. A better way to include several assumptions about growth and free cash flow in the years to come is a discount cash flow calculation. However, such a calculation comes at a cost: we must make several assumptions for the years and decades to come and these assumptions are rather difficult.
At first, we need a free cash flow for fiscal 2022 to start with. I often use the free cash flow of the last four quarters as basis (or some average of the recent past). However, in case of Amazon the free cash flow is negative right now. We can be rather optimistic and assume lower capital expenditures for fiscal 2022 again and maybe the free cash flow of fiscal 2020 is a good assumption ($25,924 million) and an amount Amazon can generate again in this fiscal year.
A second challenging task is estimating the growth rates for the years to come. We could for example take the assumptions analysts are using for the years to come and when calculating with growth rates between 25% and 50% for the years to come, Amazon is clearly undervalued. But – as already mentioned – I consider these assumptions as extremely optimistic and while these high growth rates are possible, I don’t want to bet on those growth rates.
Instead, we assume Amazon can grow 20% in the next year and growth will slow down over the next decade to low double-digit growth (10%). But to be fairly valued right now, we still must assume a growth rate of 7% till perpetuity (and in this scenario we assume “only” 10% discount rate and I would assume that most investors are betting on higher returns from their Amazon investment). In my opinion, Amazon could be fairly valued when assuming 10% annualized return. But the stock is certainly not a bargain and the stock must drop lower for current investors being able to outperform in an impressive way (15% CAGR or higher for an investment).
And right now, many people (analysts and investors) seem to consider a steep decline nearly impossible – like they do for companies like Tesla. But why should Amazon not decline in a similar way as Meta Platforms (FB), Alibaba (BABA) or Tencent (OTCPK:TCEHY) and many other stocks. And compared to these companies, which can also be described as high-quality businesses, Amazon is trading for a rather high valuation multiple and the business is also facing headwinds (regulatory headwinds, increasing competition, higher costs).
When looking at the chart, Amazon is trading in a sideway range with the upper range being around $3,800 and the lower end of the range being around $2,875. But in January 2022, the stock also broke below the lower end of the range and set a new low around $2,715, which was tested again in the last few days.
When we assume, the current support level is not holding, the 200-week simple moving average around $2,475 would be the next potential support level for the Amazon stock, followed by the highs of the years 2018 and 2019 around $2,050 (when Amazon was in its last corrective phase).
And while many analysts, investors and people that are bullish on Amazon consider a steep correction rather unlikely (or when reading the comments under some article, a steep correction seems impossible), we also must think about that possibility. It is very well possible, that we will see a larger correction of the long upward wave, that took Amazon from $100 to almost $3,800. And we should also keep in mind, that a CAPE ratio around 35 for the S&P 500 (at the beginning of March) is not the norm. When looking back in history, the stock market could very well trade for single digit P/E or CAPE ratios again and a company like Amazon can also be trading for valuation multiples of 30, 20 or even 10 (if these valuation multiples would be justified is another question).
I am rather neutral on Amazon right now and I think it is possible that the support level will hold, and the stock might move higher again. However, I don’t know if Amazon can set new all-time highs in the foreseeable future. And I also don’t think that Amazon is a bargain right now or a great investment. The company is without any doubt a great business and will be able to grow with a high pace for several years to come – but at current valuation multiples, it has to be.
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Disclosure: I/we have a beneficial long position in the shares of BABA, FB, TCEHY either through stock ownership, options, or other derivatives. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.