These Triggers Could Lead To Big Swings In Amazon’s Stock Price

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AMZN: Amazon logo
AMZN
Amazon

Amazon (NASDAQ:AMZN) has displayed stellar performance this calendar year, with its stock rising by over 110% year to date. This performance has come on top of an acceleration in growth across all key markets, along with improvement in bottom-line results. Moreover, the company has lately outperformed in various business categories, including electronics and general merchandise (EGM), as well as Amazon Web Services (AWS). While our $604 price estimate for Amazon’s stock represents near 10% downside to the current market price, we believe there are certain possible developments that could influence stock price performance considerably over the coming years. Specifically, we think the key triggers for Amazon in the future include profitability results and performance in the cloud services business. We believe these factors underlie certain plausible scenarios, that could influence stock-price changes for better or worse.

See our complete analysis for Amazon

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Operating Margin Stays Constant Over Our Forecast Horizon (-20%)

Profitability has been among the key issues for Amazon’s investors in the past, as the company is known for sacrificing short-term profits for long-term gains.  This has led to huge variability in the company’s margins over the past few years. Though Amazon’s operating margin (in GAAP terms) came in at 4.1% and 1.8% in 2010 and 2011 respectively, the same decreased to 0.2% in 2014. Also, we note that during the nine months ended September 2015, its operating margin was seen at 1.6%, as compared to -0.7% in a similar period a year ago. These past results also suggest that the company’s bottom-line results in the future could remain uncertain, in our view.

In our valuation model, we have estimated Amazon’s EBIT margin will rise from our estimated 4% in 2015 to 8% by the end of our forecast horizon. This is as we believe the company’s thriving third-party e-commerce business and an increased proportion of higher-margin cloud services business could boost Amazon’s profitability over the coming years.

But what happens if Amazon’s operating margins stays constant over our forecast period? According to estimates using Trefis technology, we believe this scenario could lead to over 20% downside to our price estimate, taking our valuation to $460. A few factors that make this scenario plausible include: 1) the possibility that huge investments in growth strategies such as Amazon Prime and hardware business bring lower-than-expected results; 2) the possibility that a rapid rise in competition in the cloud-services and e-commerce business worldwide could lead to significant drop in profitability; and,  3) that an increased share of international revenues in overall results, along with its lower margins, could drag down overall profits.

 

Operating Margin Rises To 12% By 2022 (+20%)

In contrast to the above downside scenario, there is also the possibility that Amazon’s operating margin consistently rises to 12% by 2022. This scenario could lead to a greater than 20% increase in our price estimate to $740. The large variability in Amazon’s margins in the past, make it difficult to forecast the exact direction of its future profit margins. We believe this scenario is also plausible, because: 1) Amazon’s market share gains raise the possibility of price increases in the future, directly leading to higher margins; 2) the use of automation and other tools (such as drones) could bring down costs significantly over the coming years; and,  3) Amazon’s ongoing move to a marketplaces business model will support higher margins in the future.

 

Amazon Web Services Grows To Over-$55 Billion Business By 2022 (+10%)

In our current price estimate, we estimate that revenues in the AWS segment will increase at around a 30% CAGR over our review period to reach over-$40 billion by 2022. This is based on the assumption that the cloud services market is expected to see explosive growth in the coming years. Together with Amazon’s leading position in the market, this will likely catapult into rapid growth in the AWS segment.

However, a more bullish estimate of over-35% compounded growth in AWS revenues to $55 billion by 2022 would lead to over-10% increase in our price estimate to $675. This scenario is plausible given Amazon is known to innovate quickly in this business, and follows superior pricing strategies to win against its competitors. We believe these factors allow for the possibility of significant market share gains for Amazon in the cloud services business over the coming years.

 

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