Amazon: Why Shares May Be Poised To See New All-Time-Highs (Rating Upgrade) (AMZN)

Amazon.com, Inc. (NASDAQ:AMZN) reported exceptionally strong Q4 results, beating analyst consensus projections on all major metrics, including top line and profits. The better than expected commercial momentum was carried by a record-breaking holiday shopping season, with strong events for Black Friday and Cyber Monday. On cloud, Amazon also surprised to the upside, as management suggested an accelerating growth outlook heading into 2024, highlighting “significant interests” in AWS’ GenAI solutions.

Overall, I argue that Amazon is poised for a strong calendar year 2024, as the artificial intelligence, or AI, investment tailwind is clearly supporting AWS demand, while an improving macroeconomic backdrop is a tailwind to consumer sentiment aiding Amazon’s retail e-commerce business. Adjusting my valuation framework in line with EPS consensus estimates through 2028, I calculate a fair implied share price for Amazon stock equal to $223/ share, suggesting about 30% upside. In accordance with this, I assign a rating upgrade from “Hold” to “Buy.”

For context, Amazon shares have unperformed the broad equities market in 2023: For the trailing twelve months, AMZN shares are down about 52%, compared to a gain of 19% for the S&P 500 (SP500).

Amazon Reports Q4 Above Expectations

On Thursday, 1st of February, Amazon disclosed its financial results for the fourth quarter of 2023, surpassing analyst forecasts for both revenue and profit. During the period from September through end of December, Amazon achieved group revenues of $169.86 billion, marking a 14% increase YoY compared to the same period one year earlier. Notably, Amazon’s top line exceeded analyst consensus by a strong $3.7 billion, with management citing a record-breaking holiday shopping performance as a major reason for the better than expected sales number. For the full year, sales increased 12% YoY, to $574.8 billion.

In terms of profitability, Amazon reported an operating income of roughly $13.2 billion, which compares highly favorable to the $2.7 billion reported in Q4 2022. The net income was reported at $10.6 billion ($1 per share), beating estimates by close to $2 billion ($0.2 per share).

Interestingly, the positive profitability momentum for both Q4, as well as FY 2023, was supported by all major segments, incl. International, North America and AWS. Thus, I feel comfortable to assume that the margin expansion is well-anchored across the business. Viewing Amazon’s profitability from the perspective of the trailing twelve months (TTM), I highlight that operating income now stands at close to $36.9 billion, about triple the profits achieved for the respective TTM view one year earlier.

The record-breaking performance in Amazon’s retail business has already been highlighted; however, I point out that also AWS performed exceptionally well in Q4. During the period, the segment’s topline increased 13% YoY, to $24.2 billion, while operating profits jumped 38% YoY, now at $7.16 billion.

Discussing the strong performance in the cloud business, Amazon management highlighted major customer deals with companies like Salesforce (CRM), BMW (OTCPK:BMWYY), and Nvidia (NVDA), thereby underscoring AWS’s strong customer pipeline and commitment renewals. In addition, significant progress was also made in GenAI, with AWS focusing on three layers of the GenAI stack and launching products like Trainium2 for AI training, Bedrock AI for leveraging large language models, and Amazon Q, which can be understood as a “work productivity” companion with features similar to ChatGPT.

While Amazon’s Q4 performance was strong, in my opinion the most important takeaway for Amazon relates to the company’s guidance: After voicing a slowing growth environment for retail and AWS through most of 2023, Amazon management commentary finally shifted notably bullish again. Heading into the new year, Amazon sees generative AI as a potential catalyst for reviving accelerating sales growth for AWS. In that context, Amazon CFO Brian Olsavsky to pointed to fading customer cost-cutting initiatives and heightened interest in long-term infrastructure investments on more favorable financing (e.g., lower interest rates). And while Amazon did not give specific guidance, CEO Andy Jassy mentioned that generative AI revenue is already significant for the company, and the revenue specific to AI product is expected to reach “tens of billions” of dollars in the future.

Taking a high level perspective on Amazon’s growth outlook, I am encouraged to note that analysts, according to data collected by Seeking Alpha, currently project a 11-12% top line CAGR through 2026 …

… and a robust 30-35% CAGR for earnings!

AMZN Valuation: Set TP At $223/Share

Valuing a growth asset like Amazon is difficult; however, as an analyst I support the idea that most assets value can roughly be estimated through a residual income framework, which anchors on the idea that a valuation should equal a business’ discounted future earnings after capital charge. As per the CFA Institute:

Conceptually, residual income is net income less a charge (deduction) for common shareholders’ opportunity cost in generating net income. It is the residual or remaining income after considering the costs of all of a company’s capital.

With regard to my AMZN stock valuation model, I make the following assumptions:

• To forecast EPS, I anchor on the consensus analyst forecast as available on Seeking Alpha.
• To estimate the capital charge, I anchor on AMZN’s cost of equity at 8.35%, which is about in line with the CAPM framework.
• For the terminal growth rate after 2025, I apply 4.25%, which is about 150-175 basis points above the estimated nominal global GDP growth. The growth premium should reflect the structural expansion outlook for Amazon’s AI exposure through AWS, as well as the company’s track-record to capture sizeable growth in various speculative ventures (think streaming, pharmacy, etc.)

Given these assumptions, I calculate a base-case target price for AMZN stock of about $223/share.

As I argued that my estimates for growth and equity charges may be too conservative for some, and too aggressive for others, I acknowledge that investors may hold varying assumptions regarding these rates. Therefore, I’ve included a sensitivity table to test different scenarios and assumptions. See below.

Investor Takeaway

In the December quarter, the Amazon’s top line grew 14% YoY, while operating income more than quintupled vs. the same period in 2022. Moreover, Amazon is expected to have a strong year in 2024, supported by AI investments and an improving positive macroeconomic environment. Despite the 8% surge in shares as a response to strong Q4 reporting, AMZN stock is still trading about 7% below all-time highs ($184/ share, November 2021). But after reflecting on optimistic management commentary heading into 2024, I expect that Amazon shares will soon chase new all-time highs again. Based on a residual earnings valuation framework, I suggest a fair share price of $223, indicating a potential 30% upside; and accordingly I upgrade my rating from “Hold” to “Buy.”