Following an underwhelming 2019 in which Amazon (AMZN -1.65%) stock has underperformed the S&P 500 index by nearly 9 percentage points, one analyst is calling the e-commerce and cloud-computing giant one of his firm's "Best Ideas for 2020." Shares could appreciate about 34% over the next year, he believes.
This bullish outlook contrasts from the bearish response the Street had to Amazon's most recent earnings report. While the company's revenue beat expectations in the third quarter, its earnings per share missed analysts' consensus forecast as aggressive investments weighed on profitability. But could Amazon's performance in 2020 surprise to the upside?
Image source: Amazon.com.
The path to a $2,400 share price
E-commerce, cloud computing, and subscription services will drive more strong revenue growth in fiscal 2020, predicts Cowen analyst John Blackledge. More importantly, Cowen believes the company's fast-growing cloud computing business (Amazon Web Services) and its advertising business will lead to margin expansion next year.
Together, these catalysts could help Amazon shares rise to $2,400 within 12 months, Blackledge believes. With shares trading at $1,783 at the time of this writing, this price target implies significant upside.
Cowen's bet that Amazon Web Services (AWS) and advertising could drive margin expansion in 2020 is sensible. AWS' trailing-9-month revenue increased 38% year over year, easily outpacing its consolidated revenue growth of 20%. More importantly, the cloud computing segment boasts a trailing-9-month operating margin of 26% versus Amazon's consolidated operating margin of about 6%.
Meanwhile, though Amazon doesn't break out the growth rate or the operating margin of its advertising business, there's good reason to believe it will positively impact profitability in 2020. Management has said advertising accounts for the bulk of its "other" segment -- and this segment saw 45% year-over-year revenue growth in Q3. Further, management has said in the past that its advertising business was having an accretive impact on gross profit, suggesting it's a lucrative business.
What about that sky-high P/E ratio?
While catalysts, including AWS and advertising, do appear poised to help support strong top-line growth and margin expansion for Amazon in 2020, investors should keep in mind that top-notch execution from the company is largely priced into the stock. Shares currently trade at 79 times earnings, baking in both meaningful revenue growth and margin expansion for years to come.
Of course, Amazon's long history of exceeding expectations makes the stock well worth its frothy valuation. Could a year of underperformance be an opportunity for investors to buy shares? If Amazon can maintain its strong revenue growth rates in 2020 while expanding its gross margin, investors may look back nostalgically at 2019 as an attractive entry point to buy shares of a great company.
Of course, it doesn't hurt for investors to proceed with caution. For those who are bullish on the e-commerce king's long-term prospects, consider starting a small position instead of going all in. While Amazon could very well exceed investors' expectations next year, damage to the stock could be significant if business performance falters.
