It's a great time to be a long-term investor. Right now, the U.S. economy is in its longest economic expansion in recorded history, and the stock market is riding a nearly 11-year bull-market run. There have been some close calls over this period where the bull nearly gave up its horns, but historically low lending rates have helped push growth stocks to the forefront.
Arguably one of the biggest beneficiaries of this long-tenured rally in equities is e-commerce giant Amazon (NASDAQ:AMZN). Since the stock market bottomed out in March 2009, shares of Amazon are up almost 3,500% through this past Thursday, Feb. 13, with its stock going for $2,150 per share.
The thing is, $2,150 a share for Amazon could still very well be considered a bargain. While that might sound overly optimistic if not borderline crazy on the surface, I believe Amazon could reach $5,000 by 2023. Such a price point would value Amazon at close to $2.5 trillion, making it the most valuable publicly traded company in the world.
Is Amazon "overvalued?"
Before I dig into the reasons Amazon could not only see, but support, a $5,000-a-share valuation within the next four years, let me run through some of the arguments that could keep it well below what must sound like a pie-in-the-sky valuation.
One of the more obvious concerns of the Amazon operating model is that it's highly dependent on retail. Based on the company's recently reported full-year results, $245.5 billion of its $280.5 billion in net sales were derived from its e-commerce operations, with the remainder coming from its cloud services, known as Amazon Web Services (AWS). While Amazon boasts of having 38% of the U.S. e-commerce market, according to a June 2019 eMarketer estimate, retail is an inherently competitive and low-margin business. Of this $245.5 billion in sales in 2019, only $5.34 billion in operating income was generated.
Amazon also reported declining growth rates in all of its major categories in 2019. Year-over-year net sales growth slowed from 33% in North America to 21%, with international net sales growth dipping to only 13% from 21% in the prior year. The faster-growing AWS also saw sales growth slow to 37% in 2019 from 47% in 2018.
But perhaps the biggest argument that can be made against Amazon is the company's valuation. Even with the benchmark S&P 500 valued aggressively on a forward-earnings basis, Amazon is seemingly a value-investor's nightmare at an estimated 53 times Wall Street's consensus earnings per share (EPS) for 2021 and 75 times this year's consensus EPS. Fundamentally, this looks like a fully valued company, and then some. However, such thinking couldn't be further from the truth.
Here's why Amazon to $5,000 in less than four years is genuinely achievable
Arguably the most exciting aspect of Amazon is the company's rapidly growing cloud operations. Although AWS' sales growth slowed a bit from the previous year, which is to be expected due to increased competition in the enterprise cloud space, AWS continues to represent a growing share of total sales for the company (12.5% in 2019 vs. 11% in 2018).
This increase in AWS' importance for the company is meaningful for one big reason: the margins generated from AWS are light years better than what Amazon generates from e-commerce. After only pocketing $5.34 billion in operating income on $245.5 billion in non-AWS net revenue, Amazon generated $9.2 billion in operating income on $35 billion in AWS net sales in 2019. Although AWS' margins declined by a tad over 2 percentage points year over year, this has everything to do with Amazon reinvesting in new products for AWS and nothing to do with core product weakness. Put simply, as AWS becomes a larger component of total revenue, Amazon is going to see a serious expansion in operating cash flow.
Secondly, although e-commerce is a relatively low-margin business, I don't believe Wall Street has fully reflected on the importance of Amazon's Prime membership. Amazon has recently added a host of additional perks to Prime, including the most coveted perk of one-day shipping, and Prime has soared past 150 million worldwide members. Mind you, this comes only 21 months after Amazon announced that it had eclipsed the 100 million mark in Prime memberships. While the costs to include additional perks, such as one-day shipping, won't be small, the payoff even one or two years down the line in terms of brand loyalty and dollars spent within its ecosystem could be enormous.
But the major factor that Wall Street and investors might be overlooking is the rapid expansion in the company's operating cash flow per share. Companies like Amazon that choose to reinvest a vast majority of their capital and put their money to work in a number of nontraditional ventures (e.g., purchasing Whole Foods Market) shouldn't be valued according to the same archaic price-to-earnings metrics that we hold a mature company like Coca-Cola to. Rather, price to cash flow is a much more accurate measure of value for a company like Amazon.
Over the past 10 years, Amazon has been valued at an average of 28.6 times its annual operating cash flow per share, with a low of 23.5 coming out of the Great Recession in 2010 to a high of 37 in 2013. As of Feb. 13, Amazon was valued at 28.1 times its 2019 cash flow per share, which is more or less in line with its decade-long average.
However, with the higher-margin AWS growing into a larger share of total sales, and new Prime initiatives expected to result in healthy domestic and overseas growth, Wall Street is looking for the company's cash flow per share to more than double from $76.42 in 2019 to $192.01 by 2023. This places Amazon at 11.2 times Wall Street's consensus 2023 cash flow per share, based on its Feb. 13 closing price. If Wall Street and investors simply stay the course on Amazon's historic premium-to-cash flow ratio over the past decade of 28.6, you get a share price of $5,491.
Amazon at $5,000 sounds crazy, but when you get a closer look at the company's upcoming cash flow expansion, it's a very realistic price target that's attainable in less than four years.