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Up 71% in 2020, Is Amazon Still a Buy?

By Sean Williams - Dec 10, 2020 at 7:21AM

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Can the third-largest public company in the U.S. still put some pep in your portfolio's step?

This year will go down as one of the most volatile on record. We've witnessed the quickest bear market decline of at least 30% in history, the fastest rebound to new highs from a bear market bottom, and even a brief period when West Texas Intermediate crude futures pushed well into negative territory.

Despite the chaos brought on by the coronavirus disease 2019 (COVID-19) pandemic, one FAANG stock has been steady as a rock. E-commerce giant Amazon ( AMZN -1.38% ) was never lower than the height of the stock market crash in March, when it was down 9% for the year. It now finds itself higher by 71% on a year-to-date basis.

With a valuation of $1.59 trillion, many investors are wondering if Amazon can head even higher. 

Let's take a closer look at the buy and avoid arguments surrounding Amazon.

A parent holding an Amazon package under their arm, while their child opens a door for them.

Image source: Amazon.

Here's why Amazon might be worth avoiding

Perhaps the biggest concern for Amazon is on the legislative front. The third-largest public company in the U.S. is facing European antitrust charges. In a 449-page report, the Democrat-led House Judiciary Committee concluded that Amazon had monopoly power in the U.S. 

It's unclear if lawmakers will seek to alter how Amazon operates, such as by prohibiting Amazon from selling its own products in its marketplace. A potential blue wave on Capitol Hill could spur changes, though. 

Amazon could also be susceptible to corporate tax policy changes. The Trump administration lowered the peak marginal corporate tax rate to 21%, which represents a roughly eight-decade low. That's great news for corporate America, and especially Amazon, which loves to reinvest its operating cash flow in its business. If President-elect Biden is successful in raising the peak corporate tax rate to 28%, corporate earnings will fall by around 10%, and Amazon would have less available cash for reinvestment purposes.

Amazon could fall victim to sector rotation, too. If COVID-19 vaccine efficacies remain above 90% during final analyses and enough people choose to take the vaccine, there's a real chance of halting the pandemic within the next year. Should this happen, we could witness a rotation out of popular stay-at-home stocks like Amazon and into brand-name value plays that have been largely left behind.

Finally, investors have to keep an eye on Amazon's growing competition in the cloud infrastructure space. Amazon's cash flow and deep pockets have allowed it to bully other retailers. But the big players in cloud infrastructure have pocketbooks that are even bigger than Amazon's. It's always possible that the company's competition will erode Amazon Web Services' (AWS) market share.

An illuminated blue cloud on a box that's surrounded by circuitry.

Image source: Getty Images.

Amazon could head a lot higher

Now that we've taken a closer look at the many reasons Amazon's share price could head lower, let's have a look at the catalysts in its sails.

First, Amazon is the undisputed leader in U.S. e-commerce sales. According to an eMarketer report from March, Amazon was expected to control an estimated 38.7% of all online sales in 2020, and further boost its share by 100 basis points to 39.7% in 2021. No other online retailer is expected to be within 33 percentage points of Amazon in 2020 in terms of online revenue share.

Although retail margins are nothing to write home about, Amazon has been able to pivot its dominance in the online retail space into more than 150 million Prime memberships worldwide. The fees the company collects from Prime members help it undercut brick-and-mortar retailers on price. Like warehouse club memberships, the Prime model provides an incentive for members to stay within Amazon's product and service ecosystem.

Another reason to be excited about Amazon is the growth in AWS. Annual spending on cloud services and infrastructure was forecast to grow from around $229 billion in mid-2019 to almost $500 billion by 2023, according to IDC. Infrastructure-as-a-service providers will see the fastest five-year compound growth rate at 32%. Since Amazon generates the lion's share of its operating income from substantially higher-margin cloud services, continued rapid growth in AWS is its key to expanding its cash flow

Lastly, Amazon's valuation is an upside catalyst. After spending the entirety of the 2010s valued at between 23 and 37 times its year-end operating cash flow, Amazon is currently trading at a multiple of less than 14 times Wall Street's 2023 cash flow estimate. If the company's stock were to simply hit the midpoint of its valuation range in the previous decade (30 times cash flow), it would more than double over the next three years.

A person holding up a white puzzle piece with a question mark drawn on it.

Image source: Getty Images.

The verdict

It's time to answer the $64,000 question: Is Amazon still a buy?

Without a doubt, I believe Amazon remains a top stock to buy.

While no company is without risks, Amazon's clear-cut dominance is too impressive to overlook. From its share-leading online marketplace to its superior logistics, retailers in the U.S. are going to have a difficult time competing with Amazon and luring away its users. Even if retail margins are razor-thin, the company is more than happy to keep users loyal to its brand for the long run.

I'm also very excited about the potential of AWS to triple Amazon's operating cash flow per share over the next three years. Since Amazon is more aptly valued by its cash flow than traditional earnings metrics like the price-to-earnings ratio, its respective valuation is a lot more attractive than most folks might otherwise realize.

Though it's probably not going up another 1,670% over the next decade, Amazon's continual outperformance suggests it has plenty of additional upside.

This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium advisory service. We’re motley! Questioning an investing thesis – even one of our own – helps us all think critically about investing and make decisions that help us become smarter, happier, and richer.

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