Growth stocks are shares in companies expected to increase revenue and earnings faster than the market average. They usually boast large valuations (meaning they aren't cheap) but make up for it with the potential for explosive growth.
Let's explore the reasons why Walt Disney (DIS -0.22%) and Amazon.com (AMZN -2.73%) fit the bill and could make slam-dunk investments right now.
1. Walt Disney
Great companies turn challenges into opportunities, and Disney is a prime example of this concept. The diversified entertainment giant used the coronavirus pandemic as an opportunity to supercharge its streaming platforms. And now that the crisis is starting to ease up, the company plans to ramp up content production to drive sustainable growth.
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Second-quarter earnings were a mixed bag. Revenue fell 13% year over year to $15.6 billion, which is a significant improvement over the first quarter when sales were down 22% against the prior-year period. Disney's direct-to-consumer business (up 59% to $4 billion) helped make up for weakness in its amusement parks and content licensing. But Wall Street was disappointed by Disney+ subscriber growth, which now totals 103.6 million compared to analyst expectations of 109 million.
The deceleration is likely due to the easing of coronavirus-related tailwinds. But investors shouldn't get caught up on short-term setbacks and keep a long-term perspective. Management maintains its guidance for 230 million to 260 million subscribers by the end of 2024. And lasting success will depend on Disney's original content and IP, not a temporary pandemic boost. Disney plans to drive growth by creating more original content for all its streaming platforms (Disney+, ESPN+, and Hulu+).
With a forward price-to-earnings (P/E) ratio of 34, Disney's valuation prices in substantial long-term growth. But the stock still looks reasonable compared to streaming rival Netflix, which trades for 39 times forward earnings.
2. Amazon
Amazon is a top growth stock because it doesn't rest on its laurels. Instead, it explores new opportunities that synergize with its massive scale and captive audience. The company's core e-commerce business is surging. And further investments in cloud computing and online entertainment will help bolster its long-term expansion.
First-quarter revenue increased 44% year over year to $108.5 billion, while operating income surged 122% to $8.9 billion. Amazon generates 11% of its revenue from its Amazon Web Services (AWS) cloud computing segment. And management is seeing "strong momentum" as more enterprises move to the AWS platform to save costs and enjoy better capability. In the quarter, AWS enjoyed migrations from popular sports leagues like the NHL, PGA Tour, and Formula 1 racing.
Amazon is also getting more serious about direct-to-consumer streaming, which helps differentiate its Amazon Prime platform from competitors like Walmart+, which doesn't have a big presence in streaming entertainment.
Prime Video streaming hours have increased 70% over the trailing 12 months (although management hasn't provided much info on the exact number of customers who regularly use the service). Growth in the period was likely driven by exclusive original content, like Coming 2 America, which topped Nielsen's streaming charts for two weeks. Amazon also plans to expand its live sports offering through a partnership with the NFL for exclusive rights to Thursday Night Football starting in 2022.
A surprisingly good value
With forward P/E multiples of 34 and 44, respectively, Walt Disney and Amazon shares are not cheap. But these valuations look reasonable compared to the S&P 500 average P/E of 44. Amazon is better for investors willing to pay a little more for a faster-growing company. Disney is also a great bet, but it will take longer to recover from the impacts of the pandemic because of ongoing weakness in its tourism business.
