Amazon's (AMZN 3.43%) stock price has been elevated for some time. It was last under $500 per share in 2015, placing it out of reach of many investors who don't use a brokerage that offers fractional shares. The Motley Fool recommends having 25 stocks in a diversified portfolio, if split evenly this equates to a 4% weighting for each stock within the portfolio. Following that logic, at Amazon's current $2,900 stock price, the portfolio would need to be valued at $72,500 for investors to own just one share of this company.
With Amazon's board of directors announcing a 20-for-1 stock split, the price will drop to a more reasonable $145 per share starting June 6. Now, more investors can purchase the stock without fear of overloading their portfolios. Additionally, the Dow Jones Index is price-weighted, meaning the companies are weighted according to how expensive their shares are. A $2,900 stock price would destroy the balance in the index, but $145 would be par for the course. While I don't know if Amazon will be inducted into this group of 30 companies, the share split is a step in the right direction.
Image source: Getty Images.
Though being mostly cosmetic, stock splits have triggered several bull runs for a few companies. Take Tesla and Apple. Both companies announced stock splits during 2020 and saw a huge return after their announcements, as seen in the chart.
TSLA data by YCharts. (Tesla announced its split on Aug. 11, and Apple during its earnings.)
Although I don't expect a run-up as massive as these two stocks saw, Amazon's stock was up 5% on the news. Still, there are three better reasons to own the stock over the impending split.
1. Amazon Web Services
Amazon's fastest-growing division, Amazon Web Services (AWS), powers the cloud infrastructure for thousands of businesses. It is the market leader and holds a 32% market share over second-place Microsoft Azure at 21%. Throughout 2021, AWS sales grew at a 37% clip to $62.2 billion. Additionally, it was by far the most profitable segment within Amazon.
| Operating Margin by Segment | ||
|---|---|---|
| North America Retail | International Retail | AWS |
| 2.6% | (0.7%) | 29.8% |
Data source: Amazon.
AWS is driving nearly all of Amazon's profitability, pulling in more than three times more operating income than the retail segments. This is Amazon's greatest division, despite many consumers knowing little about it. With recurring revenue built into the subscription pricing model and more customers coming online each quarter, this is the segment Amazon investors should be focused on.
2. Prime price bump
During the fourth-quarter conference call, management announced an Amazon Prime price hike from $119 to $139 effective Feb. 18 for new members and March 25 for existing ones. A lot has changed economically since its last increase in 2018, so investors and consumers alike shouldn't be surprised by this move. With over 200 million Prime members worldwide, this equates to at least $4 billion in extra annual revenue for Amazon. While this seems like a lot, it is less than 1% of total revenue, as Amazon brought in $470 billion during 2021.
Still, this price increase will offset rising costs in delivery and wages. Management also noted the increasing number of services being offered to Prime members, like the NFL's Thursday Night Football on Prime Video, Amazon Pharmacy, and Prime Gaming. Consumers are accustomed to free two-day shipping and will likely digest the price increase, so Amazon will probably see little churn.
Even though the price bump isn't a huge catalyst, it shows Amazon's commitment to offering customers the best Prime experience possible, even if it costs a few more dollars.
3. Low relative valuation
Amazon's profitability is up and down, so valuing it from an earnings or free cash flow perspective can mislead investors. Instead, its revenue should be used to evaluate the company from a price-to-sales (P/S) standpoint, as seen in the chart.
AMZN PS Ratio data by YCharts
At a rock-bottom P/S valuation, Amazon's stock looks like a great buying opportunity, as it hasn't reached this valuation since the pandemic bottom in 2020. Still, investors are spooked by slowing retail sales growth, with North American sales only rising 9% year over year and international sales falling 1% over the same period.
Regardless, a P/S ratio of around 3 is probably too low for the world's largest e-commerce retailer and cloud infrastructure leader. With the stock still down more than 20% from its $3,770 high, it looks like a great buying opportunity.
Within the same stock split announcement, the board of directors also authorized a $10 billion stock repurchase program. At its nearly $1.5 trillion valuation, this only represents 0.67% of shares outstanding. While it is a positive shareholder action, this amount hardly affects the business valuation.
A stock split gathers big headlines, but the actual consequences of the decision hardly affect the business or stock. Instead, investors should focus on the business execution and overall valuation of the stock when determining whether now is the right time to purchase Amazon shares.
With a historically low valuation and strong AWS growth, I believe Amazon's stock is a solid purchase right now. Any gains received from the stock split headline are just a cherry on top.
