Shares of Amazon (AMZN -0.36%) are currently down by 34% so far this year. Investors are rightfully concerned about the impact of rising inflation on the company's logistics and labor costs. The company is also facing challenges associated with staff productivity and excess capacity in its fulfillment and transportation network. These headwinds may further intensify in case of an economic recession, since reduced consumer discretionary spending may further pressurize the already low margins of this tech giant's online retail business.
While none of these challenges can be ignored, there remain at least three compelling reasons to view Amazon as a long-term buy, as well as two solid reasons to sell off the stock in July 2022.
Reason to buy No. 1: AWS is the leading player in the global cloud services market
Amazon's AWS is the leader in the cloud infrastructure services space and accounted for 33% market share in the first quarter of 2022 (ending March 31, 2022). With enterprises focusing on a cloud-first strategy and shifting their data and resources from on-site networks to hybrid or the public cloud as a long-term strategy, AWS seems well poised to withstand recessionary pressures. This is especially evident when we consider that AWS' robust order book with signed customer contracts was valued at $88.9 billion as of March 31.
By adopting a cloud-based infrastructure-as-a-service model, which involves sharing costs, technology companies can significantly reduce their capital expenditures. The cloud also enables companies to ramp up or ramp down storage and processing capability rapidly, thereby resulting in increased business efficiency. Technology research firm Gartner expects over 85% of organizations to adopt cloud-native architectures and technologies by 2025.
Reason to buy No 2: The advertising business is gaining momentum
Amazon's advertising business raked in revenues of $31.2 billion in 2021. While advertising accounted for only 6.6% of the company's total revenues, it is poised to become a major growth driver in the coming years. Amazon operates one of the most popular websites in the U.S. The company is now focused on further monetizing this audience base through targeted advertising.
eMarketer expects Amazon's U.S. digital advertising revenues to reach $39.45 billion in 2023. With 64% of the brands selling on Amazon reporting increased sales, this estimate seems quite reasonable.
Reason to buy No 3. Amazon's low valuation
In 2021, AWS accounted for only 13% of Amazon's total revenues but over 74% of the company's total operating income. With AWS accounting for the bulk of the company's profits, it is more logical to compare Amazon's valuation with other cloud players.
Amazon is currently trading at 2.2 times forward sales, the lowest it has traded since 2016. The company is also trading at a deep discount to other dominant cloud players such as Microsoft (NASDAQ: MSFT) and Alphabet (NASDAQ: GOOG). This means the current exaggerated pullback in the company's shares may present an attractive entry point for retail investors.
Two reasons to sell: Wage inflation and overreliance on AWS may further affect profitability
Amazon had an employee count of 1.6 million at the end of March 2022, significantly higher than that of peers such as Microsoft, Alphabet, and Apple (NASDAQ: AAPL). The labor-intensive business model of Amazon exposes the company to higher wage inflation, thereby affecting the company's profits more than those of the competition.
In the face of a potentially impending recession, Amazon's overreliance on AWS for profitability and for subsidizing its other businesses such as e-commerce and media can prove to be a major risk in the coming months.
Amazon remains an attractive pick
While the difficulties cannot be ignored, Amazon still has several positives in its favor.
Amazon's two-day shopping event, Prime Day, is scheduled for July 12 and 13 this year. This event is expected to not only bring in significant revenues for the current quarter but also add new members to the company's Amazon Prime subscription program. With 98% of Amazon Prime members renewing their subscription for a second year in the first quarter of 2021, this can be considered to be a sticky customer base.
All of these factors point to Amazon's robust potential as an attractive investment in July 2022.