If you've been investing for any decent amount of time, you likely have a story of "the one that got away." I have several of them, but these stocks never fall off my radar. Instead, I keep them on a list, and I open a position when the valuation is correct. I may not have the same great returns I would if I had purchased it years ago, but if the business still has room to run, it can still be a great investment.
One stock that I recently initiated a position in is Amazon (AMZN 0.96%). I whiffed on buying this stock when the market crashed because of the COVID-19 pandemic, and I watched it run all the way up in 2020 and 2021. However, Amazon's stock is now about where it was in May 2020, despite growing its revenue by 64% since the first quarter of 2020. This decline isn't the only reason I opened an Amazon position. Let's dig into the rest.
My primary investment catalyst
While Amazon may be known for its e-commerce business, I'm more interested in Amazon Web Services (AWS). This cloud computing business provides the infrastructure for its clients to run apps and websites or process computations through its data centers. Cloud computing is a massive market, and Precedence Research projects it will grow by 17.4% annually through 2030 to $1.6 trillion.
AWS is currently the cloud computing market leader and commands a 34% market share. Cloud infrastructure makes up about half of that cloud computing market share, so if AWS can maintain its 34% market size, then it should generate about $272 billion in annual revenue in 2030. For reference, AWS brought in $19.7 billion in the second quarter of this year, and Amazon as a whole generated $470 billion in 2021.
The massive potential for cloud computing is my top reason to own the stock. However, there's another reason why I thought now was a prime opportunity.
A reasonable valuation
On a price-to-sales (P/S) basis, Amazon is the cheapest it has been in some time.
AMZN PS Ratio data by YCharts
The last time it reached this level, AWS didn't make much money, so Amazon was valued solely as an e-commerce business. Plus, Amazon also has a robust advertising business today to consider. So, now that the stock has returned to this level, it may be smart to value Amazon's business by segment, as each is vastly different.
First, let's look at the revenue these businesses generated over the past 12 months.
| Segment | Revenue (TTM) |
|---|---|
| Commerce | $379.9 billion |
| Advertising | $33.9 billion |
| AWS | $72.0 billion |
Data source: Amazon. TTM = trailing 12 months.
Now, let's assign a business to compare these segments to and see what we learn. For commerce, I'll choose Walmart, arguably Amazon's biggest commerce competitor. Walmart stock trades at a P/S ratio of 0.6, but I'll give Amazon a 33% premium to that because of its much smaller physical footprint and millions of Prime subscribers -- which is a high-margin business.
Advertising is a bit trickier as there isn't a great comparison. I've selected Alphabet because 80% of its revenue is derived from advertisements. These ads are placed on Alphabet's platforms (such as YouTube and Google), much like how Amazon's ads are placed on its platforms. I'll use Alphabet's P/S ratio of 4.7 without any premium because these are similarly strong businesses.
Finally, AWS can be compared to DigitalOcean, a pure-play cloud computing company. However, AWS is growing faster than DigitalOcean, has a larger addressable market, and is profitable, so I'll increase its valuation by 25% from DigitalOcean's P/S ratio of 7.8.
From this, I can derive a valuation for Amazon's stock by multiplying its trailing 12-month revenue by an adjusted P/S ratio to get a business value.
| Segment | Revenue (TTM) |
Comparison Company P/S Ratio + Estimated Premium |
Segment Valuation |
|---|---|---|---|
| Commerce | $379.9 billion | 0.8 | $303.9 billion |
| Advertising | $33.9 billion | 4.7 | $159.3 billion |
| AWS | $72.0 billion | 9.8 | $705.6 billion |
Data source: Amazon and Y! Charts.
Altogether, that equates to Amazon being fairly valued at $1.17 trillion (at least according to my valuation technique) -- it currently trades at $1.15 trillion. While that's not a massive discount, it at least informs me that I'm not overpaying for Amazon, something I was concerned about when Amazon traded for $1.6 trillion or more from July 2020 to June 2022.
By summing all the parts of Amazon's business together, investors can realize what the most valuable portions of Amazon's business are. Additionally, it can be used to assess the fair value of a business with many segments (like Amazon).
With the market opportunity of AWS and Amazon trading for a reasonable valuation, I was finally able to open up a position. Just because you miss a stock once doesn't mean you've missed it forever. With many stocks in the market reaching lows not seen for many years, now could be a great time to check up on some of the stocks you missed and see if the companies behind them are still worth buying.
