For a long time, Amazon (AMZN 0.81%) was considered overvalued. But now, that script may have flipped. Let's look at some critical factors for Amazon and determine why its stock represents a genuine bargain.
Amazon's stock has unlinked itself from revenue growth
It's pretty easy to see that Amazon's stock price has followed its revenue growth until lately.
Why this disconnect? It's likely because Amazon has been burning through cash since Q2 2021, although this burn looks like it peaked in Q2 2022 with a FCF outflow of $33.5 billion. Since then, Amazon has made great strides, with a FCF burn of only $12.8 billion in Q4.
The company still has a long way to go before generating positive free cash flow again. With management's focus on efficiency, however, investors should continue to see improvement throughout 2023.
Just how undervalued is Amazon? Let's dig in.
Amazon's largest segment is likely being mispriced
We need to use a price-to-sales valuation to assess Amazon, as it has been mostly unprofitable since its inception.
AMZN PS Ratio data by YCharts.
2015 was the last time when Amazon traded at its current level, and its business has shifted quite a bit since then. Looking at its three segments below, you can see how much it has grown and the shift in the revenue makeup.
| Segment | 2015 Total | 2015 Makeup | 2022 Total | 2022 Makeup |
|---|---|---|---|---|
| North America sales | $63.7 billion | 60% | $279.8 billion | 60% |
| International sales | $35.4 billion | 33% | $127.8 billion | 27% |
| Amazon Web Services | $7.9 billion | 7% | $62.2 billion | 13% |
Source: Amazon.
While North American sales have grown and maintained its position, Amazon Web Services (AWS), the company's cloud computing division, has nearly doubled its revenue share within Amazon.
Why is this a big deal? AWS is the only segment within Amazon that makes any money and produced a $5.2 billion operating profit in Q4. Furthermore, AWS is a much higher-margin business than retail, and higher-margin businesses demand greater valuation multiples.
Let's use a sum-of-the-parts valuation method to see how cheap Amazon's stock is, which is when you value each segment individually as if it was a stand-alone business.
If you give AWS a software stock's valuation of 10 times sales (which is fair, considering its growth rate and operating margin), that means AWS alone is worth $800 billion. Considering Amazon's market cap sits at $1.02 trillion, the rest of the retail business is only worth about $220 million. That means its retail business is only valued at 0.5 times sales, which is severely undervalued, compared to other retail giants like Walmart (0.66 times sales) and Target (0.74 times sales).
However, even valuing Amazon's commerce at Walmart's or Target's levels is a mistake because that segment also contains high-margin subscription services, a rapidly growing advertising business, and capital-light third-party seller services.If you attach a one times sales multiple to that business (which I would argue is still too cheap because Costco, a primarily membership-driven company, trades at 0.97 times sales), that means a ballpark valuation for Amazon's stock is $1.23 trillion, indicating 21% upside.
That's a pretty low valuation in my eyes and doesn't include the 8% revenue growth analysts expect this year.
As Amazon improves its FCF state throughout 2023, the stock may see tremendous upside because it's undervalued. I'm a buyer of Amazon's stock here, as the valuation doesn't match up with the actual business makeup.
