Though many stocks have had a strong run in 2023, a large cohort remains significantly down from its all-time high. While some stocks will likely never regain their highs due to their business being overhyped in 2021, some trade at bargain levels.
Amazon (AMZN 0.03%) is at that point and currently sits about 45% off its all-time high, last reached in late 2022. This valuation doesn't reflect the company Amazon is becoming, and I think investors would be wise to pile into the stock.
Service revenue is the future for Amazon
Everyone knows Amazon's e-commerce store. It has become a staple for consumers purchasing goods online, but it's not the giant it used to be. In fact, online store sales fell by 2% in the fourth quarter. Amazon also tried to get into physical stores, but that effort seems to be backfiring, with only a 6% growth rate in Q4. These two segments made $69.5 billion for Amazon in Q4 -- 47% of Amazon's revenue.
But what excites me most is the other 53% of Amazon's revenue: service revenue. Just look at the growth rates of product versus service sales in 2021 and 2022.
| Segment | Q4 Growth | Full-Year Growth |
|---|---|---|
| Product sales | (1.3%) | 0.5% |
| Service sales | 19.2% | 18.9% |
Data source: Amazon.
Clearly, service revenue growth is the new reason to invest in Amazon, and it's far superior to e-commerce product sales.
So why is it better for Amazon to become service-focused? It all comes down to margins. When you have to buy the products, then turn around and sell them, it's a capital-intensive process. Additionally, you may take losses occasionally if you can't move products quickly enough. But if you provide services to other retailers (captured in Amazon's third-party seller services segment), many of those problems disappear.
If you adjust for currency effects, third-party seller services are actually speeding up its growth.
| Quarter | FX-Adjusted Revenue Growth |
|---|---|
| Q1 | 9% |
| Q2 | 13% |
| Q3 | 23% |
| Q4 | 24% |
Data source: Amazon. FX = currency effects.
But that's enough about commerce. Let's look at some other stars.
Advertising service and cloud computing are two service segments to watch
Another rapidly growing segment is its advertising services, up 19% in Q4. Advertising revenue comes from multiple sources, but it's evident that markets are willing to pay Amazon to promote their products for them. If you look at Alphabet's advertising services, it's clear that this industry is lucrative. Amazon's ad business growing in Q4, while almost every other advertising-focused company's revenue has shrunk, speaks to the importance of this segment.
Although its growth has slowed recently, Amazon Web Services (AWS) is still putting up strong 20% growth. With a 33% market share, AWS is the leader in cloud computing. And with some estimates pegging the cloud computing industry as a $1.6 trillion market opportunity by 2030, this is a massive industry to watch. Furthermore, AWS is the only profitable segment within Amazon, posting a 24% operating margin in Q4.
This level of profitability isn't attainable in e-commerce, but service divisions (like AWS, third-party seller services, and advertising) have the potential to attain the same level of profitability.
Despite the increase in higher-margin businesses (which will eventually trickle down to Amazon's bottom line), the stock trades like it's still just an e-commerce company.
AMZN PS Ratio data by YCharts. PS Ratio = price-to-sales ratio.
It seems like a mistake to value Amazon this way, which is why I'm a buyer at these prices. Amazon is slowly transitioning to a service company, but most of the market hasn't grasped that. When they do, expect the stock to be valued at a more premium price. By getting in now, you can pick up shares at a discount, and if you hold the stock for at least three to five years, I'm optimistic that Amazon will be a market beater.
