The last few years have been a wild ride for technology investors. After one of the largest bull markets and speculative bubbles in history, stock prices across various sectors tumbled rapidly in 2022. Even the renowned FAANG stocks -- which seemed to defy gravity for many years -- all underperformed the S&P 500 in 2022.
Stock prices are up to begin 2023, but I still think there is plenty of opportunity for investors to go fishing for technology investments right now. Specifically, I love FAANG member Amazon (AMZN -3.65%) at the moment and think it is set up to deliver fantastic returns for shareholders over the next few years. Here's why.
AMZN total return level data by YCharts.
Amazon: Why now?
Amazon is talked about ad nauseam as one of the best-performing stocks of all time. However, over the last three years, its share price is flat. The market is concerned about the company's inability to generate consistent profits even though its annual revenue zoomed past $500 billion.
In the fourth quarter of 2022, Amazon only generated a measly $2.7 billion in operating income, with its e-commerce/retail division posting a loss of approximately $2.5 billion in the period. There are also concerns that revenue growth at Amazon Web Services (AWS) -- a huge profit driver -- is going to slow considerably over the next few quarters.
I think these concerns are overblown and provide a nice buying opportunity for people who plan to hold this stock for many years. Amazon's retail/e-commerce division was unprofitable in 2022 due to overinvesting in logistics and warehouse capacity during the pandemic. This also caused the company to overhire employees as management expected to grow at a much quicker pace.
There is a simple fix to these issues. First, Amazon is going to slowly grow into its new warehouse capacity, which solves the problem of overcapacity. As for employees, the company is implementing layoffs -- 27,000 at last count -- that will save billions of dollars a year.
Once these cost-cutting initiatives are fully implemented, Amazon's retail segment should start to see higher profit margins.
All indicators point to AWS facing a slowdown in the upcoming quarters. But over the long term, it is still the leading cloud infrastructure provider worldwide, in an industry that is going to approach $1 trillion in annual spending within 10 years. With phenomenal profit margins, I don't think investors should have any concerns with AWS right now as long as the company retains its position as the No. 1 cloud provider.
The stock is cheap; you just have to look into the future
Today, Amazon stock looks expensive, with a trailing price-to-earnings (P/E) ratio of 77. But at a market cap of $1 trillion, I think the stock is cheap based on the earnings it will generate in 2024 and 2025. Let's run some math to show why.
At AWS, annual revenue is likely going to surpass $100 billion within the next year or so. With historical profit margins of around 30%, this would equate to $30 billion in annual operating income from just AWS (it generated $23 billion in earnings last year).
In retail/e-commerce, $500 billion in annual revenue is within reach two to three years from now. With high-margin subscription and advertising revenue becoming an increasing portion of this retail revenue pie, I think the division can post 10% profit margins, which equates to $50 billion in earnings at $500 billion in revenue.
AMZN PE Ratio data by YCharts.
Combine these, and Amazon could be generating $80 billion in earnings two to three years from now. That would give the stock a P/E of just 12.5 based on where shares trade today, which is much too low for a durable revenue grower like Amazon. It is likely the stock will trade at a P/E of 20 or even slightly higher once the profits start showing up.
From my seat, it looks like Amazon shares have a strong chance of performing well over the next few years if the company can finally turn the corner on profitability.
