Many stocks that had a terrible 2022 are rebounding strongly in 2023. Take Amazon (AMZN -1.14%), for example; its stock fell 50% in 2022 and has now risen about 45% in 2023. However, that doesn't equate to approaching a break-even figure. When a stock loses 50%, it must double (return 100%) to achieve its previous price. Think of it this way: If you had $1 and lost 50%, you'd have 50 cents. To return to the previous $1, you'd need to double what you have.
Doubling a stock price is no easy feat and often takes time. So with Amazon's stock closing in on a 50% gain in just under six months, is it still a buy? Or has it reached a limit? Let's find out.
Amazon's businesses are mostly doing well
Amazon's business likely needs no introduction. Its online stores revolutionized how consumers shop and how quickly packages are delivered, but Amazon is much bigger than that. While Amazon is known for the products it sells, this business isn't growing, as it was flat in Q1. However, its third-party seller services segment is rapidly increasing because third-party vendors use Amazon's platform to sell their items. With this segment up 18% in Q1, it's picking up where Amazon's online stores' segment left off.
Outside of commerce, Amazon has a booming subscription service business, which includes Amazon Prime fees and other segments like e-books and video services. Although this segment rose 15% in Q1, that growth comes with an asterisk, as Q1 partially lapped the Amazon Prime fee increase from $119 to $139 annually. We'll get a better picture of organic growth (new customer acquisition, not price raises) in Q2.
That leaves its two most exciting business segments, subscription and Amazon Web Services (AWS). Usually, advertising-focused businesses struggle during challenging economic times. However, Amazon has sustained growth of 20% or greater in this segment throughout all of 2022 and in Q1.
While I consider AWS an exciting segment for Amazon, its performance lately has been abysmal. Its cloud computing wing has seen its growth steadily tick down (only 16% growth in Q1 compared to 37% a year ago). However, with artificial intelligence demand ramping up, AWS could see a new wave of growth because cloud computing is instrumental in this technology.
Overall, the trend of Amazon's business is positive. It has some caveats but could show serious growth when headwinds subside. But is this hope enough to warrant its 2023 stock performance?
Amazon's stock is still trading at a cheap valuation
Part of Amazon's poor 2022 performance is its declining profitability. After achieving high profits during COVID, then overspending to meet the demand, Amazon was left in a tough spot and was forced to lay off employees and cut spending to adjust to the subsequent decrease in business.
However, Amazon's newfound focus on efficiency is paying off, as its Q1 earnings per share (EPS) rose from a $0.38 loss last year to a $0.31 profit in 2023. That marks three straight quarters of profitability, and investors will have their eyes on Amazon's Q2 report to ensure they get a fourth.
Still, Amazon is nowhere near peak profitability, which makes using an earnings-centric metric like price to earnings to value the company problematic. At nearly 300 times earnings, it would be easy to shut the door on the stock, say it's overvalued, and walk away. But that's not a true statement.
If you look at Amazon's price-to-sales ratio, it tells a different story from a historical standpoint.
AMZN PS Ratio data by YCharts
Amazon's price-to-sales (P/S) ratio is now at the same level seen in 2016. However, its gross margins have substantially risen since that time. But why is that important? With higher gross profit, Amazon can achieve a great profit margin at peak profitability. Therefore, its P/S ratio can rise to higher levels because there is more wiggle room between the gross profit and future net profits. This is why software companies always carry a higher P/S ratio because of its more significant profit potential.
With Amazon's low P/S ratio and increasing profit potential, the stock has a lot of room to run. While Amazon is no longer the bargain it was five months ago, it's still a stock worth owning at these levels.
