When you think of discounted stocks, Amazon (AMZN 1.62%) probably doesn't come to mind. But, if you take a hard look at the company, that's exactly the case. Still, a stock's valuation isn't the only consideration when deciding whether a stock is a buy.
With that in mind, should you take a position in Amazon just because the stock looks cheap? Or are there other factors at play that investors must understand?
Amazon's stock is the cheapest it has been since 2016
First, we need to understand what makes Amazon undervalued. There are multiple ways to value a stock, whether it's the price-to-earnings (P/E) ratio, price-to-sales (P/S) ratio, or some other metric. Over the past year, Amazon hasn't been consistently profitable, so the P/E ratio shouldn't be used.
That leaves the P/S valuation, which is the lowest it has been since 2016.
Data source: YCharts
That is significant because 2016 Amazon looks a lot different than 2023 Amazon.
The current iteration of Amazon's business is more concentrated in higher-margin segments like third-party seller services, advertising, and Amazon Web Services (AWS), the company's cloud storage business. As a result, the stock should be valued at a higher level. You can see this switch play out in Amazon's gross margin, which has substantially widened since 2016.
Data source: YCharts
While Amazon hasn't translated this gross margin improvement to the bottom line yet, management has set a course for the company to get there.
Margins are improving in some segments
Amazon has steadily improved its profitability over the past few quarters, showing that Chief Executive Officer Andy Jassy is moving the company in the right direction.
Data source: YCharts
However, this is just the beginning. Chief Financial Officer Brian Olsavsky said on the first-quarter earnings conference call that increasing the company's efficiency is "a longer road than bouncing back in one or two quarters."
But that's not to say there aren't headwinds.
Amazon's cash cow, AWS, has steadily declined in profitability. One year ago, it posted an operating margin of 35%. Despite increasing its sales by 16% in Q1, operating income declined by 21%, leaving AWS with a margin of 24%.
That's not a good sign, but there is a culprit: efficiency -- not on Amazon's end but on the customer's side. With economic uncertainty (especially during the first quarter) dominating the headlines, many businesses looked at their large expense items and attempted to reduce them. AWS wasn't spared.
However, Amazon is focused on long-term customer relationships and is using its sales team to help businesses optimize their spending. That decision will hurt Amazon in the short term but will build the relationships necessary to ensure clients don't switch cloud computing services.
Even though this is a bump in the road for cloud computing, the long-term projections for this industry are still bright. AWS remains the market leader, and actions like this will solidify its top position in a market that some estimates peg as a $1.55 trillion opportunity by 2030.
Although AWS may be struggling, Amazon's North American commerce business has picked up the slack and posted its first operating profit in five quarters. That's a positive sign, and it shows Amazon's decision to lay off workers and close some distribution centers probably was the right one.
With all of that in mind, it seems like the long-term trajectory of Amazon's business is still quite positive, but only if you have a three- to five-year mindset. If you can look at it that way, then the prices for Amazon's stock today are quite attractive.
