The FAANG stocks are a group of mostly tech stocks that led the way for the market over the past decade. They are: Facebook (now known as Meta Platforms), Apple, Amazon (AMZN 0.75%)Netflix, and Google (now known as Alphabet)
While this cohort trounced the market leading up to 2022, it hasn't done well since then. Part of the underperformance was from high expectations and subsequent letdown. But overvaluation also had to do with much of the decline. This has led to fantastic buying opportunities for some of the best-run companies in the world, as some of the stocks are the cheapest they've been in years.
If you're looking for my top pick for the rest of 2023 (and beyond), read on.
Amazon's gross margin has been steadily rising
Being the cheapest stock doesn't necessarily mean a dollar figure; instead, a cheap stock is one that you can pick up for a low valuation. Of the group, Amazon consistently has the lowest valuation because of its asset-heavy e-commerce business. But its latest business moves decreased its dependence on commerce.
Amazon is much more than the website you shop on. It has a massive advertisement wing, third-party seller services, and cloud computing (Amazon Web Services, or AWS). All three businesses have much higher gross margins than typical online sales thanks to lower cost of goods, so Amazon is trending more like it's a tech company rather than a commerce one.
This can be seen with Amazon's gross margin.
AMZN Gross Profit Margin (Quarterly) data by YCharts
These high-margin businesses are also Amazon's fastest-growing, meaning they are becoming a more important piece of the puzzle for Amazon.
| Segment | Revenue (in Billions) | Growth (YOY) |
|---|---|---|
| Online stores | $57.3 | 7% |
| Physical stores | $5.0 | 6% |
| Third-party seller services | $34.3 | 20% |
| Subscription services | $10.1 | 14% |
| Advertising services | $12.0 | 26% |
| AWS | $23.1 | 12% |
| Other | $1.2 | (3%) |
Data source: Amazon. YOY = year over year.
As Amazon's gross margin rises, so does its potential to generate higher profits. The company's third-quarter operating margin of 7.8% is almost the highest it's ever been at the company.
However, none of that is factoring into the valuation investors are giving Amazon.
The stock is valued like its old self
Amazon is starting to get its profitability grove back, as it posted earnings per share (EPS) of $0.96 in Q3. But because Amazon's profits haven't been very consistent, valuing it on a trailing earnings basis is problematic.
From a price-to-sales basis, its stock is near the same levels it traded in 2016 when e-commerce (lower gross margins) was a much larger part of the business. In 2016, Amazon's gross margin was less than 10%. Now that it's up to nearly 20%, Amazon has a higher profit potential, which should increase its valuation.
AMZN PS Ratio data by YCharts
With the business now producing higher margins, its valuation should be increasing, but it's not.
This is my bull case for Amazon, as CEO Andy Jassy has made it his primary mission to make Amazon more efficient. Rising margins will dramatically improve profits, which makes Amazon an attractive investment. While it will never reach the profitability levels of other FAANG stocks due to what each company's core business is, improving profits is a great sign.
Couple that with revenue growing at an above-market pace of 13% and unbelievable free cash flow of $21.4 billion in Q3, and Amazon looks like a top-tier investment.
