Several Wall Street analysts have selected Amazon (AMZN -0.61%) as a top pick in 2024, including Thomas Champion at Piper Sandler, Doug Anmuth at JPMorgan Chase, and Scott Devitt at Wedbush Securities. The reason for that optimism can be summarized in three points: improving profitability in retail, strong momentum in digital advertising, and a potential reacceleration in cloud services revenue driven by demand for artificial intelligence (AI).
Argus Research analyst Jim Kelleher highlighted that last point in a recent note to clients, speaking on the potential of Amazon Web Services (AWS): "As the leading provider of infrastructure-as-a-service and other cloud services, AWS is uniquely positioned in the burgeoning AI-as-a-service market, and the Anthropic partnership meaningfully strengthens AWS at a key time in the AI gold rush."
That may surprise some investors given that Nvidia is viewed as the best AI stock in certain Wall Street circles. But the point is somewhat irrelevant because attempting to pick a single winner is a poor strategy. It would be more prudent to build a basket of AI stocks, and Amazon definitely deserves a place in such a basket. Here's why.
Amazon has a strong presence in three growing markets
Amazon reported encouraging financial results in the third quarter. Revenue increased 13% to $143.1 billion on strong growth in advertising services. The cloud computing business Amazon Web Services (AWS) continued to drag on the top line, but deal trends point to a reacceleration in the coming quarters. On the bottom line, net income under generally accepted accounting principles (GAAP) more than tripled to reach $9.9 billion due to cost reduction efforts like regionalization of its U.S. fulfillment network.
The graphic below details third-quarter revenue across all seven business segments.
Chart by Author. Shown above is Amazon's third quarter revenue across all seven business segments.
Amazon has a strong presence in three markets that should support double-digit sales growth for many years to come.
- E-commerce: Amazon operates the most visited online marketplace in the world, and it has steadily gained share across North America and Western Europe over the last four years. In 2023, Amazon accounted for 38.7% of retail e-commerce sales in those geographies, up from 36.4% in 2019. That scale creates a powerful network effect that naturally brings more buyers and sellers to the marketplace. It also lets Amazon reinvest more heavily in its business than its peers. As an example, the company has constructed a logistics network that rivals UPS. That infrastructure supports fulfillment services for merchants and rapid delivery for buyers, making its marketplace more compelling for all parties.
- Digital advertising: Amazon has evolved its retail footprint into a booming advertising business. The company has a unique ability to engage shoppers and source data from its marketplace, and that makes it an ideal partner for media buyers looking to reach consumers with relevant advertising. Amazon accounts for 75% of retail media spending in the U.S. -- 10 times more market share than second-place Walmart -- and it recently became the third-largest advertising company in the world. Moreover, Amazon should continue gaining share given that retail media is the fastest-growing channel in the broader digital advertising market.
- Cloud computing: Amazon Web Services is the market leader in numerous cloud verticals, including compute, networking, storage, database, and machine learning services. In total, AWS accounted for 32% of cloud infrastructure and platforms services (CIPS) spending in the third quarter, while Microsoft Azure ranked second with 23% market share and Alphabet's Google Cloud ranked third with 11% market share. Rapid innovation is a big reason why the company has been so successful. Research company Gartner says AWS has the greatest breadth and depth of CIPS capabilities.
Turning to the future, Straits Research expects online retail sales to increase at 8% annually through 2030, and Grand View Research believes the cloud computing and adtech markets will compound at 14% annually during the same period. That gives Amazon a good shot at 10% annual sales growth through the end of the decade, though its AI product roadmap leaves room for upside.
Amazon is uniquely positioned to monetize AI cloud services
Spending across AI hardware, software, and services is projected to grow at about 40% annually over the next decade. Amazon is ideally positioned to benefit from that tailwind. AWS is not only the leader in the broader CIPS market, but also the leader in the cloud AI developer services market. Moreover, the company has a robust development pipeline that is creating new revenue streams at all three layers of the AI stack.
- AI infrastructure: AWS is designing custom silicon for AI training (Trainium) and inference (Inferentia). According to CEO Andy Jassy, those chips have "better price performance characteristics" than other options. Amazon also announced a partnership with Anthropic, an AI start-up for which AWS will serve as the primary cloud provider. Anthropic will use Trainium and Inferentia chips to build future foundational models, and it will collaborate with AWS on future chip design.
- AI model services: AWS recently launched Amazon Bedrock, a cloud service featuring pretrained foundational models from Amazon and third-party providers like Anthropic. Bedrock allows businesses to customize pretrained models with their own data to build and deploy generative AI applications.
- AI software: CodeWhisperer is a generative AI coding companion that automates certain aspects of software development. That product launched in April 2023. The company more recently announced a generative AI business assistant called Amazon Q. That product can summarize text, draft emails, and surface relevant information across various data sources and systems, including third-party products from Microsoft and Google.
Here's the upshot: Amazon is well positioned to monetize AI given its leadership in cloud computing and ongoing product development efforts. That should help AWS maintain or even increase its market share, which lends credit to the idea that Amazon can grow sales at 10% annually (or faster) through the end of the decade.
With that in mind, the current valuation of 2.9 times sales looks quite reasonable, and it's a slight discount to the three-year average of 3 times sales. Investors should feel comfortable buying a small position in Amazon today as part of a bigger basket of AI stocks.
