Investors who have followed Amazon (AMZN 0.58%) for a long time are aware of its path to megacap status. What started as an online bookselling business that pioneered e-commerce has evolved into a tech conglomerate with a $2.2 trillion market cap.
While that is a testament to the company's rock-solid business model, it also presents a challenge. Companies that reach such a size tend to grow more slowly, not because of deficiencies in the business model, but instead due to the law of large numbers.
Nonetheless, Amazon is still on track to continue beating the market. Here's why its days of growth are far from over.
Image source: Amazon.
Amazon's enduring growth drivers
Indeed, Amazon's size does not work to its advantage in some respects. As mentioned, higher-percentage growth is harder for large companies to achieve. Moreover, Amazon's largest, most well-known enterprise, online sales, grew its revenue by 6% annually, and it is unclear whether it turns a profit for the company.
Fortunately, that business is also well-positioned to serve as a loss leader for other enterprises under Amazon's e-commerce umbrella. Selling digital advertising on the sales site has become a lucrative endeavor, as the $14 billion in revenue it generated in Q1 rose 19% year over year. Subscription services, which includes Amazon Prime, surged 11% higher over the same period to nearly $12 billion.
Still, Amazon's primary growth driver stems from the second industry it pioneered: cloud computing. Amazon Web Services (AWS) generated over $29 billion in Q1 revenue. It accounted for 19% of the company's revenue and grew 17% compared to 12 months prior.
Additionally, AWS accounted for nearly $12 billion of the more than $18 billion in operating income the company generated in Q1. That strength affords Amazon the opportunity to stay at the forefront of tech by investing in advancements such as artificial intelligence (AI).
Furthermore, it means its retailing does not have to earn a profit, better enabling Amazon to compete against retail giants like Walmart and Costco.
What the financials and valuations tell us
Thus, in Q1, the company's overall revenue of nearly $156 billion was 9% above year-ago levels, influenced in part by the aforementioned law of large numbers. In comparison, Amazon's operating expenses grew 7% over the same period.
Other income also shifted from a loss of $2.7 billion to a profit of $2.7 billion during that time, accounting for most of its earnings gain. As such, the company's Q1 net income of over $17 billion increased by 64% during that period.
Admittedly, Amazon's free cash flow picture is not so rosy. In Q1, free cash flow was -$8 billion, down from $4 billion in the year-ago quarter. That was primarily because spending on capital expenditures rose from under $15 billion to more than $25 billion amid heavy investment in AI.
Investors seem to have largely shrugged off those results. Although the stock is up by only around 10% over the last year, its growth closely approximates that of the S&P 500's total return. Still, when looking at the five-year chart, Amazon has fallen short of the returns of that index.
Nonetheless, that growth rate does not take into account the company's falling earnings multiple. Amazon stock trades at a 34 P/E ratio, down from over 100 in July 2023. That also is lower than Walmart, Costco, and its biggest rival in the cloud space, Microsoft. This implies that Amazon could be a value stock as much as it is a growth stock, and the multiple compression that has reduced Amazon's returns may not last much longer.
AMZN PE Ratio data by YCharts
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Ultimately, Amazon should turn into a market-beater. Indeed, the stock price history over the last five years implies continued underperformance. Nonetheless, Amazon's low P/E ratio looks like a bargain, given the valuations of its most mature retail competitors and its largest cloud peer.
Additionally, some of its retail-related businesses are growing revenue rapidly. Moreover, AWS remains tremendously profitable, and the company is investing heavily to stay ahead in the AI race. Such moves often bring rising costs in the short run, but increase the odds of higher returns in future years.
In the end, Amazon's large size will likely continue to weigh on the company's percentage growth rates. However, that effect is not likely to be so negative that Amazon can't beat the market in the coming years.
