Artificial intelligence (AI) has been the driving force behind many of the stock market's biggest winners over the last three years. Big companies like Microsoft (MSFT 1.57%) and Alphabet (GOOG 0.56%) (GOOGL 0.42%) have seen their share prices reach new all-time highs, driven by strong AI-related business results across both software and cloud computing. Both companies are pushing toward $4 trillion valuations. Meanwhile, Nvidia briefly touched a $5 trillion market cap this year as big tech companies continue to buy up its graphics processing units (GPUs) as fast as it can sell them.
But not every AI-related stock has zoomed higher this year. One company, in particular, has seen its stock stuck in neutral, climbing less than 5% this year while the S&P 500 is up more than 17%. But that could be a buying opportunity for long-term investors. In fact, the stock could produce very strong returns as soon as next year. Here's why you'll want to own Amazon (AMZN 0.87%) in 2026.
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A dominant force across three major industries
Amazon may have started as a small online bookseller, but it has grown to be much more. Its marketplace offers nearly everything you can think of, and it can ship millions of items to U.S. customers within one to two days thanks to its massive fulfillment network. It has built a burgeoning advertising business that has expanded from retail media ads to video ads served through its Prime Video service and other streaming partners. And it's the largest cloud computing platform in the world, operating Amazon Web Services (AWS).
All three businesses are experiencing rapid growth and demonstrating strong momentum.
The online retail business continues to produce high-single-digit revenue growth despite generating over $250 billion in annual sales. Its third-party seller services, which enable other businesses to sell through Amazon's marketplace, are showing accelerating growth, up 11% in the most recent quarter. The entire ecosystem rests on Amazon's Prime subscription service, which has steadily pushed subscription revenue 10% higher.
Amazon's advertising business is accelerating, climbing 24% in the most recent quarter, reaching a $70 billion run rate. Prime Video is a key catalyst for that continued growth, as 80% of subscribers are on the ad-supported tier and Amazon adds more live sports content to the service. It has also partnered with several major streaming platforms through its demand-side ad-buying platform.
NASDAQ: AMZN
Key Data Points
Overall, Amazon is seeing operating margin expansion in its North American and International reporting segments. A couple of factors are leading to higher margins. First, advertising sales have extremely high margins relative to product sales and even third-party services. The second is that Amazon's improvements to its fulfillment center have reduced its shipping costs. Shipping costs have increased at a slower pace than paid units in each of the last eight quarters.
Amazon's cloud computing business remains the company's most important segment, accounting for most of the operating income and growing quickly. Management has successfully reaccelerated revenue growth for the segment, achieving 20% year-over-year growth last quarter, driven by strong triple-digit revenue from AI services. That rate is significantly slower than both Microsoft and Google, but AWS is also growing off a larger base.
CEO Andy Jassy expects sales to continue at the current pace for the foreseeable future. That's supported by a growing backlog, which reached $200 billion by the end of the third quarter. Amazon also signed deals in October with commitments exceeding everything it booked in Q3, so there's a lot of momentum behind the cloud computing segment to keep growing.
Amazon looks undervalued right now
Amazon is investing heavily to capitalize on the opportunities it sees in both cloud computing and e-commerce. It spent $90 billion through the first three months of the year on capital expenditures (capex), and management expects full-year cash capex to come in around $125 billion. That's well above Alphabet's planned $92 billion in capex for the year and slightly more than Microsoft (which spent $80 billion through the first nine months of the year).
That high spending has weighed heavily on Amazon's free cash flow, which fell to $14.8 billion over the trailing-12-month period. That's down from $47.7 billion in the previous 12-month period. Indeed, the high capex has hit Amazon's cash flow much harder than capex has hit either Microsoft or Alphabet. That's in part because its competitors have high-margin software businesses that continue to grow quickly, offsetting their spending, while Amazon's retail business still has relatively low margins.
But Amazon has gone through multiple investment cycles throughout its history. Each time, it has emerged with much stronger cash flows than it had before the investment cycle. Considering the growing backlog of cloud computing contracts and the secular trend toward migrating to cloud computing services, investors should remain confident that the pattern will hold. While management expects to increase its capex further in 2026, free cash flow will eventually trough as capital intensity levels off. With strong operating cash-flow growth, Amazon should see a rapid recovery in free cash flow.
Amazon has historically traded around 50 times its free cash flow near its peaks. With its current market cap of $2.5 trillion, investors are merely expecting it to return to its peak free-cash-flow levels from a bit over a year ago. It seems very likely that Amazon will far exceed those levels over time, pushing its stock price significantly higher.
