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This Analyst Believes Stock Could Rise 35%: Here's Why

By Andrés Cardenal - Sep 19, 2015 at 2:21PM

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Why Amazon Prime could drive big gains for investors in Amazon stock.

Amazon (AMZN -3.21%) stock is truly on fire lately, rising by nearly 70% in the last year on the back of vigorous sales growth and expanding profitability. Even better, the stock still offers substantial room for gains, at least according to the analysts at RBC Capital Markets. The research company has recently published a new report on Amazon stock with a price target of $705 per share. This implies a big upside potential of 35% from current prices.

These kinds of price forecasts always depend on multiple and fallible assumptions of all kinds. Besides, Wall Street analysts can make mistakes just like everyone else. With this in mind, it's important for investors to always do their own homework when making investment decisions, as opposed to blindly following Wall Street recommendations.

On the other hand, we can often gain valuable insights from professional analysts; so let's take a look at the main thesis behind RBC's bullish view on Amazon stock, and try to find out whether it makes sense or not.

The importance of Amazon Prime
There's little doubt about the fact that Amazon Prime is becoming an increasingly important strategic asset for the online retail giant. Prime members pay $99 per year for membership, and they get access to free two-day shipping of more than 20 million eligible items, as well as  additional benefits such as digital video and music streaming with Prime Video and Prime Music. Prime members also get unlimited photo storage with Prime Photos, early access to lighting deals, and access to the Kindle Owner's Lending Library.

Amazon has invested plenty of resources to make Prime compellingly attractive to customers over the years. This is a smart move considering that the program is a powerful tool to consolidate customer loyalty, and sustain sales growth over the long term.

Amazon doesn't provide official membership figures for Prime, but the company has admitted that the service has reached massive scale, and is also growing at full speed. In the company's earnings report for the fourth quarter of 2014, Amazon said that it has tens of millions Prime members, and worldwide membership increased 53% during 2014, with U.S. memberships increasing by 50%, and international markets growing even faster.

Crunching some numbers
Based on data from its own survey, RBC Research calculates that nearly 40% of Amazon customers are now Prime members, a big increase versus an adoption rate of 25% in 2013. This leads RBC to estimate that Amazon has nearly 50 million U.S. Prime members and approximately 60 million to 80 million global subscribers. 

According to this research, Prime members spend considerable more than non-members. Even better, expenditure levels tend to materially increase over time for Prime subscribers.

Based on RBC's survey data, only 15% of non-prime Amazon customers spend more than $800 a year on the platform. Among customers going through the first year of their membership, more than 40% spend more than $800 annually. When looking at customers who have been Prime members for four years, almost 70% of them spend more than $800 annually on Amazon purchases. 

RBC believes that the amazing strength of Amazon Prime will allow Amazon to outperform growth expectations in the long term, and the company should also be able to expand profit margins during the years. Hence, RBC believes that Amazon stock is still undervalued, even after delivering impressive gains in the last year.

Can Amazon deliver?
Other sources seem to agree with the data from RBC's survey. According to a report from Consumer Intelligence Research Partners, Amazon could have as many as 44 million Prime members in the U.S. as of June 2015, gaining 3 million new members during the second quarter of the year. The research firm estimates that Prime members account for a big 47% of all Amazon customers, and that they spend, on average, $1,200 per year versus $700 per year for non-members.

Because there's no official data from Amazon on Prime, we can't know for sure how precise these estimates are. Still, both research companies have a similar view when it comes to the size and the strategic value of Amazon Prime.

Amazon's stock performance during the coming year will depend on a multiplicity of variables. This will not only be related to the health of the business, but investor sentiment and general market mood will also play a role. Nevertheless, there are strong reasons to believe that Prime is firing on all cylinders, and this is certainly a huge positive for investors in Amazon stock.

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