Pros And Cons Of Investing In Amazon Stock (NASDAQ:AMZN)

Elevator Pitch

I continue to assign a Hold to Amazon.com, Inc.’s (AMZN) shares. I wrote about AMZN’s 2022 outlook in a prior article published on December 17, 2021.

My latest article focuses specifically on the pros and cons of investing in Amazon’s shares. I come to the conclusion that the risk-reward for Amazon is more or less evenly-balanced, which justifies my Hold rating. On one hand, AMZN has pricing power in its home market with respect to Prime, and the decrease in capital expenditures and the shift in revenue mix should be positive for Amazon’s future profitability. On the other hand, Amazon might struggle to compete in new growth areas or geographic markets, while there are no lack of competitors in its core e-commerce business.

AMZN Stock Key Metrics

Prior to detailing the pros and cons associated with a potential investment in Amazon, I review the company’s most recent financial metrics as per its Q4 2021 financial results.

AMZN’s revenue increased by +9.4% YoY from $125.6 billion in the fourth quarter of 2020 to $137.4 billion in the most recent quarter. Amazon’s Q4 2021 top line was largely in line with market expectations, as the company’s quarterly sales were only -0.13% lower than the market’s consensus revenue forecast.

Although Amazon’s operating income decreased by -49.7% YoY from $6,873 million in Q4 2020 to $3,460 million in Q4 2021, this was +44.2% better than Wall Street analysts’ consensus estimate of approximately $2.4 billion. AMZN’s Q4 2021 operating profit also came in at the higher end of the company’s prior operating income guidance of “between $0 and $3.0 billion.”

Looking ahead, AMZN’s forward-looking guidance is mixed.

On the positive side of things, Amazon’s Q1 2022 revenue guidance of “between $112.0 billion and $117.0 billion” and operating income guidance of “between $3.0 billion and $6.0 billion” as per its fourth-quarter earnings release imply that the company is expected to generate operating income margins in the 2.7%-5.1% range in the current quarter.

In other words, AMZN’s operating margin should improve significantly in Q1 2022 as compared to the company’s Q4 2021 operating margin of 2.5%. In my earlier December 17, 2021 update for AMZN, I expressed my concerns that “Amazon’s actual 2022 earnings could possibly fall short of expectations due to a larger-than-expected increase in labor expenses.” A shortage of workers now appears to be less of a headwind than earlier feared. At the company’s Q4 2021 earnings call on February 3, 2022, Amazon specifically mentioned that “the labor challenge is not as great in Q1 (2022) as it is in Q3 and Q4 (2021).”

On the negative side of things, the mid-point of Amazon’s Q1 2022 revenue guidance at $114.5 billion was -5.4% below the sell-side analysts’ consensus top line forecast of around $121 billion.

I highlighted in my earlier December 2021 article that “it is very likely that e-commerce sales growth will gradually normalize closer to pre-pandemic levels” which “will translate into a slower pace of retail revenue growth going forward.” My views are supported by that fact that AMZN’s revenue guidance for the first quarter of this year was weaker than expected.

After having discussed AMZN’s key financial metrics, I will touch on the pros and cons of being an investor in Amazon in the subsequent two sections of this article.

Pros Of Buying Amazon Stock

In my views, the key investment merits for AMZN are the company’s pricing power in relation to its US Prime membership, a more favorable revenue mix with higher-margin businesses growing faster, and a moderation in capital expenditures gradually going forward.

Pricing Power

Amazon disclosed in its Q4 2021 earnings media release that it “will increase the price of a Prime membership in the U.S., with the monthly fee going from $12.99 to $14.99 (+15%), and the annual membership from $119 to $139 (+17%).”

Notably, this is not the first time AMZN has raised the price of Amazon Prime in the US. The yearly subscription cost of the Amazon Prime membership was increased by +25% from $79 to $99 in 2014. Amazon subsequently introduced a monthly subscription option for Prime priced at $10.99 in 2016. In 2018, the company increased the pricing for its monthly and yearly Amazon Prime subscription plans by +18% and +20% to $12.99 and $119, respectively.

Furthermore, Amazon also stressed in its Q4 2021 results briefing that it “welcomed millions of new Prime members” and saw “consistently high member renewal rates” in the recent quarter.

In a nutshell, Amazon’s Prime membership base is “sticky” as evidenced by the high proportion of existing members retained as highlighted above, and this gives the company significant pricing power.

More Favorable Revenue Mix

Based on the company’s FY 2021 10-K filing, Amazon’s AWS (Amazon Web Services) revenue grew by +39.5% from $12.7 billion in Q4 2020 to $17.8 billion in Q4 2021, while its other (advertising) revenue increased by +32.2% from $7.4 billion to $9.7 billion over the same period. In contrast, AMZN’s retail revenue expanded by a mere +4.1% YoY in the recent quarter.

Recent research by Gartner (IT) published in February 2022 forecasted more than half of “enterprise IT spending” in the “the application software, infrastructure software, business process services and system infrastructure markets” to be shifted towards “public cloud computing” by 2025. This suggests that AWS’ strong growth momentum should be sustained in the next few years. Separately, Amazon’s advertising revenue is also expected to grow rapidly for the foreseeable future. Apple’s (AAPL) iOS privacy changes are a tailwind for AMZN, but a headwind for other internet advertising companies reliant on third-party data. A May 6, 2021 CNBC article noted that “Amazon holds an enormous amount of in-depth consumer data” which “will likely become a more rare and valuable commodity for marketers.”

I noted in my earlier December 2021 article on AMZN that “Amazon will benefit from a favorable revenue mix (which is positive for profitability) as the revenue contribution of the higher-margin AWS and advertising businesses (as compared to retail business with lower margins) grows.” I still hold the same views.

Expectations Of Lower Capital Expenditures

According to S&P Capital IQ data, Amazon’s capital expenditures are expected to decline from $61.1 billion in fiscal 2021 to $55.8 billion, $54.6 billion and $49.7 billion for FY 2022, FY 2023 and FY 2024, respectively. This is aligned with the company management’s comments at the recent Q4 2021 results briefing.

Amazon mentioned that capital expenditures relating to the “fulfillment center side” are “moderating” and “will probably now match growth of our underlying businesses” in 2022 and beyond, when asked when AMZN is “emerging from this investment cycle” at the recent earnings call.

In summary, I am positive on Amazon for its ability to raise prices for its Prime membership. A more favorable revenue mix and lower capital expenditures could translate into higher profitability for AMZN in the intermediate term, which are also key investment merits for the stock.

In the subsequent section of this article, I turn to the negatives and risk factors relating to an investment in Amazon.

Cons Of Buying Amazon Stock

In my opinion, the key risk factors or negatives associated with an investment in AMZN’s shares include stiffer-than-expected competition in e-commerce, and the challenges linked to expansion in new geographies and new product categories.

Competition In The E-Commerce Space

Amazon’s Q4 2021 retail or e-commerce revenue growth has been modest and its Q1 2022 overall revenue guidance was below expectations as discussed earlier in this article. The increased competition that AMZN is facing in the e-commerce space is a key factor.

AMZN is facing stiffer competition from both social media companies and niche e-commerce platforms.

The lines between e-commerce platform operators and social media companies are blurring. Meta Platforms (FB) introduced Facebook Shops in the middle of 2020, which it describes as a new initiative that allowed companies to “easily create an online store on Facebook and Instagram for free” that is focused on a “mobile-first shopping experience.” Separately, Snap (SNAP) is making its bet on augmented reality or AR e-commerce. A January 26, 2022 Bloomberg article highlighted that SNAP is working with “businesses to introduce products via camera overlays in its Snapchat app, so users can digitally try on a new lipstick shade or style of shoe.”

On the other hand, Amazon also has to compete with niche players in e-commerce. Prior to being the retail giant that it is now, AMZN was a niche book seller which subsequently expanded into other retail verticals. Despite Amazon’s dominance, companies like Etsy (ETSY) and Wayfair (W) have managed to carve out a niche in their respective areas. Although these niche players are unlikely to grab significant retail market share away from Amazon, they could limit AMZN’s future expansion in specific product segments. For example, Amazon has not found success in challenging ETSY in the hand made product category.

Foreign Market Expansion Is Tough

After years of venturing overseas, the split between Amazon’s domestic (North America) and foreign revenues is still about 2:1 in 2021 as per the company’s fiscal 2021 10-K filing.

The company’s reply to a question of the potential for an increase in Amazon Prime pricing in international markets speaks volumes about AMZN’s relative competitiveness in overseas markets. Amazon’s response at the company’s Q4 2021 results call was that “we look at the relative price to the customer versus our cost to supply that, and the usage and the value that we’re creating for customers” in determining whether to raise the price of the Prime membership in specific markets. I will interpret this as Amazon having relatively lower pricing power in international markets where it is less entrenched and faces formidable local competitors.

In conclusion, it might be too optimistic to expect faster growth in international markets to more than offset moderating growth in its home market for Amazon in the long run.

Expansion Into New Growth Areas Might Not Be Successful

Certain investors are excited about Amazon’s opportunity to expand into new areas of growth like healthcare and lending, and eventually achieve similar success as it did to AWS or its core e-commerce business. But the truth is that the low-hanging fruits might have already been picked, and Amazon’s new growth initiatives might not be as successful as what investors hope for.

One example is the grocery segment. Although AMZN acquired Whole Foods Markets in 2017 and spent lots of money growing this business for years, Amazon currently boasts only a low single-digit market share in the US grocery market. This might be a reflection of the fact that Amazon does not have a clear edge or competitive advantage in these new segments where competition is very intense.

To sum things up, Amazon’s core e-commerce business faces substantial competition, and the company might not live up to its growth potential in new markets or areas of growth.

Is Amazon Stock Worth Investing In?

A stock is worth investing in, if there are more pros than cons, and valuations are very attractive. This does not appear to be the case for Amazon.

Amazon is currently valued by the market at a consensus forward next twelve months’ EV/EBITDA multiple of 19.2 times as per S&P Capital IQ data. This is lower than AMZN’s 10-year mean forward EV/EBITDA of 22.9 times.

However, AMZN does deserve to trade below its average historical EV/EBITDA multiple, as there are expectations of slowing revenue growth for the company in the medium term. Amazon delivered a revenue CAGR of +27.2% for the FY 2016-2019 period, but it is forecasted to achieve a much slower revenue CAGR of +14.9% for the FY 2022-2025 period based on consensus forecasts sourced from S&P Capital IQ. On the flip side, the moderation in AMZN’s top line expansion in the next few years is compensated for by an improvement in profitability. Market consensus expects Amazon’s EBITDA margin to expand from 15.3% in FY 2021 to 18.2% in FY 2025.

Bottom Line

Amazon is a Hold, as I see both tailwinds and headwinds for the company in the years ahead. AMZN’s current valuations are not expensive, but they are not exactly cheap either, which makes a Hold rating fair.