Jeff Bezos again sold billions of dollars worth of Amazon stock (NASDAQ:AMZN), according to a regulatory filing. He hasn’t made a sale this size since 2021, just before the stock crashed into 2022. And, although we cannot know exactly why Bezos is selling, I think Amazon’s stock price is discounting very low future returns. After a massive run-up in 2023, 2024 looks like a favorable time to sell this Magnificent Seven darling. Let me explain why I am bearish on the shares.
Although Amazon trades at a high valuation (58.3x earnings), the company is quite cyclical. Because the company sells so many non-essential goods and advertisements, its earnings are vulnerable to a recession.
Also, Amazon is vulnerable to inflation shocks like we saw in 2022. The company engages in the very capital-intensive business of storing and delivering goods, as well as operating data centers. In 2022, Amazon’s expenses inflated rapidly, causing a 51% decline in its operating income. Over the past couple of months, shipping prices have increased, as have Brent crude oil prices, both of which tend to eat into Amazon’s bottom line.
Top-line revenues have grown at a CAGR of just 10.6% over the past two years, and the company’s cloud margins are shrinking (year-over-year) with strong competition from Microsoft (NASDAQ:MSFT). So, while Amazon’s earnings rebounded big time in 2023, I don’t expect this kind of year-over-year growth to continue.
Shrinking Cloud Margins
Microsoft has been a very tough competitor for Amazon Web Services. Microsoft seems to have the advantage here because it is so deeply intertwined with so many businesses. And because it can bundle its cloud services with its many other services (for example, Microsoft Office). Microsoft’s “Intelligent Cloud” segment grew revenues by 17% year-over-year compared to AWS’s 13%. This means Microsoft is stealing AWS’s cloud market share.
Moving over to the margin side, Microsoft’s Intelligent Cloud boasted an operating margin of 43%, while AWS’s operating margin was just 27%. This indicates to me that AWS has no durable competitive advantage against Microsoft’s Intelligent Cloud.
This lack of a moat becomes more evident when we look at the trend of AWS’s operating margin, which stood at nearly 30% in 2020 and 2021, fell to 28.5% in 2022, and continued to fall to 27.1% in 2023. While this looks like a small move on the surface, AWS’s margins would have fallen even further if not for the segment’s huge headcount reduction last year. This is a worrying trend for Amazon’s most important business.
I think that as the cloud industry matures, we will see more price competition, just as we see today in the semiconductor and telecommunication industries. This would be bad news for AWS, but businesses can and do change over time. Just look at the once-dominant AT&T (NYSE:T) and Intel (NASDAQ:INTC).
Amazon’s Capital Allocation
Amazon’s executives indicated in their Q4 earnings call that capital expenditures (CapEx) would increase again in 2024. The company will be spending money on the latest trend: Generative AI, language models, and AI chips, just as it spent money on Amazon Alexa, Prime Video, and Amazon Fire Phone in the past. All of these past endeavors have thus far lost money for Amazon shareholders. And, with Amazon not being a clear leader in any of these new categories, it is unclear if these projects will ever be profitable.
Lackluster Financials
First, investors in Amazon should be wary that management is diluting their ownership percentage over time through the use of stock-based compensation, a figure that stood at $24 billion in 2023. If we deduct this and the company’s three-year average lease principal repayment ($7.8 billion) from the company’s $32.2 billion of free cash flow, we may get the impression that the company is making no money. Yet, the market cap stands at $1.76 trillion.
However, because Amazon invests so much capital into its growth, I think a better metric to look at over time is the company’s operating income, which averaged $24.66 billion over the past three years. With such a small figure in relation to the market cap, Amazon’s valuation depends solely on its future growth.
I think we can expect Amazon’s international commerce business to eventually turn a profit. But, as we saw earlier, AWS is facing competitive threats. Its margins may continue to shrink over time, offsetting improved margins in the company’s other segments.
Lastly, the balance sheet isn’t looking stellar, with a current ratio barely above 1x and a long-term debt and lease liability of $136 billion. This leaves the company vulnerable to further share dilution or debt accumulation if it should report negative free cash flow again, which was the case in 2021 and 2022.
In Benjamin Graham’s iconic book Security Analysis, he stated that during the boom of the late 1920’s (just before the Great Depression), investors stopped valuing companies based on dividend records, asset values, and average earnings and began valuing them “almost exclusively on the earnings trend ~ that is, on the earnings expected in the future.” This can be a dangerous game, but it is clearly the case for Amazon’s stock, which trades at nearly 9x its book value and 86x its three-year average net income, while paying no dividend.
Is AMZN Stock a Buy, According to Analysts?
Looking at what others think of Amazon, all 41 analysts covering AMZN stock now give it a Buy rating. The average AMZN stock price target is $208.23, implying upside potential of 19.48%. Analyst price targets range from a low of $175 per share to a high of $230 per share. My bearish view on AMZN stock is thus a very contrarian one.
The Bottom Line on AMZN Stock
Amazon stock sells at a very high multiple. But, I do not believe it is justified. I believe Microsoft’s Intelligent Cloud has a better competitive position. It’s taking share from AWS and posting much higher operating margins.
The cloud computing industry may become more and more competitive as it matures, resulting in shrinking margins, which would offset increasing margins in Amazon’s other businesses. Meanwhile, Amazon has grown revenue at a CAGR of just 10.6% over the past two years and is vulnerable to both shipping and fuel inflation, as well as a recession.
With a lackluster balance sheet, optically high valuation, history of capital allocation blunders, mediocre competitive position in the cloud industry, and $24 billion of stock-based compensation, I see no reason to own the stock as founder and chairman Jeff Bezos trims his ownership.
