If Amazon Is a Top Growth Stock, Then Why Does It Trade at Just 21.3x Forward Earnings While the S&P 500 Trades at 20.4x? This Is the Only Answer I Can Think Of.
Key Points
AWS sales increased 37.5% year over year in the second quarter, its best peformance in 18 quarters.
The chip business has long-term commitments from companies like Anthropic and OpenAI.
The e-commerce business is still growing by double digits, too.
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Amazon (NASDAQ: AMZN) has emerged from a challenging period with high growth and massive opportunities. Its artificial intelligence (AI) spend, which provoked an exodus from the stock last year, is paying off, and the market is starting to appreciate it again.
Amazon stock is up 15% year to date, edging out the S&P 500's 13% gain, but it still looks cheap; it's trading at 21.3 times forward, 1-year earnings, a very slight premium to the S&P 500 average of 20.4.
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Image source: Amazon.
Amazon has massive opportunities
CEO Andy Jassy has maintained over the past few years that the AI spend is necessary to harness the incredible opportunities in AI. Amazon has a first-mover's edge and the most to gain, since it's the largest cloud company in the world.
At times, Jassy has appeared surprised by the intense, negative market reaction to what seems logical and necessary. He has reiterated many times that this is the biggest opportunity since the internet, and that there's going to be a shift to the cloud. Well, that time has come, and Amazon is ready.
Although Amazon has been reporting strong growth for a while, the second quarter was a standout. Sales increased 20% over last year, all the more impressive now that Amazon is the largest company in the world by sales. It's highly profitable as well, and operating income rose from $10 billion last year to $27.5 billion this year.
Amazon Web Services (AWS), the cloud segment, is doing a lot of the heavy lifting. Sales for the cloud business increased more than 37% year over year, the highest in 18 quarters. That's in turn driven by AI. AWS offers a vast platform for AI development with a large array of features and products for every budget. It serves a huge client base of top-tier companies like Warner Bros. Discovery, Snowflake, and Moody's, all of which it signed new deals in the second quarter. AWS operating income increased from $10.2 billion to $16.6 billion, accounting for more than 60% of the total.
It also has a fast-growing chip company which would be one of the largest chip businesses in the world on its own, and it signed multi-year commitments with Anthropic and OpenAI in addition to many more clients in the second quarter. Amazon's Graviton5 chip has 25% better compute performance than Graviton4, and the line already has 30% to 40% better compute performance than similar chips. Revenue commitments for Graviton increased threefold sequentially in the second quarter.
Investors shouldn't ignore progress in e-commerce, though. Amazon added 80 U.S. cities to its ultra-fast delivery service, which gets orders to customer in less than 30 minutes. E-commerce is still Amazon's bread and butter, and the money coming in from the core e-commerce segment provides the foundation for the company to launch new businesses like AWS and the brand-new Amazon Leo satellite broadband business, which competes with Space Exploration Technologies' Starlink business. E-commerce is still growing by double digits, and if not outshined by AI, it would be impressive on its own.
Is Amazon stock a bargain?
So why is Amazon stock so cheap?
When a company is as big as Amazon, or any of the mega-cap companies, the market sees a cap on growth. Although Amazon is growing by double digits, it's not the same kind of astronomical growth as a young upstart. So while there's a long opportunity ahead, it's going to come more slowly and more steadily. That's the only reason I can think of for why Amazon stock looks so cheap today.
Investors should keep that in mind when considering Amazon stock. The company can still outperform the market and create shareholder value, but it's not going to deliver the same life-changing wealth it did in the past.
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Jennifer Saibil has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Amazon, Moody's, Snowflake, and Warner Bros. Discovery. The Motley Fool has a disclosure policy.
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