Amazon‘s (NASDAQ: AMZN) stock split has come and passed, and it is now trading on a split-adjusted basis. Given the newly lowered share price, it is an excellent time to consider the bear and bull case for investing in Amazon’s stock.
The bear case will center on its rapidly rising costs amid decelerating revenue growth. Meanwhile, the bull case will focus on higher-profit segments taking a more meaningful share of the revenue, making the stock arguably cheap. Let’s dive deeper.
Bear case: slowing revenue and rising costs is a poor combination
Amazon came through in the clutch for hundreds of millions of households when the coronavirus pandemic forced nonessential businesses to close their doors to in-person shoppers. Sales surged for Amazon as it became a prominent alternative for folks looking to avoid shopping at brick-and-mortar stores. Indeed, revenue jumped $106 billion higher in 2020 from 2019.
Fulfilling an increase of that magnitude is no easy task. It required Amazon to double the size of its fulfillment network in 24 months.
Those investments in capacity are now weighing on profits as revenue growth is decelerating from pandemic highs. In its most recent quarter ended on March 31, revenue increased by 7%, or less than $8 billion from the same quarter in the year prior — its slowest rate of growth in several years. Meanwhile, total operating expenses rose by over $13 billion.
Unfortunately, management projects this trend to continue while it works to balance capacity with sales. Amazon forecasts revenue to grow by an even lower 5% in its second quarter. Worse yet, it expects operating income to fall to $1 billion, down from $7.7 billion in the same quarter last year. The estimates are midpoints.
There is no telling how far revenue growth will decelerate as economic reopening gains momentum, which will continue weighing on operating income in the near term.
Bull case: more profitable segments are growing faster
Amazon’s revenue growth is slowing after the surge at the pandemic’s onset. Internally, however, Amazon’s more profitable segments are taking more importance. Its Amazon web services segment accelerated growth to 37% in its most recent quarter, up from 32% in the prior year. That segment boasted an operating profit margin of 35% in Q1. Amazon is a leading force in the cloud services industry, which is estimated to reach $495 billion in spending in 2022.
Moreover, Amazon has developed a burgeoning advertising business. Revenue in this segment grew by 25% in Q1 to reach $7.9 billion. Marketers spent $763 billion globally in 2021, and it is reasonable to expect Amazon can take a more meaningful share of this market. Hundreds of millions of shoppers visit Amazon’s website, looking to spend money. Advertisers would love the opportunity to influence those decisions.
The rise of these more profitable revenue sources has improved Amazon’s operating profit margin from 0.2% in 2014 to 5.3% in 2021. Finally, to make the case more compelling, Amazon’s stock is as cheap as it’s been in a long time. At a price-to-earnings ratio of 51, it’s near the lowest in the previous five years.
Bulls win out
Overall, the bull case is stronger than the bear. The temporary imbalance between capacity and sales will eventually balance. On the side of the bulls, the growth in Amazon’s web services and ad businesses will likely last long term. Couple that with an inexpensive valuation, and it makes Amazon stock an excellent buy right now.
John Mackey, CEO of Whole Foods Market, an Amazon subsidiary, is a member of The Motley Fool’s board of directors. Parkev Tatevosian has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Amazon. The Motley Fool has a disclosure policy.