Why Amazon's Stock Surge is Just the Beginning

Amazon has delivered an impressive performance this year, with its stock appreciating over 20%. Many analysts believe this is just the beginning of a much larger upward trend.

Amazon's business model is undergoing a significant transformation, presenting a unique opportunity for investors. Here are three key insights that make a compelling case for buying Amazon stock now.

Resurgence in Amazon Web Services' Growth

Amazon Web Services (AWS), the company's cloud computing division, is experiencing a strong resurgence. AWS allows clients to rent computing space and run workloads over the cloud, a popular strategy that enables customers to scale computing power as needed. This is particularly relevant as many companies are developing AI models to enhance their operations.

Despite sluggish demand for AWS in 2023 compared to competitors like Google Cloud and Microsoft Azure, the outlook is improving. Amazon's significant investment in Anthropic, a generative AI startup, has equipped AWS with advanced AI tools. CEO Andy Jassy highlighted this in Amazon's Q1 conference call, stating, "We see considerable momentum on the AI front where we've accumulated a multibillion-dollar revenue run rate already."

This positive development is reflected in the financial results. In Q1, AWS saw a 17% year-over-year increase in net sales and an 84% rise in operating income. Another growth catalyst is the end of the optimization trend. Last year, companies focused on cost-cutting, including optimizing cloud computing spending. With this trend now complete, AWS is benefiting from new workloads, rather than declining revenue from reduced workloads.

AWS remains Amazon's most profitable segment, which is crucial for its success. However, other areas of the business are also starting to contribute significantly.

Amazon's Accelerating Cash Generation

While AWS has long been profitable, Amazon's commerce divisions haven't always shared that success. The company had to recover from significant investments in its supply network in 2021 and 2022, which affected its North American division. Additionally, Amazon's international operations have historically been unprofitable, but this is starting to change. In Q1, the international segment posted its first profitable quarter since 2021.

This turnaround has significantly bolstered Amazon's cash generation, which is now gaining momentum.

In the past 12 months, Amazon has generated $50.1 billion in free cash flow (FCF), a stark contrast to the $3.3 billion FCF outflow in Q1 of the previous year. The trends associated with this FCF are equally encouraging.

Historically, the first quarter is weak for Amazon due to high spending in Q4. This pattern results in a relative peak at the start of each new year, followed by a significant decline. This occurred again in 2024, but notably, this was the first year in recent memory that the drawdown did not result in a negative FCF. Additionally, the Q4 peak was the highest it has ever been.

This indicates that Amazon's cash flows are improving and sustainable, which is a positive sign for investors. As Amazon's cash flows increase, the company could initiate a dividend or start repurchasing stock, benefiting long-term investors.

Amazon is Still Below Its Average Valuation

Despite Amazon's significant cash flow growth and improvements across its business, the stock is still undervalued based on its price-to-sales (P/S) ratio. Traditional valuation metrics centered around earnings aren't as useful for Amazon yet, but the P/S ratio indicates that Amazon is valued at levels seen during the post-COVID demand drawdown and before that in 2018.

This suggests that the stock isn't overvalued and could be a reasonable purchase today.

Considering Amazon's growth prospects and increasing FCF, Amazon is an excellent buy right now. There are still many aspects of Amazon's business poised for transformation, and investors will benefit from buying and holding it for the long term.

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Amazon may not be every investor's favorite stock. Known for its high valuation ratios, the e-commerce and cloud computing giant has seen its revenue growth slow in recent years. As its market cap soars to $1.94 trillion with $591 billion in trailing revenues, sustaining significant growth becomes increasingly challenging.

However, overlooking Amazon now could be a decision you regret later. While its roots are in online retail, Amazon's future is deeply intertwined with artificial intelligence (AI).

AI is transforming Amazon's business model in profound ways. By integrating AI tools and services across its operations, Amazon is enhancing efficiency and unlocking new business opportunities.

For example, Amazon Go stores leverage AI to deliver seamless, cashier-less shopping experiences through smart shopping carts that track purchases in real-time. Amazon Web Services (AWS) uses AI to attract a growing number of enterprise clients with robust, scalable solutions. Furthermore, Amazon's warehouses and shipping centers are highly automated, featuring advanced inventory tracking and numerous robotic product-picking devices.

AI is also driving Amazon into new sectors such as healthcare, through initiatives like Amazon Care and AI-driven diagnostic tools. Notably, Amazon recently invested $4 billion in AI research firm Anthropic, reflecting a strategic move similar to Microsoft's $13 billion investment in OpenAI, the creator of ChatGPT.

In essence, AI is integral to Amazon's operations. Without it, maintaining the current pace would be challenging. However, with its innovative AI capabilities, Amazon sets a high standard for operational efficiency across multiple sectors.

This comprehensive approach keeps Amazon at the forefront of innovation, continually evolving its business model to seize new growth opportunities. From e-commerce to advanced AI services, Amazon's success is powered by diverse and sophisticated AI technologies.

Consider the potential value if Amazon decided to spin off AWS into a separate entity. AWS generated $90.8 billion in sales in 2023. Using Amazon's price-to-sales (P/S) ratio of 3.3, AWS alone could be valued at $300 billion.

However, Amazon's overall P/S ratio reflects its less profitable e-commerce division. Companies focused on the AI market have P/S ratios ranging from 7 to 37. Taking an average P/S ratio of 20 for AWS suggests a market value of at least $1.8 trillion. Even a conservative P/S ratio of 11, akin to Microsoft's, values AWS at around $1 trillion. This valuation does not include Amazon's e-commerce business.

This estimate might actually be conservative. Nvidia, for instance, trades at 81 times its last fiscal year's operating income. Applying a similar metric to AWS results in a valuation of about $2 trillion, roughly equal to Amazon's entire current market cap.

If the market fully recognized Amazon's AI-driven AWS division, it seems to be overlooking the

value of its leading online retail platform and extensive logistics network.

Thus, AWS alone could be seen as a trillion-dollar operation, especially if Amazon were to spin it off. Meanwhile, the e-commerce division appears significantly undervalued. Investing in Amazon today means accessing the high-growth potential of AWS and a substantially discounted investment in e-commerce, offering a dual advantage.

Given these insights, Amazon should be a cornerstone of any diversified investment portfolio, and it’s not too late to get in. As the world's largest start-up, Amazon continues to pursue substantial global growth, leveraging its pioneering AI technology to drive future expansion and maintain its market-leading position.