29/05/2024

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Major Growth Could Be Ahead for Amazon: 1 Chart All Investors Should See

Major Growth Could Be Ahead for Amazon: 1 Chart All Investors Should See

Amazon (AMZN 0.65%) founder Jeff Bezos once said, “Your margin is my opportunity.” Today, the e-commerce giant helmed by Andy Jassy is on a path to generating better profit margins than it has in its history.

Amazon’s North American business, accounting for over 60% of the company’s revenue, has improved its operating margin for six straight quarters. And it’s likely to build on that progress in the fourth quarter and throughout 2024.

There are several factors driving the improved profitability of Amazon’s core business. One chart shows where Amazon’s bottom line could go in 2024.

Where Amazon’s been can tell us where it’s going

Amazon has historically moved from cycles of strong profits to high levels of investment. That leads to widely fluctuating profit margins for its retail business, as seen in the chart below.

A chart depicting Amazon's North American operating margin over time. It shows a steep drop starting in 2019 and a recovery in 2023.

Image source: Author.

What’s notable about this chart is the valley in operating margin in the third quarter of 2017 and the recovery through the first quarter of 2019. Amazon saw its North American operating margin fall to 0.4% in the third quarter of 2017. Amazon’s profits swiftly recovered in the fourth quarter of 2017 (thanks to the seasonality of its business), and it continued to improve all the way through the first quarter of 2019. It reached an operating margin of 5.7% that quarter.

So what happened after the first quarter of 2019?

Following its first-quarter earnings results, Amazon announced it would move Prime two-day shipping to one-day shipping. That required a massive investment. In fact, Amazon saw its capital expenditures increase from $11.3 billion in 2018 to $55.4 billion in 2021.

While a lot of that went toward supporting growth in Amazon Web Services, its cloud computing business, nearly as much went toward expanding the footprint of its fulfillment network. Amazon fully doubled its fulfillment network capacity in the two years from 2019 through 2021.

After a long investment cycle, Amazon is back on a path to new record profits. It’s spending less on capital expenditures, cutting headcount, and optimizing its costs. What’s more, it’s finally growing into its added fulfillment capacity with its new regionalized fulfillment operations, which save the company money and speed up deliveries to customers.

And there’s reason to think Amazon still has a long way to go before it reaches the peak of its operating margin in this cycle and invests in the next big area of growth for the business.

CEO Andy Jassy says he’s not done yet

In his prepared remarks following Amazon’s third-quarter earnings release, CEO Andy Jassy told analysts, “We have a long way before being out of ideas to improve cost and speed.”

Specifically, Jassy sees opportunities to improve inventory placement, which will expedite shipping speeds and consolidate more orders into fewer shipments. Likewise, he says there’s an opportunity to improve the process it uses to bring new inventory into the system, which could reduce costs.

Overall, greater throughput per warehouse, with inventory closer to customers, requiring fewer shipments per order, will have a dramatic reduction in Amazon’s largest expense — shipping. And while it’s shipping more and more packages with its own delivery trucks, it could also get some help from lower rates from shipping partners as they struggle to fill their own trucks.

Investors should expect continued strength in operating margin next quarter and into 2024 as Amazon looks to continue optimizing its fulfillment network while experiencing continued growth in sales.

Should you buy Amazon stock?

Amazon has long focused more on long-term free cash flow growth than net earnings per share. But even then, its free cash flow is extremely lumpy as it goes through investment cycles and capitalizes on those investments.

That makes it hard to value Amazon stock based on simple valuation ratios like price-to-earnings or price-to-free-cash-flow. Therefore, an investor’s best bet to understand where Amazon stock will be in the future is to look at analysts’ estimates for future earnings growth, and determine whether Wall Street undervalues its future earnings potential or not.

Analysts expect Amazon’s earnings per share to improve 30% next year. While that’s certainly a striking improvement, it’s important to remember it could be spending the entire year with an operating margin of around 5%, maybe even higher, for its North American business. That’s four times higher than the first quarter this year.

As such, I think it’s possible Amazon outperforms operating income expectations going forward. And as long as it does that, the stock should outperform.

John Mackey, former CEO of Whole Foods Market, an Amazon subsidiary, is a member of The Motley Fool’s board of directors. Adam Levy has positions in Amazon. The Motley Fool has positions in and recommends Amazon. The Motley Fool has a disclosure policy.