Here’s the math

AFP via Getty Images The stock market is a funny place: When great businesses go on sale, most people don’t rejoice. Instead they freak out. This presents an excellent opportunity for long-term investors who keep their wits about them and triangulate between price and value.

As I perform my own triangulations, I find many tech stocks on sale today, though in this market, as in any market, one must discriminate. Some in the group are worth a look, while others deserve to be crushed. The reason is simple: Like companies in any other industry, most tech companies are doomed to failure, or at least mediocrity, by the viciously corrosive nature of free-market capitalism.

Only companies with moats, to use Warren Buffett’s famous and accurate metaphor, can withstand the intense competition it begets.

For this reason, the key to unlocking successful tech investments remains the same as it has in all previous generations. We must identify, buy, and hold companies with competitive advantages that will allow them to thrive while others languish.

Amazon AMZN, -1.99% is one such company. Down almost 34% in 2022 through Monday, I believe it represents an excellent long-term investment at Monday’s closing price of $2,216.21.

Here’s why:

Even the biggest skeptic will concede that Amazon has large and formidable moats around both its major businesses. Its original business, e-commerce, commands nearly 50% of all online retail traffic, and nobody comes close to matching its mix of selection, price and convenience plus its vast distribution network.

The company’s cloud platform, Amazon Web Services, has a similarly dominant market share of outsourced computing. And while AWS’s core business is renting out “dumb servers,” it bundles that commodity with a suite of powerful software and analytics tools that gradually become embedded in customers’ everyday business processes. This gives AWS a Prime-like stickiness.

Amazon’s moats are therefore beyond any reasonable doubt. The more salient issue is: Can they make money behind them? How much profit, exactly, can Amazon produce from behind its castle walls? This is a tricky question, because its profit history has been erratic.

Let’s get the easy part out of the way: Unlike core e-commerce, AWS shows consistently healthy GAAP profits. Last year, AWS made a 30% operating margin, in line with other capital-intensive tech businesses operating at scale.

AWS, however, has much more growth ahead of it than mature tech hardware companies like Cisco CSCO, -1.13% . Experts estimate that companies spend only about 10%-15% of their computing budget on the cloud today. Over the next generation, that figure could quadruple.

AWS made $18.5 billion in operating profit last year. Even if you decelerate its growth rate from the historical 35% to 20% over the next three years, AWS will make more than $25 billion in after-tax income in 2024. Capitalize that at 20 times, a reasonable multiple for a superior business even in today’s environment of rising interest rates, and it yields a value of roughly $500 billion. By coincidence, that’s roughly half of Amazon’s current market capitalization, less its cash on hand.

The question then becomes: What’s e-commerce worth? The answer depends on how much money e-commerce can make.

Having followed the company for 20 years, I’m convinced that e-commerce has the potential to earn roughly 10 times what it reported in 2021. That should strike any reasonable person as an outlandish statement, so let me explain why this constitutes rational rather than magical thinking.

My first point is that Amazon has shown it can produce profit more or less at will in e-commerce. It can harvest the business it’s growing behind its moat and show bountiful profits that would rival old-economy companies. Amazon has instead decided that with so much more business to capture, spending $1 today and penalizing current profits will generate multiples of that down the road.

Amazon IPO’d during the boom, and from 1997 to 2001 the company spent like mad to build out its e-commerce moat, producing $2 billion in cumulative operating losses. In the bust that followed, Amazon lost 80% of its equity market value. Chastened by the capital markets, Amazon went into harvest mode from 2002 to 2007, producing margins in the 5% to 6% range and nearly $2 billion in operating income.

E-commerce made 5% operating margins in 2009, and again in 2018 and 2019—but when the pandemic came, Amazon again went into investment mode. It doubled in 24 months the distribution infrastructure it had taken 24 years to build. No wonder that earlier this month it reported its first quarterly operating loss in […]

source Opinion: Amazon’s stock price has slumped almost 34% this year. This money manager says it’s a steal and could surge 76% to $3,900 in 2 years

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