For the last couple of weeks investors have gotten their quarterly downloads for portfolio companies as earnings season is on full display. As usual, big tech garnered a fair amount of scrutiny given investor curiosity and expectations around artificial intelligence (AI). For Microsoft, Alphabet, and Amazon (AMZN -2.33%) in particular, the cloud business was at the center of management discussions.
All three behemoths gave investors reasons to cheer. Microsoft's cloud computing platform, Azure, stole the spotlight yet again and helped give the stock some life. Moreover, Alphabet continues to make steady progress in its own cloud business, while also reaccelerating growth in its core advertising business as it fends off competition from TikTok and Instagram.
But as the holiday season approaches, one of these "Magnificent Seven" stocks looks most enticing. Although the prospects of Amazon's cloud unit look more bullish than ever, I see other reasons to buy the stock. After taking a close look at the results in e-commerce and advertising, I think now could be a great opportunity to buy some shares in Amazon and hold for the long term.
Don't sleep on the advertising business
One of the lesser-known segments of Amazon's ecosystem is its advertising business. Typically, when people think of Amazon they likely think of the company's e-commerce storefront or its cloud network, Amazon Web Services (AWS). But what if I told you that for the company's latest quarter, ended Sept. 30, advertising services were Amazon's fastest-growing segment?
During Q3, Amazon reported $12.1 billion in revenue for advertising, an increase of 26% year over year. By comparison, Alphabet's advertising revenue increased 9% year over year during Q3, while Meta Platforms' grew 23%.
During the earnings call, Amazon CEO Andy Jassy told investors that the company is investing heavily into machine learning as it relates to advertising. By doing so, Amazon is better able to target certain ads to specific demographics at the right time. Another way Amazon is disrupting advertising is by leveraging external channels. For example, the company is working closely with social media platform Pinterest to increase its online surface area -- using the image-sharing site to promote products as a third party.
Jassy expressed his positive outlook and the potential depth of Amazon advertising when he said, "I think that we have barely scraped the surface with respect to figuring out how to intelligently integrate advertising into video, into audio, and into grocery."
Given the company's ability to stretch the ads business across its various product categories like the Internet of Things (IoT) or grocery is reason enough to get excited. But with the holiday shopping season right around the corner, the intersection of Amazon ads and its core e-commerce platform could help fuel even more growth sooner than investors realize.
Image source: Getty Images.
The holidays are coming
Online stores are Amazon's largest revenue generator by far, accounting for 40% of total revenue in Q3. Unsurprisingly, the fourth quarter tends to be a big one for the e-commerce giant as shoppers get ready for the holidays. During Q4 2022, Amazon reported revenue of $64 billion in its e-commerce business, which represented only 2% growth year over year.
Bearing that in mind, I'd contest that this year the company's growth could be much better. For starters, the Federal Reserve has been doing what it can against inflation. While the current inflation rate of 3.7% is still higher than the Fed's long-term goal of 2%, I think Jassy summed it up perfectly when he said, "even in a harder economy, there's going to be a lot of e-commerce purchasing".
Given how much progress Amazon is making in targeted ads, coupled with its position as a leading e-commerce platform, I think Q4 will see some more pronounced growth compared to prior years. Should this be the case, the stock could be heavily discounting the potential of Amazon's end-of-year results, making now an interesting time to consider buying.
Should you invest in Amazon stock?
The chart below shows Amazon's price-to-free cash flow benchmarked against its Magnificent Seven cohorts of Microsoft, Alphabet, Apple, Nvidia, Meta Platforms, and Tesla.
AMZN Price to Free Cash Flow data by YCharts.
Investors can see that over the last year, Amazon's valuation fell the most within this cohort on a free cash flow-basis. This, of course, has to be taken with a pinch of salt, as the stock has been trading at a very high valuation for quite some time. In a sense, the stock past high valuation was justified, and the company rewarded the market's faith by posted two consecutive quarters of positive free cash flow that has brought the stock's FCF valuation back in line with historical levels.
To me, this is a clear sign regarding the company's ability to reward its shareholders, and there's no reason to believe Amazon will fail to deliver again in the future. While 2022 and early quarters of 2023 were rough, the company has really turned things around quickly.
In a different sense, the chart above also demonstrates that the market is yet to realize the company's progress, and is perhaps seeking more predictable growth. For long-term investors looking to take advantage of some depressed pricing action, I'd buy Amazon at these levels. With some on Wall Street calling for new highs in the S&P 500, Amazon looks primed to thrive.
