Amazon: Don't Fight AWS Momentum

| About: Amazon.com, Inc. (AMZN)

Summary

Amazon's momentum over the surprise AWS operating profit continues to grow with the recent analyst upgrades.

Margin improvements and earnings forecasts don't match the excitement over the prospects of the AWS segment.

Investors should ride the momentum higher, despite the continued overvaluation of the stock.

The recent Q1'15 results for Amazon (NASDAQ:AMZN) brought excitement to the market over the positive numbers from the Amazon Web Services segment. The ironic part, though, is that the better than expected numbers for AWS were offset by mixed numbers for the retail business.

The stock is up $40 since the earnings report, and over 40% since the January lows. Normally one would consider taking profits or shorting a stock after that big of a run, but the stock could keep running for now.

AWS Excitement

The excitement over the unexpected operating profit for the AWS segment is now evidenced by the large $600 target assigned by Bernstein. The analyst is so enthusiastic about the prospects for AWS that the firm hiked the target by $150. Is the excitement really justified?

Even analyst Ben Thompson, who appears bullish on Amazon, has the following to say:

The profitability of AWS is a big deal in-and-of itself, particularly given the sentiment that cloud computing will ultimately be a commodity won by the companies with the deepest pockets.

The key implications are that the combination of Amazon and a commodity business is typically not a good set-up for lasting profit margins.

The details from Q1 provide further hints at the commodity future of the service. While the market was excited about the fact that AWS had an operating profit, it didn't seem to bother much with the fact that those profits only grew 8% over the last year on 49% sales growth.

Source: Amazon Q1'15 earnings slides

The hard, cold facts are that a commodity business with competitors like Google (GOOG, GOOGL) and Microsoft (NASDAQ:MSFT) isn't one that makes me see a very profitable future for it.

The Big Catch

No matter how the numbers are spun, at the end of the day, the expectations for 2015 still remain bleak. Analysts only forecast Amazon producing a miniscule profit of $0.37 that is now lower than at the time of the Q1 report. The 2016 estimates are trickling up, but Amazon always finds a way to eventually lower future numbers down by the time it actually occurs.

Source: AMZN Earnings data from Yahoo Finance

The stock trades at 169x 2016 EPS estimates, so Amazon still maintains the typical high multiples of the past.

Takeaway

At the end of the day, the excitement over the prospects of the AWS segment appears misaligned with the reality. Sure, the margins on the business are better than expected, but the margin growth is right in line with the Amazon way. In total, the Q1 results showed an overall business that was no healthier than expected.

A key investing element remains that price is truth. As long as fellow investors and analysts see this news as bullish, the stock is heading higher for now. Investors shouldn't fight the ongoing momentum in Amazon. Once the stock hits that $600 price target, it might set up one tasty short. For now, though, it's best to go long or just sit on the sidelines.

Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: The information contained herein is for informational purposes only. Nothing in this article should be taken as a solicitation to purchase or sell securities. Before buying or selling any stock you should do your own research and reach your own conclusion or consult a financial advisor. Investing includes risks, including loss of principal.

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