Reinvesting for Growth – Why Amazon.com, Inc. (NASDAQ:AMZN) is Undervalued Even in This Market

This article first appeared on Simply Wall St News

Since Amazon.com, Inc. (NASDAQ:AMZN) entered its final bull run in the middle of 2020, with investors wondering if the company is still attractive. In this article, we will review some key drivers for future growth and see why the business can increase in value.

How Amazon is growing

For a business to grow, it must reinvest in the business. Generally, growth can be broken down into 2 variables:

With that in mind, I’ve checked out Amazon’s latest developments over the past year, and as we’ll see in the chart below, the company has been extremely aggressive:

notable-events-on-amazon

The orange dots below the stock price are notable developments that Amazon has engaged in or that have been reported by third-party sources. Most of these developments are centered around business growth and expansion, and their effect should be felt in the future.

If you want to see a summary of each event in the table above, go to Amazon’s profile and click on any point of interest. You can also zoom in on a 3 month view for better readability.

Then we have to see how much capital Amazon is putting behind these developments, and growth in general. We can do this by looking at the cash flow statement.

There we have an item that shows how much money the company has spent on investments, including capital expenditures!

amazon-cash-flows

amazon-cash-flows

Let’s break this table down.

There are 3 main types of cash flow: cash flow from operating activities (what the business sells, after expenses), cash flow from financing (taking out a loan, selling stock, etc. ), and the object of our analysis, cash from investing (purchase of other companies, equipment, infrastructure, IP, etc.).

The cash flow statement shows as positive (+), how much money has come into the business, and as negative (-), how much money has been spent.

In the case of a growing business like Amazon, spending money isn’t necessarily a bad thing, because it the money is actually invested in the long-term development of the company.

If you go to the previous section for Amazon, you can click through to see cash from operations, while the difference between cash from operations and free cash flow is capital expenditure. (a close approximation of cash from investing).

We can see that Amazon has invested $58 billion in the past 12 months, while it earned $46 billion in operations and $6.2 billion in funding. This means that the company is still quite aggressive when it comes to growth and invests more than it earns. In the case of Amazon, this is not a problem, as the company has more than enough financing capacity to cover these expenses.

Although we have covered cash flow from investments, there is another aspect to consider. Amazon does quite a bit of R&D, and it looks like a lot of it will result in long-term growth. If we wanted to count R&D expenses, which in the case of Amazon seems justified. We need to capitalize on them and calculate the value of R&D. With that in mind, the value for the last three years is $96.5 billion (straight-line), with $56 billion spent in the last 12 months.

It means that a more realistic measure of how much Amazon is investing in growth are the cash flow from investment + R&D, resulting in $154.7 billion in investments.

The amount a business invests will help us estimate its revenue growth potential!

First, we take the capital invested in the company: Equity + Debts (including leases) – Cash + Value of R&D + Reinvestments

Invested capital: $138.3 + $116.3 – $96 + $154.7 = $313.3 billion

And then we can multiply by what the business has made in revenue on that capital. It is the quality of decision making the sink. For AMZN it has been between 1.63 and 1.9 for the last 4 quarters ttm, we will start with the most recent value of 1.84.

Now that we know how much the company has invested and what it earns on the income from those investments, we can calculate a fundamental growth rate of income.

We get: 313.3 * 1.84 = $576.5 billion in estimated revenue next year

Finally, to get the estimated annual growth, we need: 576.5 / 469.8 – 1 = 21.8%

(Estimated revenue next year / Revenue last ttm – 1)

Depending on how much Amazon reinvests in the business and the relevance of those investments in the past, we can expect growth of around 20%. Note that there are moving parts and the analysis is quite subjective – for example, management may make mistakes or make better decisions, which will impact the rate.

Alternatively, instead of cash flow from investing activities, we can simply use capital expenditure. In this case, we would achieve revenue growth of 23.8% for the next 12 months.

This revenue growth rate is in line with growth over the past 12 months (21.7%) and close to the $540 billion or 15% that analysts expect for fiscal 2022.

Evaluation

Growth is great, but to invest we need to link that to value and see if it’s worth digging deeper into the business.

For this, we can take advantage of the Discounted Cash Flow (DCF) model. This attempts to estimate the value of a business by adding the present value of all the cash it will generate in the future. However, a DCF is just one of many evaluation metrics, and it is not without its flaws.

Check out our full analysis for Amazon.com

To begin with, we need to obtain cash flow estimates for the next ten years.

Where possible, we use analyst estimates, but where these are not available, we extrapolate previous free cash flow (FCF) from the latest estimate.

A DCF is based on the idea that a dollar in the future is worth less than a dollar today, so we need to discount the sum of these future cash flows to arrive at an estimate of present value:

Estimated free cash flow (FCF) over 10 years

2022

2023

2024

2025

2026

2027

2028

2029

2030

2031

Leveraged FCF ($, millions)

$37.6 billion

US$55.4 billion

$81.9 billion

$104.9 billion

$128.8 billion

US$146.5 billion

US$161.4 billion

US$173.8 billion

$184.2 billion

$193.0 billion

Growth rate estimate Source

Analyst x14

Analyst x14

Analyst x6

Analyst x4

Analyst x4

East @ 13.73%

Is at 10.19%

Is at 7.71%

Is at 5.97%

Is at 4.75%

Present value (in millions of dollars) discounted at 6.4%

$35,300

$48,900

$68,000

$82,000

$94,600

$101,200

$104,800

$106,200

$105,800

$104,200

(“East” = FCF growth rate estimated by Simply Wall St)
10-year discounted cash flow (PVCF) = $851 billion

After calculating the present value of future cash flows over the initial 10-year period, we need to calculate the terminal value, which takes into account all future cash flows beyond.

Present value of terminal value (PVTV)= TV / (1 + r)ten= 4.4 t USD ÷ (1 + 6.4%)ten= $2.4 billion

the Total valueor equity value, is then the sum of present value of future cash flows, which in this case is $3.2 billion.

Compared to the current share price of $3.2,000, the company seems reasonably undervalued with a 50% discount.

Although this may seem like a bit of a stretch, we can assume that the company is still significantly undervalued and encourage investors to dig deeper. In fact, why not test a model yourself with our tool.

The assumptions of any calculation have a big impact on the valuation, so it’s best to treat this as nothing more than a rough estimate.

dcf

dcf

Key points to remember

In this article, we explored why reinvestment is crucial for Amazon’s growth, and we saw that the company is very aggressive with new investments in the business.

We estimated a revenue growth rate of around 22% and coupled this with analyst forecasts.

Ultimately, the goal is to see if a company is undervalued, so we took analyst forecasts and used them to get a rough estimate of intrinsic value.

It seems that the company is still on the road to expansion and the investments will create value for investors in the future.

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Simply Wall St analyst Goran Damchevski and Simply Wall St have no position at any of the companies mentioned. This article is general in nature. We provide commentary based on historical data and analyst forecasts only using unbiased methodology and our articles are not intended to be financial advice. It is not a recommendation to buy or sell stocks and does not take into account your objectives or financial situation. Our goal is to bring you targeted long-term analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price-sensitive companies or qualitative materials.

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