Stock of the Week: Amazon

Amazon shares have pushed to new highs in the pandemic, but could a new US President mean life is about to get harder for tech giants?

22/10/2020 18:01:00

Post-It Note

Tech earnings season is in full swing and investors will get to see how in-demand stocks like Amazon and Tesla have fared in the third quarter of 2020. Our Twitter followers have voted in force for Amazon as our stock of the week, which releases results on Thursday after the stock market closes.

Amazon (AMZN) has, of course, been one of the obvious stock market winners of the Covid-19 pandemic and its shares are up around 70% this year so far. But it is longer-term investors who’ve seen the most impressive gains – shares have increased a staggering 19 times since 2010. The upward march has continued as the company has rolled out services such as Amazon Prime, Kindle, Amazon Video and Amazon Fresh.

Part of the original cohort of FANG (Facebook, Amazon, Netflix and Google) stocks, Amazon’s $1.6 trillion market cap means it is now bigger than the rest of this group. But Apple (AAPL), which underwent a stock split at the end of August, has already beaten Amazon to become the first $2 trillion company.

Despite Amazon’s mammoth share price gains in recent years, Morningstar analysts believe the shares are still slightly undervalued at current levels, with a fair value estimate of $3,500, above a current price around $3,200. The e-commerce company also has a wide economic moat. “Its operational efficiency, network effect, and laser focus on customer service provide its marketplaces with sustainable competitive advantages that traditional retailers cannot match”, says Morningstar’s RJ Hottovy. (Network effect works when a company becomes more attractive to customers the bigger it is).

The company continues to find new ways to evolve, says Hottovy, from its subscription service Prime (with 150 million members at the start of 2020) to entering the grocery market via Amazon Fresh, putting it head-to-head in the UK market with e-commerce success story Ocado (OCDO) in London, and indirectly via a fulfilment deal with supermarket Morrisons. Amazon also competes with Netflix (NFLX) (and now Disney (DIS)) in video streaming with Amazon Prime Video, and its Amazon Studios division now produces TV shows and films. Could the company now prove a rival to the cinema business, which is facing an existential threat this year as blockbusters are delayed and lockdown measures resume?

The Risk of Regulation

Morningstar’s Hottovy notes that Amazon has recently staked its clam in another on-trend industry: healthcare. This has come with the launch of the Amazon Halo subscription service in the US. The Halo is a wearable band like a Fitbit that monitors your sleep patterns, your body fat and even whether your “tone of voice” suggests mental health issues. This isn’t Amazon’s first foray into healthcare as it already has a stake in non-profit venture Haven Healthcare with JP Morgan and Warren Buffett’s Berkshire Hathaway.

But Amazon faces a number of challenges to its dominance in the coming years. If the polls are to be believed, the US will get a new President next year, and the Democrats could bring a much tougher regulatory regime for America’s biggest companies. Google-owner Alphabet has just been hit with an antitrust case from the US Department of Justice; Hottovy says that Amazon faces similar risks from regulators and governments across the world, which include the threat of higher taxes. The UK Government, for example has imposed a “digital services tax” with the aim of raising £500 million from global tech giants (Amazon will not have to pay the tax on goods it sells directly to consumers, but third-party sellers on its website will).

He also says that competition from other retailers also poses a significant risk: “Amazon must maintain its value proposition and logistics efficiency to drive site traffic while competing with other merchants for market share.” There’s also a risk that in tougher economic times people will cut subscriptions like Amazon Prime (£7.99 a month in the UK), but Hottovy thinks that Amazon will continue to keep customers loyal with new offerings and incentives.

The company is owned by a number of funds that are highly rated by Morningstar, including Gold-rated Morgan Stanley US Advantage, which has a 6% weighting towards Amazon and has posted gains of more than 50% this year.

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