Which stock has contributed the most to the US stockmarket over the past year?
Apple? No. Google? Not quite. Netflix? Sorry, wrong again.
It’s Amazon. Since September 2014, Amazon has gone up by nearly 70%. This alone has boosted the S&P 500 by just over 5%.
At the start of 2009, it had a market cap of $22bn. Now it’s $246bn. In terms of market valuation, it overtook supermarket giant Walmart this summer, and it’s now the 11th largest listed company in the US.
So can it keep it up? Or are there better bets out there in the tech sector?
Why Amazon is doing so well
One big reason Amazon has done so well in the past year is that it is starting to increase its profit margins.
From the start, Amazon’s emphasis has been firmly on growth. To gain market share, it has been prepared to offer deep discounts on the goods that it sells, sometimes to the point of selling at a loss.
That’s certainly made it popular with consumers. But suppliers and investors have been less happy about it. Amazon only turned its first profit in 2001, seven years after launching. And since then it has done the minimum that it can to reassure investors that it is a viable company. Indeed, chief executive Jeff Bezos has stated several times that he isn’t too fussed about margins.
The company has also been willing to invest significant sums in its ‘Amazon Prime’ service. That has allowed it to slash the time it takes to deliver goods – a key factor in keeping ahead of the competition.
Of course, ‘growth at any cost’ is a risky strategy, and leaves Amazon vulnerable to a sudden downturn. And concerns over this issue mean that Amazon’s shares have traditionally being very volatile around earnings season – no one quite knows what to expect. So you can see why investors are so happy that Amazon is finally starting to convert its sales into profits.
Profiting from cloud computing and online TV
What’s interesting is that the surge in profitability is mainly coming from one area – Amazon Web Services (AWS). This has nothing to do with selling books online. Instead, AWS enables firms and individuals to store data online, rather than on their own hard drives. That means they can access their files and software programs from anywhere with an internet connection.
Amazon is far from being the only firm to offer these services – there are lots of firms trying to do something similar. However, it does have one thing that they don’t have – a brand that is well known and respected. That matters, because there are still plenty of security concerns around cloud computing – not helped by all the recent hacking headlines.
For now, this area of the business only accounts for 8% of total revenue. But it’s growing by more than 50% a year. So it could end up being a goldmine for Amazon.
The other thing that has Wall Street excited is Amazon’s move into TV as part of its Amazon Prime package. This is all part of the rise of ‘on-demand’ TV and films, delivered over the internet via high-speed broadband connections.
As with AWS, Amazon hopes that its brand name and large customer base will give it an advantage over rival services, such as Netflix. It has gone on a buying spree, buying up rights to TV shows and films, and producing its own – the most notable being the £160m it has paid for a motoring show by the Top Gear trio of Jeremy Clarkson, Richard Hammond and James May.
The best way to invest in the battle of the internet giants
All these projects make Amazon look very tempting. Yet if you don’t hold it already, I’d suggest you stay clear for the moment. I have two big concerns.
Firstly, Amazon still looks really expensive. It currently trades at 54 times future earnings. Even if it meets future growth expectations, its price/earnings ratio will not fall below 20 until 2019.
And can it keep growing at this rate? Google, Apple and, to a lesser extent, Netflix are all formidable competitors, scrambling for the same ground. It’ll be a vicious fight, and in the battle for market share, margins again will be one of the first casualties.
If you’re interested in investing in the future of cloud computing or online TV, then you might be better off looking at companies that can provide the one thing that all of these big players need – security.
There are plenty of interesting players in the market, and it also ties into a wider theme of cybersecurity in sectors such as networked smartcars. It’s a topic I’ve covered in MoneyWeek magazine a number of times, and we’ll be returning to it again in the near future. (If you’re not already a subscriber, sign up now.)