Admittedly, Amazon (NASDAQ: AMZN) is not an obvious stock to see making a "parabolic" move. Its $1.6 trillion market cap implies a size that makes huge surges in the stock price more difficult to execute. But the more you dig down and take a closer look at its business model, the better chance you have of convincing investors that such a move is possible.
One investor who belatedly caught on to Amazon's potential was Berkshire Hathaway CEO Warren Buffett. His company first became an investor in 2019. Buffett and his lieutenants likely saw that Amazon's business model yielded most of its profits from a relatively small segment of the company.
The continued growth of that segment, as well as some surprising growth from a few other newer segments under its e-commerce umbrella, are increasing revenue rapidly. It's these factors that could eventually lead to parabolic growth for this internet and direct marketing retail stock.
Amazon's path to rapid growth
Investors can probably understand what Buffett likes about this business simply by looking at its business model. Although the public knows Amazon best for e-commerce, it is one of the least profitable parts of the company. While e-commerce accounts for the largest share of Amazon's revenue, but it grows more slowly and it is expensive to keep it operating efficiently, sometimes even generating losses.
Instead, its profit center is Amazon Web Services (AWS). AWS pioneered the cloud computing industry, and with its higher operating margins, it accounts for most of the company's operating income.
In the first nine months of 2023, AWS made up $67 billion of Amazon's $405 billion in revenue in the same period, about 17% of the total. However, AWS earned $17 billion of the $24 billion in operating income earned by Amazon.
Also, even among Amazon's two e-commerce segments, North America and International, the most rapid revenue growth comes from services. In the first three quarters of 2023, third-party seller services, subscription services, and advertising combined made up approximately $158 billion in sales, slightly less than the $161 billion from online sales during that time. Still, yearly revenue growth for each of the service businesses was well into the double digits, while online sales grew at just 7%.
Amazon did not break down operating income for each business, but it is possible that such services are the profit drivers in the e-commerce segments. In either case, it shows that comparatively smaller segments drive the majority of operating income. This makes income growth easier to achieve than it would be for other companies of Amazon's size.
Growth prospects for Amazon stock
Buffett tends to like stocks that maintain their appeal in all business cycles, but a strong performance is a bonus. Like many growth stocks, improved business conditions seemed to have helped Amazon. The bear market bottom for the stock occurred in late 2022, and over the last year, it has risen by approximately 60%, far above the S&P 500 index's total return of around 25%.
Admittedly, its P/E ratio of 80 may deter some investors from buying. Still, high earnings multiples are nothing new for the company. Hence, investors are unlikely to sour on the company for this reason anytime soon.
Moreover, analysts anticipate enough earnings growth that the forward P/E ratio is 43. This is well below 2021 levels when the forward earnings multiple often exceeded 80, implying more room for the stock to surge higher.
Can Amazon stock go parabolic?
Although no stock analyst can promise a stock will go parabolic, Amazon's large size has not blunted the potential for such gains. Indeed, smaller companies have an advantage in this area since they are better able to drive higher-percentage growth rates.
Nonetheless, Amazon is like a smaller company in that its growth comes from its smaller businesses. Thus, its largest segment by revenue, online sales, can serve as a loss leader that helps drive revenue for higher-growth segments. Additionally, with Amazon's forward P/E ratio at a lower level historically, it can rise rapidly without reaching historical highs in valuation.
Time will tell if the increases meet a "parabolic" standard. Still, Amazon remains well positioned to deliver market-beating returns for the foreseeable future, which should give investors like Buffett good reason to stay with Amazon and add shares.
Should you invest $1,000 in Amazon right now?
Before you buy stock in Amazon, consider this:
The Motley Fool Stock Advisor analyst team just identified what they believe are the 10 best stocks for investors to buy now... and Amazon wasn't one of them. The 10 stocks that made the cut could produce monster returns in the coming years.
Stock Advisor provides investors with an easy-to-follow blueprint for success, including guidance on building a portfolio, regular updates from analysts, and two new stock picks each month. The Stock Advisor service has more than tripled the return of S&P 500 since 2002*.
*Stock Advisor returns as of January 22, 2024
John Mackey, former CEO of Whole Foods Market, an Amazon subsidiary, is a member of The Motley Fool's board of directors. Will Healy has positions in Berkshire Hathaway. The Motley Fool has positions in and recommends Amazon and Berkshire Hathaway. The Motley Fool has a disclosure policy.
The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.