Evaluating Amazon’s (NASDAQ:AMZN) in the context of its anticipated growth rate we see that the company is currently undervalued.
I’d like to change the usual format of my articles and reveal my findings in advance: there is a substantial reason to believe that Amazon is an underestimated company, and not an overestimated one. And it’s not my emotions, but the result of the mathematical calculations.
To begin, let’s simply compare the key multipliers of Amazon with those of its closest competitors:
This comparison results in almost complete nonsense. The fair price of Amazon’s share is $200 based on the P/E (forward) multiple, negative (!) based on the EV/EBITDA and significantly undervalued, judging by the P/S (forward).
I admit that the comparative analysis of the three companies may contain significant error. So as the next step, I compared Amazon with all the companies from my database, without sticking to a particular industry. However, the result almost has not changed. Furthermore, three months ago it was approximately the same.
So, the standard approach to evaluating a company through its multiples is clearly not suited to Amazon. We need another technique.
Why do investors buy Amazon’s shares?
Of course, they do it not because they count on the potential dividends or buy back. In my opinion, the main reason is the growth rate of the company. No, it’s not about it. The main reason is the growth rate that investors expect from Amazon in the future.
It is the future growth that is Amazon’s main driver and the only prism this company can be compared and evaluated through.
Based on Yahoo! Finance data I collected and systematized the average analysts’ projections of the earnings per share and the revenues of the companies I closely monitor for the current and the next year. Here is what I’ve got.
As you can see, Amazon is the indisputable leader in terms of the expected growth of earnings per share:
The company is ranked fourth and is significantly higher than the median in terms of the expected revenue growth. Please also note that the expected absolute growth of Amazon’s revenue exceeds the expected aggregate revenue growth of the companies that are ahead of Amazon on this list.
OK, the forecasted growth of Amazon exceeds that of the other companies even in spite of its enormous rate. But what if the current price of its shares already reflects this optimism?
In this situation, it would be reasonable to compare Amazon through the multiples previously adjusted for the expected growth rate. That is, I suggest to compare and evaluate Amazon through the P/E (forward) and P/S (forward) multiples divided by the expected growth rates. The higher is the growth, the lower are the value of each multiple and the relative value of the company. In this case, we compare the dollar evaluation of each percent of the future company’s revenue and profit growth. Here I provided the detailed description of the formulas.
This is what we get analyzing the revenue growth rate, i.e. the P/S to growth (forward) multiple:
In this case, Amazon is almost the cheapest company on the list.
This is what we get analyzing the growth of earnings per share i.e. the P/E to growth (forward) multiple:
In this case, Amazon is the median value of the list.
Now let’s get back to where we started from and compare the new multiples of Amazon with those of its key competitors:
Now Amazon is almost fairly valued in terms of P/E to growth (forward) and undervalued in terms of P/S to growth (forward).
And, in conclusion, let’s use the new technique and compare Amazon with all the companies from my list:
The result: Amazon is fairly valued but is below the upper range border in terms of P/E to growth (forward) and is enormously undervalued in terms of P/S to growth (forward).
Putting It All Together
Amazon is one of the companies whose growth has not yet reached its limit and not even entered the plateau phase. While this situation remains, the market will assess Amazon only through the prism of the expected growth without much regard to the absolute indicators. As I’ve demonstrated, this approach to the assessment indicates that Amazon is now rather underestimated than overestimated.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.