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Can Amazon (AMZN) Justify Its Stock's Sky-High Valuation?

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Shares of Amazon (AMZN - Free Report) closed slightly lower on Friday after Japanese anti-trust officials raided the company’s Tokyo offices for the second time in two years. The concern that Amazon is assembling a global monopoly is one of many critiques faced by the e-commerce behemoth these days.

From Wall Street’s perspective, the main criticism of Amazon is that its stock’s valuation is stretched beyond that of a “normal” company. Amazon has been among the hottest stocks in the world over the past few years, but the company has not prioritized calls for near-term profitability, leaving some bearish traders to question whether its momentum is justified.

To visualize exactly what we are talking about here, take a look at how Amazon’s Forward P/E has trended over the last year compared to its peer group:

 

Amazon’s peer group includes other global internet and e-commerce powerhouses like JD.com (JD - Free Report) , Alibaba (BABA - Free Report) , and Ebay (EBAY - Free Report) . These companies are not perfectly comparable to Amazon, but they help show how investors tend to value modern digital giants.

Investors are clearly willing to pay a significant premium for these types of companies versus the broader market, but Amazon’s valuation is a different situation entirely.

With a Forward P/E of nearly 160, investors are so confident in Amazon’s ability to outperform the market that they are ready to dish out 160x the company’s expected profits over the next year for the stock right now. And this has been trending upward over the past 52 weeks, implying that AMZN has found interested buyers regardless of its ever-stretching valuation.

Nonetheless, these buyers have been proven right so far. As we can see from this price performance chart, Amazon has significantly outpaced the returns of its peer group over the past year:

 

So one reason for Amazon’s sky-high valuation is that its stock has been an absolute machine recently, surging higher at a pace that would have any investor excited. But what is the underlying reason for this momentum?

Well, one factor is Amazon’s ability to attract positive responses to great earnings reports while effectively shrugging off weak reports. For example, the company missed the Zacks Consensus Estimate for earnings per share by an entire dollar in late July, but in the two days following the report, its stock was only down about 3% from where it was two days prior to the report.

In the next-reported quarter, Amazon crushed the Zacks Consensus Estimate for earnings and moved 13% higher over the same type of timeframe.

Still, there has to be more to the story here. Why is it that Amazon is frequently met with more investor optimism than pessimism? How can traders continue to send the stock higher despite its lofty valuation?

There is no one correct answer here, but we can explain this phenomenon most effectively by considering what Amazon hopes to accomplish down the line. As mentioned, Amazon seems willing to forget about near-term earnings consistency at the moment. For instance, while its gross margin has improved significantly over the past few years, its actual net margin has remained stagnant for some time.

Investors have identified Amazon as a unique-enough company to overlook traditional valuation strategies and focus on the company’s overarching vision.

Amazon has long-since been the king of e-commerce in the U.S., but it still has plenty of room to grow in huge markets like China and India. Meanwhile, its aspirations clearly extend well beyond online shopping, and its brick-and-mortar dreams are evident in its buyout of Whole Foods and launch of Amazon Go and Amazon Books stores.

What’s more, the growth of Amazon Web Services and management’s continued investments in budding tech trends like artificial intelligence promise to situate the company at the front of the pack in the next technological generation.

To many investors, this is a speculative and risky viewpoint. But to those who believe in what Amazon is doing now—and what it might be doing in 20 years—the stock’s current earnings multiple is nothing to be concerned about.

Want more market analysis from this author? Make sure to follow @Ryan_McQueeney on Twitter!

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