“Don’t fall into this growth trap,” says the investor about Amazon shares

Amazon (NASDAQ:AMZN) offers investors the best of both worlds: the stability of a large, established company combined with the rapid growth rates of an agile, high-tech company.

The latest earnings report underscores this strength: Amazon exceeded expectations in both sales and earnings. The $2 trillion-plus giant saw operating revenue from its AWS segment jump to $10.4 billion in the third quarter of 2024, representing an impressive 50% year-over-year growth.

Despite these impressive numbers, investor Stuart Allsopp advises caution and warns: “Amazon's extreme valuation and already enormous sales make it a potential candidate for a growth trap.”

Allsopp explains that a growth trap occurs when high valuations are fueled by the belief that past growth rates will continue at the same pace. If growth falls short of expectations, stocks can fall sharply. The investor cites Alibaba as an example, whose shares have fallen by around 70% in the last four years despite strong increases in profits.

In the case of Amazon, the shares are actually not valued too cheaply at the moment, writes Allsopp. Although Amazon's recent wave of earnings has reduced its P/E ratio from 100 to 42, the investor does not believe this provides an accurate picture of the company.

Instead, Allsopp suggests that free cash flow is a more accurate measure than reported profit, given Amazon's high capital expenditures. Additionally, factoring in stock-based compensation costs increases Amazon's effective earnings multiple to 85x. By this metric, Amazon appears to be more expensive than big tech counterparts like Alphabet, Microsoft, Nvidia and Apple.

Having assessed Amazon's valuation as high, the investor turns his attention to the company's future growth prospects.

“Companies with extremely high sales tend to grow slower than average,” Allsopp notes, reminding readers that Amazon is already the second-largest company in the U.S. in terms of sales.

“Although Amazon’s earnings multiple has fallen significantly, it remains extremely expensive, especially when we consider rising capital expenditures and huge stock-based compensation,” concludes the investor, who rates AMZN stock a “Strong Sell.” (To view Allsopp’s track record, click here)

In contrast, heavily covered stocks are extremely popular on Wall Street. With 44 Buys and just 1 Hold rating, AMZN has a consensus Strong Buy rating. Its 12-month average price target of $238.35 implies a 15% upside from current levels. (See AMZN stock forecast)

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Disclaimer: The opinions expressed in this article are solely those of the featured investor. The content is for informational purposes only. It is very important to do your own analysis before investing.