Why Amazon Stock Could Be a Good Investment Today

Outwardly, Amazon (AMZN -3.65%) the stock may seem expensive. The stock is trading at 41 times earnings. But a look under the hood shows a number of reasons why the stock easily meets its premium valuation.

Here are some of the top reasons why investors may want to consider adding shares of the e-commerce and cloud computing giant to their portfolio if they don’t already own them.

Gushing with cash

Sure, Amazon’s $1.8 trillion market cap may seem overwhelming to some investors who look at the stock. However, the company’s underlying cash flow helps justify that valuation. For example, the company’s cash flow from operations over the past 12 months was an astonishing $108 billion. This massive cash flow stream allows for massive reinvestment in the company’s business while also generating significant free cash flow. Total free cash flow over the past 12 months, net of finance lease capital payments and financial liabilities, was $53 billion.

Amazon’s price-to-adjusted free cash flow ratio of 34 is much easier to accept than its price-to-earnings ratio of 41.

Lucrative Cloud Computing Business

Still, even a price-to-adjusted free cash flow multiple of 34 may seem a bit high for a company that only grew its total revenue by 10% year over year in the latest quarter. However, a review of Amazon stock is incomplete without understanding how important its cloud computing business, Amazon Web Services (AWS), is to the company. With 16% of sales over the past 12 months, some investors might make the mistake of thinking that this segment is of little importance to Amazon’s overall business. But that couldn’t be further from the truth.

First, investors should note that AWS is growing faster than Amazon’s overall business. That means it will grow as a percentage of revenue over time. Consider that AWS revenue grew nearly 19% year over year in the second quarter.

Second, AWS is much more profitable than the rest of Amazon’s business. For example, AWS’s operating income in Q2 was $9.3 billion. That gives the segment an operating margin of more than 35%. What’s more, this segment accounted for about 63% of total operating income. That means that as AWS grows, it will have a huge impact on Amazon’s profitability.

Amazon CEO Andy Jassy emphasized the importance of AWS on the company’s latest earnings call, noting that none of the company’s advances in cloud computing are particularly noteworthy. “AWS continues to be the first choice for customers,” Jassy said on the company’s second-quarter earnings call.

Of course, it’s no surprise that AWS remains the top choice for customers. The company’s market leadership in cloud computing gives it scale and cost advantages, helping it reinvest aggressively and innovate quickly.

Amazon’s scale in cloud computing is hard to overstate. Synergy Research Group estimates that AWS controls nearly a third of the global cloud infrastructure market share, with MicrosoftAzure came in second place, losing about six percentage points.

As investors realize the importance of AWS as an engine of Amazon’s growth, fundamentals will begin to justify the stock’s current valuation.

Wide moat

The final key factor that’s helping Amazon stock in a big way is the company’s competitive advantage: scale. As the world’s largest e-commerce retailer and cloud infrastructure provider, the company’s overall scale is a competitive advantage in itself.

In other words, the company is able to spread its fixed costs across a larger number of customers than its competitors, which allows it to spin its flywheel faster, so it can invest more aggressively than its competitors and further expand its economic advantage.

Given Amazon’s significant cash flow, its rapidly growing and profitable cloud computing business, and its competitive advantage in scale, the stock seems like a good buy today. Of course, there’s always the chance that the company’s advantages in retail and cloud computing will erode over time, and Amazon’s future isn’t as bright as expected. But that risk seems small given the company’s long history of rapid growth, increasing profitability, and maintaining a market share lead.

John Mackey, former CEO of Whole Foods Market, an Amazon subsidiary, is a member of The Motley Fool’s board of directors. Daniel Sparks and his clients have no positions in any stocks mentioned. The Motley Fool has a position in and recommends Amazon. The Motley Fool has a disclosure policy.