The Amazon (NASDAQ: AMZN) share price has been one of the best-performing stocks throughout the pandemic. Since the end of 2019, shares in the company have returned more than 75%.
However, over the past 12 months, the stock has come off the boil. The Amazon share price has increased by just 7% since the beginning of August 2020.
This performance doesn’t reflect the company’s underlying fundamentals. In the second quarter of 2021, Amazon reported a 48% year-on-year increase in net income.
The gap between this underlying income growth and the performance of the shares has ignited my interest in the stock. I think there could be an opportunity here, as the firm may be undervalued compared to its potential.
Amazon share price value
Wall Street analysts seem to believe shares in the retail giant may be worth more. Of the 46 analysts covering the company, 35 rate it as a ‘buy’. Analysts’ average price target is $4,170, which is just over 25% above current levels.
These are just estimates and should not be relied upon when investing. They are only designed to provide a guide as to how much the company could ultimately be worth. Nevertheless, I think these numbers imply there’s an opportunity here. My own research supports this conclusion.
The retail-to-digital advertising conglomerate is currently selling at a price-to-sales (P/S) ratio of 3.8. This is expensive compared to the rest of the retail industry, but not compared to the technology industry.
As most of Amazon’s earnings now come from its cloud computing and digital advertising business, I don’t think it’s unreasonable to compare the company’s valuation to the technology sector rather than the retail sector.
When compared to a company like Microsoft, Amazon appears cheap. The former is selling at a P/S ratio of 12.8.
The Amazon share price doesn’t deserve the same valuation as Microsoft as they are two different businesses. However, I think something between the two isn’t too far out there. I think Amazon deserves a tech sector valuation, which may justify a P/S ratio of six, or more.
These figures imply the Amazon share price still looks cheap, although they only provide a rough guide.
Risks and challenges
One of the reasons why some might be put off from investing in the technology giant is its retail business. This division barely makes money.
Only a slight increase in costs could eliminate its razor-thin profit margins. This is probably the most considerable risk to the company’s growth. A slowdown at its core retail business could slow growth across the enterprise. In this situation, the Amazon share price would almost certainly be worth less.
Despite this risk, I’d be happy to buy Amazon shares for my portfolio today. Considering the group’s growth over the past 12 months, I think it looks undervalued compared to its potential.
John Mackey, CEO of Whole Foods Market, an Amazon subsidiary, is a member of The Motley Fool’s board of directors. Teresa Kersten, an employee of LinkedIn, a Microsoft subsidiary, is a member of The Motley Fool’s board of directors. Rupert Hargreaves has no position in any of the shares mentioned. The Motley Fool UK owns shares of and has recommended Amazon and Microsoft. The Motley Fool UK has recommended the following options: long January 2022 $1,920 calls on Amazon and short January 2022 $1,940 calls on Amazon. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.