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Here’s why I believe Amazon stock is undervalued

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Historically, the S&P 500 index has averaged a P/E ratio of a little under 16. Today, that metric is approaching 30, nearly double the mean and suggests an overvalued market at risk of a correction. Meanwhile, Amazon (NASDAQ:AMZN) has a P/E of over 68. So how can I consider Amazon stock undervalued? Because it has quietly become an advertising juggernaut and is rapidly increasing market share.

Amazon stock: an Ad Tech play?

Programmatic advertising started as a way of buying up leftover online ad inventory. Now it’s evolved into a data-driven solution, enabling advertisers to serve ads to the right people at the right time. Those with the most relevant and scalable data dominate the industry: notably, Google and Meta with their gigantic userbases and intimate knowledge of our online and offline behaviours. Likewise, Amazon has a wealth of data to offer savvy advertisers.

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While Q3 results largely underwhelmed, Amazon’s ad sales revenue impressed. Almost inconspicuously, Amazon reported that ad sales totalled $8.1bn, up 49% year-over-year. Comparably, programmatic advertising giant The Trade Desk reported revenue of 301m for the same period.

Quarter Net Sales Y/Y growth, excluding F/X
Q2 2020 $4,221 41%
Q3 2020 $5,398 49%
Q4 2020 $7,952 64%
Q1 2021 $6,905 73%
Q2 2021 $7,914 83%
Q3 2021 $8,091 49%

Amazon’s ad revenue was virtually zero a few years ago. Primarily an e-commerce and cloud-computing company, ad sales are listed as the primary component within the “other” segment. Soon I believe advertising will become a prominent portion of the overall business. And as this happens, it could transform Amazon’s earnings potential — principally because advertising is usually a far more profitable business than e-commerce.

Amazon’s advertising solutions

Amazon has a growing suite of advertising solutions. First is Amazon’s search engine optimisation, which its e-commerce customers will be familiar with — specifically, the sponsored brands and products that appear in shopping results. This powerful tool allows advertisers to display their brands or products at the moment a person considers a purchase.

Secondly, audio ads play on the free tier of Amazon Music. There’s potential to expand this to popular Amazon products such as Echo, Fire TV and even Audible audiobooks.

Thirdly, and perhaps most exciting, is Connected TV (CTV). Streaming ads are exciting advertisers and investors alike. Unsurprisingly, Amazon is making aggressive moves to grab a large slice in a rapidly growing CTV pie. While Amazon Prime Video is currently ad-free, IMDB TV and Twitch both support ads and boast over 120m monthly users. Amazon has also released Alexa-integrated smart TVs to expand on its 50m monthly Fire TV users. I’ll be watching Amazon’s CTV growth closely in the coming years.

Finally, the Amazon DSP enables advertisers to programmatically buy display, video and audio ads outside Amazon’s walled garden. Additionally, through Amazon attribution, advertisers can measure Amazon sales results of non-Amazon advertising.

Tailwinds to consider

Ad tech is a competitive industry, and Google and Meta will not sit back and allow Amazon to eat up market share. Additionally, the industry continues to evolve with an emphasis on privacy and transparency. Stricter privacy laws such as GDPR in Europe could limit the scope of which Amazon’s rich consumer data can be utilised. Thus, slowing growth. However, I believe Amazon can thrive in the long term and even catch up with Google and Meta in the not-too-distant future. For this reason, I will be buying more Amazon stock, adding to my existing position.

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John Mackey, CEO of Whole Foods Market, an Amazon subsidiary, is a member of The Motley Fool’s board of directors. Randi Zuckerberg, a former director of market development and spokeswoman for Facebook and sister to Meta Platforms CEO Mark Zuckerberg, is a member of The Motley Fool's board of directors. Suzanne Frey, an executive at Alphabet, is a member of The Motley Fool’s board of directors. Nathan Marks owns shares of Amazon and The Trade Desk. The Motley Fool UK has recommended Alphabet (A shares), Amazon, and The Trade Desk. 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.

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