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Why Amazon (AMZN) Gets an "A" for Growth

Investing in stocks is a tricky business because there are so many factors to consider: the economy, the nature and dynamics of the market in which the company operates, and various internal factors like recent growth history and drivers, prospects for future growth, management execution and so on.

Then there’s the question of the inter-relatedness of stocks and the ideal time to get in or out of them in order to maximize gains.

Making sense of all this is difficult, time-consuming and risky, so it’s enough to turn away a lot of people.

But wouldn’t it be great if we didn’t have to do all the heavy-lifting ourselves? If there was some sort of model with a high degree of historical success that we could simply rely on?

At Zacks, we do have such a model in the form of the Zacks Rank, which places the companies in our universe in the Strong Buy (#1), Buy (#2), Hold (#3), Sell (#4) and Strong Sell (#5) categories. So companies with a Strong Buy (#1) rating have a very high chance of outperforming the market in the following 1-3 months. Indeed, Zacks Rank #1 stocks have yielded an average annual return of 26% since 1988, nearly triple the S&P 500.

Explaining the Zacks Style Score System

But the Zacks Rank is not all there is to it. While the rank is the primary and the most helpful tool in picking stocks, we also have another effective tool called “Style Score” that basically matches the rank to the risk appetite of the investor. Here, we have four categories in Value, Growth, Momentum and VGM (a combination of the other three) with possible scores of A, B or C describing the degree to which the concerned stock matches the category.

Understanding the Value Score

Suppose eBay EBAY has a Value Score B, it indicates that it moderately satisfies the value category and therefore, investors with a relatively low risk appetite may want to take a look at it.  

A value investor essentially looks for stocks that are trading below fair value. But all undervalued stocks may not be good investments because there may be any number of reasons for the valuation. Moreover, they could be undervalued based on one metric, but not on another. So the Value Style Score is the result of applying multiple value criteria to a stock to come up with a score that indicates whether it is truly undervalued.    

Understanding the Momentum Score

If value investing involves the lowest risk, momentum investing is at the other end, involving the greatest risk. Here the momentum trader takes a call that stocks moving in a particular direction will continue moving that way. He therefore makes the most of this trend to generate profits.

While not always the case, our analysis shows that there is a strong momentum effect in buy-rated stocks as estimates move up in response to earnings results.

So suppose Adobe has a Momentum Score A, it indicates that it is the right time to enter the stock and ride the wave with the highest probability of success.

Understanding the Growth Score

Growth stocks are a little harder to pick. That’s because they are invariably companies in attractive or nascent markets where expansion is possible. While it’s important to recognize the potential, it’s equally important to see if the company has the wherewithal to exploit the opportunity. So execution and resource management are important factors for consideration.

The Growth Style Score therefore includes both the growth prospects and corporate financial statements, namely, the income statement, statement of cash flows and balance sheet.

Amazon Has a Growth Score “A”

Amazon AMZN plays in two big markets and is the pioneering force in both.

On the one hand, it is the world’s biggest ecommerce company. The market may be getting crowded now, but Amazon is perhaps the best positioned to expand internationally, because of the knowhow it has accumulated in distribution and logistics and its strong cash position.

Amazon has an extremely effective loyalty program in Prime. It rewards Prime subscribers with free shipping, discounts, offers, video and more. In fact it isn’t easy for consumers to get a better deal on another platform. And since Prime membership isn’t free, it makes sense for consumers to use it more frequently.

The other growth area is Amazon Web Services (AWS) which offers cloud infrastructure as a service. Amazon has first-mover advantage here as well so its business is growing strongly. Microsoft MSFT is in hot in pursuit as is IBM and Alphabet GOOGL. But since the market is very large and growing, there should be enough growth opportunity for all these companies. Amazon started breaking out its AWS business last year and both revenue and margins appear impressive.

As far as the financials are concerned, revenue growth dropped off sharply in 2012, but has continued at steady double-digit rates thereafter. The operating margin seesawed during this time as Amazon built out fulfillment centers particularly in high-growth international markets. It started recovering last year on account of AWS’s stronger margins. Balance sheet cash has tripled over the last five years.

But Hold Your Horses

As mentioned above, the Zacks Rank is the best indicator of the investment potential of a stock and Amazon’s Zacks Rank is currently #3. The reason for caution is Amazon’s current expansion plans including its AWS buildout, which will require increased investments in the next few quarters. So while the longer-term prospects are strong, the shares could be range-bound in the near term.

You can instead go for STMP, Travelport TVPT and Groupon GRPN, all of which combine a buy rating with a growth score of “A.” 

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Want the latest recommendations from Zacks Investment Research? Today, you can download 7 Best Stocks for the Next 30 Days. Click to get this free report
AMAZON.COM INC (AMZN): Free Stock Analysis Report
EBAY INC (EBAY): Free Stock Analysis Report
STAMPS.COM INC (STMP): Free Stock Analysis Report
MICROSOFT CORP (MSFT): Free Stock Analysis Report
GROUPON INC (GRPN): Free Stock Analysis Report
ALPHABET INC-A (GOOGL): Free Stock Analysis Report
TRAVELPORT WWD (TVPT): Free Stock Analysis Report
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