Billionaire investor Warren Buffett is not typically known for buying stocks that are going parabolic. He tends to favor steady performers with long growth paths. Buffett even cautions people to be fearful if greed is the force taking stocks on a parabolic ride. This does not mean that the stocks Buffett owns (or is interested in) are incapable of such rapid growth. Just that he doesn’t necessarily search them out to buy.
Still, there are a few stocks in the Berkshire Hathaway portfolio that hold such potential. One of the more likely candidates is Amazon (AMZN -2.33%).
Some may question whether a stock with a $2 trillion market cap could make such a move. But, if investors take a closer look at some of the less-discussed emerging business lines, they can more easily see why a big surprise to the upside is not a far-fetched outcome.
Amazon’s growth drivers
Amazon’s cloud-computing arm Amazon Web Services (AWS) drives most of its operating income right now and continues to grow well (although that growth is showing small signs of slowing). And most investors (and consumers) know Amazon best as the dominant e-commerce player in the U.S. and numerous other countries. While peers such as Walmart and Costco Wholesale do manage to provide it with some competition, its power in the retailing space is obvious. But its sheer size means it has become a slower grower.
The stock’s potential for parabolic growth these days is tied more to emerging segments of its business that are somewhat overlooked right now. One of those is its digital advertising business. Digital ads are highly profitable as social media giant Meta Platforms has proven over the past decade. In the first quarter of 2024, Meta delivered gross margins of 82% thanks to its digital advertising segment.
Amazon does not publish gross margin data for digital ads. However, its nearly $12 billion in revenue in Q1 was up 24% year over year, growing faster than any of its other revenue-generating segments. Amazon is just getting started in its efforts to expand its advertising segment and continued growth rates at this level could spark a rally in Amazon stock. All it will take is Amazon reporting additional details on the growth in this segment to let investors know its potential.
Another potential growth area could come from Amazon’s $4 billion investment in artificial intelligence (AI) company Anthropic. Anthropic is an AI research and safety company. It works with AWS’s proprietary AI chips to provide the foundation model to train Amazon’s generative AI models. Leadership in the AI field has sparked massive gains for Nvidia, and with AWS’s market lead in the cloud, Amazon could likewise draw similar interest from AI-focused investors in its stock.
Amazon’s financials
While it works to take full advantage of its future growth drivers, Amazon is doing a good job of getting the most from its current drivers — something that Buffett considers critical. In the first quarter, Amazon reported over $143 billion in net sales, a 13% year-over-year increase.
AWS accounted for $25 billion of Amazon’s sales (roughly 17% of the total). AWS also accounted for more than $9 billion of the company’s $15 billion in operating income. Amazon’s cloud efforts — and, by extension, its AI efforts — accounted for the majority of Amazon’s profits in Q1. AWS managing a 31% operating margin goes some way to explaining how it drives most of the company’s profits.
In contrast, the operating margins for its retail-related North America and international segments were 5.2% and negative 0.4%, respectively. It’s a low-margin segment of the business and always has been. But because Amazon’s e-commerce site is one of the most widely visited sites on the internet, it is providing a base for the digital advertising segment to boost both divisions. Given the rapid growth and possibility of high margins, digital ads likely helped these segments turn an operational profit and could further expand their operating margins in the future. Digital advertising’s successes may also help explain why Q1 net income rose by 229% year over year to $10 billion.
Since a relatively small part of the company on a revenue basis drives most of its growth on an earnings basis, profits can grow at higher percentage rates. That’s not often the situation for a mega-cap company. Although analysts expect annual profit growth to come in at 59% for the year, such increases are likely a positive for the stock.
Counterintuitively, another incentive for stock price growth is Amazon’s P/E ratio of 52. This earnings multiple may sound high when compared to most stocks in the S&P 500, but Amazon has historically traded at much higher P/E ratios (its average over the past year is 67), a factor that could spark another round of stock buying.
Amazon’s prospects for parabolic growth
Although Buffett has not often chosen parabolic stocks in his decades-long investment history, his stake in Amazon holds the potential to make a rapid move higher. Rapid growth and a high likelihood of expanding gross margins are lifting Amazon’s retail segments. Also, the highly profitable AWS segment could see an additional boost with the Anthropic partnership.
Ultimately, investors should remember that Amazon stock has a history of rising to high valuations as the company’s popularity increases. With its relatively low P/E ratio of 52, its conceivable a new round of multiple expansion could take the stock much higher again.
