Amazon's stock has experienced remarkable growth over the past three years, nearly doubling its market capitalization. This impressive trajectory raises questions about its future performance. The company's continued success largely depends on two critical factors: the sustained strong growth of its cloud computing division, Amazon Web Services (AWS), and the effective realization of returns from its substantial investments in artificial intelligence (AI). Examining these facets of Amazon's operations offers insights into its potential stock performance in the coming years.
Amazon Web Services (AWS), often overshadowed by the company's retail segment, stands as its most lucrative division, demonstrating an accelerating growth rate. In the first quarter, AWS reported a 28% year-over-year revenue increase, reaching $37.6 billion, marking its fastest growth in over three years and achieving an annual run rate of approximately $150 billion. This segment's financial efficiency is particularly noteworthy; despite contributing only about 21% of Amazon's total revenue during the quarter, it generated nearly 60% of the company's operating income. Amazon CEO Andy Jassy highlighted the rarity of such rapid growth on such a vast scale, underscoring AWS's significant impact.
A substantial portion of this accelerated growth within AWS is attributable to artificial intelligence. Amazon has indicated that AI-related revenue within AWS is now operating at an annual rate exceeding $15 billion. Furthermore, the company's order backlog for AWS stood at an impressive $364 billion at the close of the quarter. A significant development post-quarter was a commitment exceeding $100 billion from Anthropic, an AI developer heavily backed by Amazon, signaling further expansion in the AI sector. Beyond AWS, Amazon's advertising revenue also contributed robustly, increasing by 24% to $17.2 billion in the quarter, becoming a high-margin operation that has surpassed $70 billion over the past year. The retail division also showed improved profitability, with North America's operating income rising to $8.3 billion from $5.8 billion a year prior, elevating Amazon's overall operating margin to a record 13.1%.
While this growth is promising, it comes with considerable costs. Amazon anticipates capital expenditures of around $200 billion across its operations in the coming year, with a significant portion allocated to AI data centers and chips. This extensive spending has put a strain on Amazon's financial liquidity. Although operating cash flow increased by 30% to $148.5 billion over the past year, trailing-12-month free cash flow declined sharply from $25.9 billion to approximately $1.2 billion, largely due to a $59 billion surge in property and equipment purchases. Recent agreements, such as a multibillion-dollar deal with Corning for fiber optic supplies for U.S. data centers and an expected $17.5 billion delayed-draw term loan facility, confirm that the substantial investment in infrastructure continues to escalate.
The inherent risk lies in these elevated spending levels persisting longer than projected, potentially delaying the anticipated improvements in margins and cash flow. The competitive landscape further intensifies this pressure, as other cloud providers are also heavily investing in capital expenditures to capitalize on the AI boom. Additionally, Amazon's current stock valuation, with a price-to-earnings ratio of 29 (or mid-30s when adjusting for the Anthropic investment gain), suggests that exceptional results are already factored into its price for the next decade, leaving little margin for error. Consequently, while Amazon's AI investments are expected to yield positive outcomes, conservative growth projections for the stock over the next three years appear reasonable given the uncertainties surrounding this unprecedented investment cycle. An annual return in the high-single-digit to low-double-digit range seems plausible, translating to a potential stock price of $318 to $336. Despite the impressive performance of Amazon's stock in recent years, the company's considerable capital expenditures and elevated valuation imply that future returns may be more modest. Given these factors, investors might consider Amazon stock a higher-risk asset and adjust their position sizes accordingly.
