AMZN is overvalued at current levels due to inflated earnings from one-off items (adjusted P/E 38x vs reported 21x); wait for a pullback to buy.

Hi, I'm Jimmy. In this video, we're looking at Amazon, ticker symbol AMZN. Now, when I was doing the research for this video, I actually came across an interesting fact. So, first, on the Investors Grow website, you can see here that when we look at the star system, these stars are pretty good.

Three stars is the best, and right now it looks fairly good.

But, I just want to point out one point, kind of give you a spoiler of where we're going with this. You can see in here that it's showing the P/E ratio is 21x, and that is accurate.

But, we're going to get to a point where I want to show how much of a trap that actually is.

But, for now, let's just jump in and look at the basics of Amazon's business, and then we will try to come up with a fair value for Amazon stock. So, this is a pie chart of the different segments that Amazon reports in.

So, when most people hear the name Amazon, generally we're thinking of online shopping. But, this chart shows us that Amazon is really a bunch of different businesses laid on top of each other.

Now, before we go ahead and break this down further, this is actually not their official reporting segments. Officially, they're technically in their annual report, they break it out into a North America, International, and AWS.

This chart, instead, is breaking down their revenue. They're about $717 billion in revenue by the type of product or service that they that generated that revenue.

So, the first major group is commerce, basically the retail part of their business. Online stores represents about 38% of revenue, and this is primarily the merchandise that Amazon owns and sells directly.

In this example, Amazon will record the full purchase price of whatever product they're selling as revenue.

Physical stores contributed about 3% of total revenue, and this actually also includes if you were to order something online, and then go pick it up at, you know, Whole Foods or something, well, that counts as an online sale.

Then, we have third-party sellers, that represents about 24% of revenue, and these are when independent merchants, independent stores, use Amazon's marketplace. Now, Amazon does not record these sellers' entire product price in their own revenue.

Instead, Amazon records commissions, fulfillment and shipping fees, and then any any other service fees that they might that they might have.

So, what's actually happening is there's a distinction between the total value of products sold on Amazon and their revenue. There's actually they have a ton of revenue, $717 billion in revenue in 2025, but that is kind of their cut of that whole thing.

If it's a third-party seller, they don't count the entire selling price.

Okay, so that was primarily their commerce, their retail part of the business. The next level of their business is it involves monetizing the customers and sellers that they already have on the Amazon platform.

So, for example, advertising contribute about 10% of revenue. This includes like sponsored listings, display advertising, and video advertising, things like that.

Then they have subscription services, that's 7% of total revenue. This is usually from like Prime memberships, and also if you have like audiobooks and music, things like that.

Anything non-AWS related. Then AWS contributed about 18% of revenue. This is Amazon's cloud computing business, a lot like Microsoft's Azure business. This is Amazon's version version of it.

And they provide uh computing power, storage, databases, analytics, AI, machine learning, and a whole bunch of other technological services that they sell to businesses, developers, governments, institutions, a whole bunch of they have a ton of customers.

This is their fastest growing business by far. We'll come back to this one in a minute. The big takeaway here is that nearly 2/3 of Amazon's revenue is still directly tied to commerce. It's directly tied to selling products.

But this chart is a broad revenue breakdown, not a profit chart. AWS produced about 18% of Amazon's 2025 sales, yet it generated about 57% of its operating income. It is by far the most profitable part of their business.

So, with that being said, let's jump in and look at some of their numbers. First up, this is a chart of revenue. And as we can see, revenue has grown impressively consistent for a long period of time.

Again, I want to point out how big their revenue is. They are They are bringing in an obscene amount of money.

Okay, but now let's jump in and look at their operating income. So, operating income is basically the amount of money that they bring in after the cost of revenue and, you know, marketing, sales, things like that.

And the interesting part here is we see the past 3 years, it is really ramped up. The primary reason for that is AWS. AWS over the past few years has significantly improved their contribution to operating income.

So, operating income has ramped up a ton as long as AWS does. Basically, it improves their profit margins. So, this is a big deal.

But this is where it gets interesting or tricky. Now, let's jump over and look at actual profit. So, we're going to look at net income. And we can see now that net income has seen some crazy growth over the past 2 years in particular, but over the past year specifically.

Now, the interesting part here is in the past the trailing 12 month, that's what TTM stands for. The trailing 12 month number for their profit is about $135 billion. But But you may have you may remember that the operating income number was about 93 billion.

In fact, let's overlay those two on top of each other so we can see them side by side. And here we can see that net income is bigger than operating income.

Now, by the way, on an income statement, after operating income, you would have things like interest expense. So, if you pay interest on your debt, that cost would come out. If you have cash and you collect interest, that income would come in.

If you pay taxes, they paid about $20 billion in taxes. Uh maybe $35 billion actually trailing 12 month. $20 billion was in 2025. Trailing 12 month, $35 billion in taxes. So, net income is generally less than operating income.

And this is crucially important to where we're going in the future. Just remember what happened here because we're going to make some adjustments to their numbers to look at a clearer picture of how it actually works for them.

But before we do that, let's jump over and look at cash and debt. So, here we could see bars for both cash and debt. Debt is in the orange bars. Now, we will see a significant jump in debt.

They all They have plenty of cash. So, at first glance, I'm not too worried about it. But this is mildly concerning if we think about it because you would think a company that has this much cash wouldn't necessarily have to take on that much debt.

But with all of their artificial intelligence building out, like the build up that all these big companies are doing, they're they're taking on some debt. And the problem with that is there is a cost to that debt.

So, I just wanted to bring it out. The number is big, but they have a lot of They have a lot of cash. Netting those two off, you're not going to be in a bad position, not for a company of Amazon size.

But it is interesting to keep in the back of our mind. If they keep increasing debt at the pace that they did going into the latest number, well, that is likely not going to be a good thing.

Okay. Now, we'll look at operating cash flow. Again, operating cash flow has ramped up fairly well, especially in the past few years as AWS has done better and better, they do they generate a lot of cash, a lot of consistent cash, which is a good thing.

But, when we jump in and look at their capital expenditures, capital expenditures have ramped up even more. So, when these companies announce that they're going to build a new data center and they're going to drop, you know, 50 billion dollars in a new data center, this is where that number would show up.

This increases an increase in expenses. This directly brings us to free cash flow. So, you take operating income you take operating cash flow, subtract capital expenditures, and that's a rough and easy way to get to free cash flow.

And because of that ramp up in capital expenditures, over the past couple years we have seen a negative drop in free cash flow.

Now, analysts will come we'll come back to analysts in a second for what they're going to do for free cash flow. But for now, let's jump in and look at some fair value metrics.

I'm going to start with price to earnings because this is the one that caught my attention as I was reading through their financial statements. So, let's jump over to a chart of the PE ratio.

By the way, all these charts and everything's available on investorsgrow.com if you want to sign up to get access to that. This is a chart for the past 10 years of Amazon's price to earnings multiple.

And you can see right now, it's on the low end. Which is good, but if we click on the button up here that gives us it adds the earnings per share bars to this chart, the problem is a few years ago they weren't that profitable or let's say profitability was a bit less consistent.

Over the past couple years it's gotten more consistent. So, if we were kind of block those off and say, okay, it is still on the low end. Right now you can see it's at about 21 X.

But is is that a good price, right? 21 X doesn't sound bad. The average for the S&P 500 over a long period of time, right now the S&P 500 is at like 28x. This is 21, so that's good.

The average is about 20x on the S&P 500. Again, 21x, not too bad, especially for a company of their size and their growth and, you know, improving profit margins. So, that's a good thing.

But, here's where it gets tricky. So, we saw the difference between the operating income and the net income. One of the reasons, the primary reason that that happened is these guys own a piece of Anthropic.

Well, if you own a if you if a company were to own stock, right? This happened with Berkshire Hathaway Berkshire Hathaway all the time. They own companies, well, they have to mark them to market, which basically means if the value of the underlying company goes up, you rewrite the value on your if, you know, if it's worth 10 billion and it now, after reanalyzing the numbers, you realize, hey, it's worth 20 billion.

You take that 10 billion and you put it as a one-off item on your income statement. You get credit for the 10 billion-dollar gain.

If after that, they over the past year, they increased the fair value of Anthropic by about 50-something billion dollars. If we removed that fair value increase, which by the way, it's not like Amazon's actually getting that money or actually getting that cash, not as of now.

So, that it's it's a paper adjustment. Well, if we were to have removed those adjustments and we were to adjust the numbers and remove the one-off items, well, these blue bars are now what the actual earnings per share over the past two quarters would look like.

And we need to remember how price to earnings is calculated. So, you take the price of the stock and you divide it by earnings per share. So, if the earnings per share is, if you look at the, you know, the pink bar all the way in the back like in the background, the one that's really tall, if you look at that, well, it's kind of artificially inflated.

Well, because of that, what one feature that we just are adding to the Investors Growth website, we just recently added it, was to also display adjusted P/E ratio. So, if we remove those one-off items, well, now the adjusted P/E ratio is now displayed up here.

Instead of the company trading at 21x, the adjusted P/E ratio, which again removes the one-off items, is trading at 38x.

38x is drastically different. I mean, that's nearly double. I mean, it's not really, but you know what I mean, it's very close to double what the current P/E ratio what is. We just said a second ago the S&P 500 is currently trading at trading at 28x.

Long-term average is 20x. 21x doesn't look that bad. Looks like maybe this is an interesting company. Well, at 38x, it doesn't even look beginning to be close to good.

So, I just wanted to This is one of the reasons that we wanted to add this feature to the website, so people, you know, we could get if there is a one-off item and you haven't still on the research, I had to go through and read why this happened, but now if you just notice the difference, you know, okay, it was one-off items.

That being said, another way to value a company like Amazon is to use discounted free cash flow. So, this is a chart of their free cash flow, and the green bars on the right are analyst estimates for free cash flow.

We can see that they have the numbers going more negative and then ramping up over the over the next couple of years. And that is largely a play on that AI, artificial intelligence, is going to start paying off.

Now, I think it would be a little bit irresponsible to ramp up that fast and then just drop down to our perpetual growth rate. So, I actually extended this chart out of five additional years.

So, now we're going out a total of 10 years and we're just gradually decreasing the growth rate between what analysts give us and then to our 2 and 1/2% perpetual growth rate. With that, we end up with a fair value of about $184 per share.

Now, this is a company that is on my bullpen and the company I will continue to watch. I think Amazon would be a very interesting company to own if we can buy it at the right price.

If you already own it, hopefully you bought it at a good price. But for me, this one's a bit overvalued right now. I'd like to see a bit of a pullback in this one before I would consider jumping in and buy it.