AWS Growth Masks AI Capex Strain, Valuation Remains Rich Amid Uncertainty

What happened

Amazon's AWS segment re-accelerated to 20.2% YoY growth in Q3, with a $200 billion backlog and EBIT margins above 30%, bolstering its position as a vertically integrated AI infrastructure supplier. However, this comes alongside a massive AI capital expenditure surge, estimated at $125 billion, which has driven company-defined free cash flow down to $14.8 billion TTM, highlighting significant reinvestment risks. Despite strong earnings beats and robust operating cash flow, the stock trades at ~32x earnings, far exceeding a conservative DCF estimate of ~$54, reflecting optimistic market assumptions on AI and cloud returns. Regulatory scrutiny and competitive pressures in retail and cloud add layers of risk, with execution hinging on large, long-dated investments in AWS, AI, and Kuiper. While AWS's performance underscores long-term earnings potential, the valuation premium and capex overhang demand caution until clearer capital efficiency emerges.

Implication

AWS's re-acceleration and vertical integration in AI signal durable competitive advantages, yet plummeting free cash flow due to soaring capex raises red flags about capital allocation and future returns. Current pricing at 32x P/E leaves minimal margin for error, necessitating sustained high growth and margin expansion to justify the premium. Regulatory and competitive headwinds could compress profitability, making the investment case fragile if capex fails to yield expected ROI. Monitoring FCF recovery and AWS monetization of AI workloads is critical, as evidence of improved capital efficiency could eventually support a more bullish stance. Until then, the rich valuation and execution risks advise patience, with potential entry points likely emerging only if growth materially outpaces capex spend.

Thesis delta

The new article underscores AWS's strong performance and AI integration, but it does not shift the core 'WAIT' thesis from the DeepValue report. Valuation remains stretched relative to DCF, and capex-driven FCF decline persists as a key overhang. However, sustained AWS growth at current rates could gradually strengthen the case for a potential upgrade, contingent on visible FCF rebound and clear ROI from AI investments.