Legg Mason Laurels Amazon.com

An analyst upgrades the stock, saying margins could improve.
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(AMZN) - Get Report

shares were charging higher in Tuesday trading on a bullish research report from one of its longtime fans, Legg Mason.

Legg Mason analyst Scott Devitt upgraded his rating on Amazon to buy from hold and put a $42 price target on the stock. Legg Mason owns 15.3% of Amazon, a share that has increased from 13.3% in the past year, according to Amazon's



Amazon's stock was trading up $1.22, or 3.7%, at $34.13 in midday trading. After hitting a five-month peak of $36.99 in early June, the stock had been steadily slumping, largely on concerns that its operating margins would continue to deteriorate this quarter.

Amazon's margins have been a sore spot with Wall Street. Several research desks have downgraded Amazon this year, including those at Caris & Co., CS First Boston and Janco Partners, following a couple of disappointing earnings reports that showed the company's efforts to build customer loyalty with free shipping and to spend on innovation were eating away at its profits.

But Devitt says it's quite possible the margin trend may reverse in the coming year. "Cash operating margins have declined for the past three quarters; however, we believe operating leverage should return to the business within the next six to nine months," he wrote. "We may be early with our recommendation; however, at current levels, we would advise long-term-oriented investors to acquire shares opportunistically."

Devitt also took issue with the argument often heard among Amazon bears that the company is just another retailer. "We would point toward its fulfillment process, negative cash conversion cycle, inexpensive shelf space and the associated long tail, as well as nascent opportunities priced into market valuations of competitors today in which Amazon will compete in the future."

"Amazon has the capacity to innovate just like others in the sector, however, given its core business of selling media products to consumers, it can take a while to move the needle," the report read. "We find comfort in its active customer base of almost 50 million."

Bill Miller, manager of Legg Mason's Value Trust and one of the most respected fund managers on Wall Street, has long been a true believer in Amazon, buying a stake in the company earlier this decade, when others were predicting its doom, or at least an extended stay in the purgatory of financial losses. Amazon turned profitable in 2003.