Amazon.com (NASDAQ: AMZN) disappointed Wall Street when it reported its third-quarter results in late October. Both its bottom line for its third quarter and its guidance for fourth-quarter revenue missed analysts’ average forecast.
But even though the quarter may have disappointed, Amazon is still a Wall Street darling, with a price-to-earnings multiple of 80. Furthermore, Amazon’s underlying business easily lives up to this valuation. Here’s a look at some areas of Amazon’s business, highlighted by management during the company’s most recent earnings call, that investors should be excited about.
AWS’ prospects remain compelling
Amazon’s cloud computing business, Amazon Web Services (AWS), is a critical part of Amazon’s business. To put its importance in perspective, Amazon’s trailing-nine-month AWS operating income was $6.6 billion, compared to consolidated operating income of $8.3 billion for that period.
But some investors may have been concerned by the company’s significant year-over-year contraction in AWS’ third-quarter operating margin, which was 25.1%, down from 31% in the third quarter of 2018.
Management, however, noted that the year-ago operating margin for AWS was achieved on the heels of heavy investments in the business in 2017 — and now management is similarly ramping up investment in the segment yet again, hoping it will pay off in future quarters.
Amazon CFO Brian Olsavsky explained:
We continue to feel really good about not only the top line, but also the bottom line in that business, but we are investing a lot more this year in sales force and marketing personnel, mainly to handle a wider group of customers, a increasingly wide group of products. We continue to add thousands of new products and features a year, and we continue to expand geographically.
AWS’ operating margin in Q3 was primarily negatively impacted by higher sales and marketing costs. Having a smaller negative impact on the segment’s profitability during the period were investments in infrastructure. While management indicated it plans to continue investing aggressively in Q4, expense growth for AWS will likely slow in future quarters; and the company’s’ investments today in the segment will likely support more strong top-line growth for AWS in the year ahead. This lull in operating margin for AWS, therefore, may only be temporary.
Amazon’s advertising business accelerated
Buried in Amazon’s financial statements is an easily overlooked segment called “other.” While it only accounts for 5% of Amazon’s total revenue, it’s a segment worth paying attention to. The segment is primarily made up of advertising revenue, which is seeing accelerating momentum.
“[O]ther revenue, which is principally advertising, grew 45% this quarter, up from 37% last quarter,” noted Olsavsky. “And the biggest thing in there is advertising — and advertising grew at a rate higher than that 45%. So we are very happy with the progress in the advertising business.”
Of course, AWS and, to a lesser extent, Amazon’s advertising business are the sort of strong catalysts investors should expect from a megacap growth stock trading at 80 times earnings. In 2020, investors should look for these key growth drivers to continue on their impressive trajectories.
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John Mackey, CEO of Whole Foods Market, an Amazon subsidiary, is a member of The Motley Fool’s board of directors. Daniel Sparks has no position in any of the stocks mentioned. The Motley Fool owns shares of and recommends Amazon. The Motley Fool has a disclosure policy.