Buy Amazon stocks, but not because of e-commerce

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One of the most notable transformation stories in technology is recently Amazon (AMZN 0.16%). The online seller pioneered e-commerce in North America and many parts of the world. And with its role in creating the cloud, it then evolved into a conglomerate.

However, growing e-commerce losses mean that the cloud segment, Amazon Web Services (AWS), generates most (or sometimes all) of the company’s profits. This does not negate the investment case for Amazon, but profiting from Amazon will force investors to consider the internet stock and direct marketing in a different light.

E-commerce as a “loss leader”

After years of profits, Amazon’s e-commerce operations are now losing money. But despite the losses in e-commerce, its reputation serves as a platform for its true drivers of growth. Indirectly, its web presence acts as an undeclared Amazon ad campaign, keeping its name in the public’s mind. It also wields considerable market power, allowing it to aggressively compete with major retailers such as walmart and Costco.

In addition, e-commerce allowed Amazon to sell advertising on its website. Due to its position in both the North American and international segments, the public was unaware of Amazon’s advertising revenue until recently.

Nevertheless, investors should pay close attention to this income stream. With nearly $17 billion in revenue for the first half of 2022, its revenue was up 20% from the same period in 2021.

Despite the advertising success, the biggest bright spot is AWS. Although only responsible for 16% of Amazon’s revenue, it is the fastest growing segment, increasing 35% year over year. It is also the only segment this year to post a positive operating result. In addition, over the past 12 months, it has recorded an operating margin of 31%. This margin helped her generate the majority of the company’s profits for years.

Amazon’s finances by segment in the first half of 2022
Segment Revenue Operating profit (loss)
North America $143,674 ($2,195)
International $55,824 ($3,052)
AWS $38,180 $12,233

Source: Amazon Investor Relations.

Valuation and stock market performance

This “loss leader” status for e-commerce also means investors should take its price-earnings ratio with a grain of salt. Admittedly, three-digit earnings multiples for Amazon are nothing new. After its P/E ratio dipped below 50 at the start of the year, it jumped above 100 again.

However, this happened not because of a rise in stock prices, but because earnings turned negative, especially in the previous two quarters. As a result, Amazon shares are selling nearly 40% off their all-time high in mid-2021.

Plus, it looks cheaper from a revenue perspective. Amazon sells about twice the sales. This closely approximates the sales multiple of the emerging e-commerce competitor Sea Limited and eclipses the price-to-sales (P/S) ratio of MercadoLibre. It also lags behind its cloud rival Microsoftwhich sells for 9 times sales, which means Amazon has arguably become a value stock.

Amazon looks like a great buy

The “loss leader” perspective is set to change the narrative for Amazon’s stocks. Investors now get the e-commerce business “for free” if they buy Amazon for AWS. Additionally, a low P/S ratio and the success of the digital advertising business strengthen the investment case.

Finally, investors should remember that Amazon’s business continues to undergo constant change. If its e-commerce segments can lose their “loss leader” status and return to profitability, they could serve as additional catalysts to propel Amazon’s stock.

John Mackey, CEO of Whole Foods Market, an Amazon subsidiary, is a board member of The Motley Fool. will heal has positions in MercadoLibre. The Motley Fool has posts and recommends Amazon, Costco Wholesale, MercadoLibre, Microsoft, Sea Limited and Walmart Inc. The Motley Fool has a disclosure policy.

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