Amazon: Earnings Are Not The Holy Grail – Seeking Alpha

Amazon (AMZN) is a company that has made quite a name for itself in the area of cloud computing, after having come to dominate the e-commerce space. Its AWS (Amazon Web Services) platform is currently seen as the leader in the area of big data storage and cloud computing, and its other offerings in this space have also proven competitive to rivals such as Microsoft (MSFT).

Despite this, that didn’t stop earnings from falling 77% in the most recent quarter. The more important question to be asked, are such lower earnings a concern?

In the long-term, clearly a drop in earnings is not a good thing. However, it’s important to put such lower earnings into context. Amazon has become heavily cloud-focused in its business model, and maintaining the servers and IT infrastructure for such technology requires large amounts of capital investment. Moreover, software is subject to high levels of depreciation due to upfront investment which results in depreciation lowering earnings over time.

According to Amazon’s Q2 2017 Financial Results, while operating income decreased to $628 in Q2 2017 (down 51% from the same quarter last year), net sales increased by 25% to $38 billion over the same period. With higher operating expenses having placed pressure on net income, it is understandable why earnings are lower under this circumstance.

Part of Amazon’s competitive advantage is that it maintains the largest cloud ecosystem of all technology providers. According to Gartner, Amazon Web Services has maintained its lead in the “Leaders” quadrant of Gartner’s Magic Quadrant for Cloud Infrastructure as a Service (IaaS) for the seventh year in a row, in recognition of the size and technological capabilities of AWS compared to its rivals:

Source: Gartner (June 2017)

The general takeaway from this is that Amazon is a company that you buy with expectation of growth – looking at valuations becomes virtually meaningless for this company. The idea is that if sales continue to grow, the revenue from sales will eventually outweigh the large amounts of capital expenditure needed to maintain Amazon’s technological infrastructure.

On the other side of the fence, there are those investors who argue that Amazon is a company that is ultimately set for failure since large amounts of capital expenditure are preventing the company from ultimately turning a profit. Amazon is ultimately pursuing a market share strategy in cloud computing, aiming to further increase its dominance as a major provider in this space.

Admittedly, I am long Microsoft (MSFT) myself – the reason being that Microsoft is less of a “risky” stock that pays a good dividend – but that’s more to do with factors such as my own individual appetite for risk, and is out of the scope of this article. A company like Microsoft has focused its Azure offering on a more focused corporate market in particular, and are not particularly targeting a maximum level of market share for its offering.

However, Amazon by contrast does not pay a dividend and is “going all in” by reinvesting heavily into upgrading its cloud computing infrastructure. Granted, there is more risk in holding a company like Amazon, but the potential payoff in terms of growth is far greater.

To conclude, earnings are not the holy grail when it comes to a company like Amazon. Amazon is reinvesting heavily to maintain its lead in the cloud computing space, and for investors who are willing to take more risk in terms of banking on such future growth, the rewards have the potential to be significant.

Disclosure: I am/we are long MSFT.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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Amazon: Earnings Are Not The Holy Grail – Seeking Alpha

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