Amazon

Amazon reported record profits in 2018,
earning $10.1 billion in net income

compared to just $3 billion 2017.

Considering the company hardly had

any annual profit until
2016, this represents major growth.

Whether that’s gap earnings, operating
income, free cash flow, this company

hit an inflection point at the beginning
of 2018. It’s one of the reasons

that the stock
materially outperformed the market.

Traditionally, Amazon has funneled most of
its money straight back into the

company itself, leading to meager
earnings compared to other tech giants

like Apple or Google. But in
spite of this strategy, Amazon has been

making enough lately that there’s still
money left after all of its

expenses on inventory,
fulfillment centers and people.

Amazon still doesn’t have the types
of profits that other big tech

companies do, say a Google or
an Apple or a Microsoft. But significantly

more than they ever have in the past
and it really allows them to do much

more experimentation with
the core business.

So what’s changed?

Though Amazon has long dominated
the U.S. e-commerce market, online sales

are not actually the biggest
moneymaker for the company. Its e-commerce

division isn’t even profitable
internationally. Instead, Amazon Web

Services, or AWS, has generated
the majority of the company’s operating

income since 2016.

AWS is Amazon’s cloud computing division,
comprised of a huge network of

servers providing processing and
storage solutions for companies,

government agencies and individuals.

What that did for Amazon is it
turned Amazon into a technology company as

well as being
an e-commerce and retailer.

Its clients, which include Netflix, Airbnb
and Yelp, are charged for their

volume of usage, the features they
subscribe to, and the services they

use.

AWS really started to grow about four
or five years ago and became a

significant force in computing.

Amazon Web Services continues to get
bigger as a percentage of overall

revenue and it’s a highly profitable
business by Amazon’s standards but by

most corporate standards. It’s doing
something like 30 percent operating

margins.

In 2018, AWS brought in 7.3
billion dollars in operating income and 25.7

billion dollars in revenue which,
for reference, is more than both

McDonald’s and Macy’s.

In this last quarter, AWS was
58 percent of total operating profit for

Amazon. So it’s still clearly the
profit driver for the overall company.

In fact in 2017, AWS was
actually more than 100 percent of Amazon’s

operating profit. So without AWS, Amazon
would not have been making any

money.

But though it’s a huge
reason behind Amazon’s recent profitability, other

areas of the company are seeing
major growth as well. The fastest growing

division of Amazon is its
other category, comprised mainly of its

advertising business. It grew 95 percent
in the fourth quarter of 2018 and

brought in $10.1 billion in
revenue for the year overall.

As Amazon has become the center of
commerce for a lot of businesses, it’s

becoming a huge
advertising play as well.

They don’t break out the profits
of this, but looking at comps like

Facebook and Google, it’s almost
certainly also in that 30 percent

operating margin range.

If advertising continues to grow at
this rate, some analysts even predict

it will be more
profitable than AWS by 2021.

The last segment experiencing major
growth is the third-party marketplace.

While Amazon traditionally buys products
in bulk from wholesalers and

sells them at a slight
markup, in the third-party marketplace outside

companies pay Amazon to sell their
goods using its platform. Amazon takes

about a 15 to 20 percent cut
of the sales, while also collecting fees for

things like storage and
shipping. While Amazon generates significantly

less revenue from third-party merchants
than from products it sells,

margins are much higher, making
it more profitable than the traditional

model.

If you assume even a small
5 percent margin, you’re talking about

potentially two billion dollars
in profit just from third-party

contributing to overall Amazon.

Today, more than half of all
goods sold come from third-party sellers, and

more and more businesses are
signing up. Sales of third-party seller

services rose 34 percent in
2018 to 42.7 billion dollars.

You really have to be on Amazon,
unless you are going to go it alone.

Amazon is the only place where
you can instantly get scale without having

to do all of the marketing yourself.

Amazon smart speakers
also have analysts excited.

The last thing I find really interesting
is Alexa. So you now have an

installed base of over 100
million of these voice-activated devices. Over

time, you’ll find yourself increasingly
turning to Alexa, and say “Alexa,

order more coffee.” And it’s one
of those things that will accelerate the

move of Amazon into two places,
the pantry and into the refrigerator.

The boom in all these
categories, from Alexa to cloud computing,

advertising and third-party seller divisions,
raises the question of how

the company should be valued.

At the size of the company now,
well over 200 billion dollars in annual

revenue, it’s just really hard to grow
at 20 plus percent. So that means

these investors who have expected
high growth repeatedly every quarter are

now looking at a company with
slowing growth but lots of profitability.

There’s clearly some consternation in the
investor community as to how to

value Amazon today.