Amazon.com, Inc. (AMZN) stock is soaring today, with shares briefly up as much as 10% in early trading after a blowout third-quarter earnings report. Fellow tech giants Alphabet (GOOG, GOOGL) and Microsoft (MSFT) are also surging this morning, as each company reported extremely strong quarters of their own.
I have a hunch the tech sector will be one of the hottest areas in the stock market today.
AMZN was already one of the year’s best performers before yesterday’s blowout quarter. With gains of 82% in 2015, it boasted the second-best returns in the S&P as of yesterday, next to Netflix (NFLX), which has doubled. After today’s gains, Amazon and Netflix will be neck-and-neck.
Okay, so investors know that AMZN stock is surging because it put together a stellar quarter. But just what about it was so special? Let’s take a look.
AWS for MVP
Going into yesterday’s report, Wall Street expected AMZN to post revenue of $24.91 billion and a per-share loss of 13 cents. Instead, Amazon posted revenues of $25.4 billion, up 23% year-over-year, and earnings per share of 17 cents — its second consecutive “surprise profit.”
The driver behind this recent moneymaking streak is Amazon’s cloud computing arm, Amazon Web Services, or AWS. It has a bevy of corporate and governmental clients, it’s second to none in the area, and it’s growing like wildfire.
AWS is no secret, but for the second straight quarter, investors and Wall Street analysts alike underestimated it. When AMZN stock ripped off 17% gains after reporting blowout second quarter results three months ago, I noted just how essential its high-margin cloud division was in driving profits. In Q2,
“AWS was just 7.9% of the company’s total revenue, but its operating income of $391 million was a remarkable 36.4% of AMZN’s total operating income of $1.08 billion. (Amazon lists operating income of $464 million, but that backs out stock-based compensation; the larger figure makes for a more accurate assessment.)”
Using the same methods to calculate the impact of AWS on Amazon’s profitability in Q3, we see an even more profound impact. In the third quarter, AWS revenue was just 8.2% of Amazon’s total revenue; but this time, AWS accounted for a staggering 52.5% of the e-commerce giant’s operating income.
I suppose if you were looking for things to criticize, you could point out that AWS revenue growth decelerated quarter-over-quarter. That’s true, but forgive met if I don’t rush to sell AMZN stock just because AWS grew by 81% in Q2 and 78% in Q3.
An Analyst’s Take:
Analysts Carlos Kirjner, Andrea Rosso and Ben Betcher of Bernstein explained in a note this morning that AWS operating margins were expanding rapidly: While they sat at 8.4% a year ago, they surged to 25% in the most recent quarter, nearly tripling the cloud division’s profitability.
Kirjner and his team currently rate AMZN stock an “outperform,” and give the stock a $675 price target, although that may be revised higher in due time. One of the core reasons for their bullishness is
“…the value of AWS, which we still have at $120 billion EV, but are increasingly confident is worth much more.”
At the end of the day, it looks like the mosaic of clues I outlined earlier this week did not do me wrong, and AMZN did indeed catapult past $600 on its strong quarter.
This looks to me like the beginning of a new era of long-term profitability for Amazon, and a defining point in the company’s history.
As of this writing, John Divine was long shares of AMZN stock. You can follow him on Twitter at @divinebizkid or email him at editor@investorplace.com.
