What a wild ride for Amazon.com, Inc. (NASDAQ:AMZN) stock. By mid-day on Thursday, AMZN stock had jumped about 3% higher to all-time highs as investors went risk-on into the earnings report. The overlap of massive Prime Day numbers with blowout results from fellow tech giants Netflix, Inc. (NASDAQ:NFLX) and Facebook Inc (NASDAQ:FB) led to bullish investor sentiment ahead of Amazon earnings.
But then the bulls went into hibernation. By late afternoon trading on Thursday, AMZN stock had wiped out all of its gains.
By the close, AMZN stock was down almost 1%. The report hit the tape after-hours, and investors weren’t too impressed. Amazon dropped about 2.5% on Friday.
All told, shares rallied to $1,080 on Thursday afternoon, only to close at $1,020 on Friday. So what should investors make of Amazon’s volatility?
I say ignore it. Buy more on this dip, as the fundamental picture hasn’t changed a bit for Amazon.
Why AMZN Stock Sold Off
Why did AMZN stock sell off after reporting blowout revenue numbers? Well, the company reported a nasty drop in profits in the quarter. That brought back profitability concerns that plagued the stock in 2014. Investors freaked, and the stock dropped.
More specifically, second-quarter earnings dropped 77%, and the driver was margin compression across the board. North America retail operating margins compressed to 1.7% versus 2.8% last quarter and 4.2% in the same quarter last year. International retail operating margins compressed to -6.3% versus -4.4% last quarter and -1.4% in the same quarter last year. Amazon Web Services operating margins fell to 22.3% versus 24.3% last quarter and 24.9% in the same quarter last year.
What’s up with the sudden pause in Amazon’s margin growth narrative?
Clearly, the e-commerce behemoth is feeling the need to spend more. Other retailers like Wal-Mart Stores Inc (NYSE:WMT) are upping their digital game. That’s forcing Amazon to spend more in order to maintain its competitive lead in retail.
On the cloud side of things, Microsoft Corporation (NASDAQ:MSFT) is really starting to apply competitive pressure with Azure. That is forcing increased investment into Amazon Web Services.
Overall, Amazon is starting to feel the competition, and the company is spending big now to hopefully mute future challengers. Moreover, Amazon is making huge pushes into new markets like groceries, meal kits, Geek Squad-like services, digital payments, appliances and social commerce. All those pushes require money, and that’s showing up on the income statement.
Why AMZN Stock Is a Buy
But here’s the thing: Amazon has done this before … and it works.
In late 2014, profitability took a huge a hit at Amazon as the company invested big to both grow its business and fend off intensifying competition. Operating margins fell to -2.6% in the third quarter of 2014.
But the margin depression was short-lived. Next quarter, operating margins jumped to 2%. And they continued to trend upward. By the second quarter of 2016, operating margins had expanded all the way to 4.2%.
It’s a strategy that Amazon has successfully executed many times before. It spends big now to kill competition and take over a market. Once it takes over the market, it stops spending, and margins and earnings skyrocket.
Investors know this. That is why despite the 77% drop in profits, AMZN stock only fell about 2.5%. That is the smallest post-earnings drop for AMZN stock in seven years.
You can’t shake the Amazon faithful. They know the writing on the wall: Invest big now, kill competition, earnings boom in mid-future and world domination at the end of the day.
Bottom Line on AMZN Stock
Let the weak hands sell their shares. Let there be some noise in the near term as bears come back to the forefront with profitability concerns.
All the while, let Amazon keep spending to grow. AMZN stock can and will head higher over both the medium and long term. Investors just need to be patient.
As of this writing, Luke Lango was long AMZN, FB, WMT, and NFLX.
