After spending half of July well above $1,000 per share, Amazon.com, Inc. (NASDAQ:AMZN) is in danger of giving up its four-digit mark and has already shed its $500 billion market capitalization. That’s thanks to a disappointing second-quarter report out Thursday night that brought back flashbacks of Amazon’s free-spending ways, leading to a selloff in AMZN stock in Friday’s trade.
Yes, quarterly revenues soared once more, but the corresponding earnings figure didn’t just fall, but fell far short of estimates, too.
It’s far from panic time at Amazon, but investors are fair to ask: Is the current rally in AMZN stock on pause, or beginning to end?
Amazon’s Second-Quarter Earnings
Momentum investors argue that the online retailer’s quest to take market share from traditional brick-and-mortar companies overrides any argument about its valuation.
It’s a steep valuation to just ignore, though, at a triple-digit forward price-to-earnings ratio and a price/growth-to-earnings ratio of 7, where anything above 1 is considered overvalued. That’s also difficult to overlook after Amazon posted 40 cents in earnings in a quarter where analysts expected $1.42.
It’ll be enough to make value investors continue to stay clear of AMZN stock. So will the fact that the nominal net income figure came to just $197 million against sales of $24.75 billion.
The shortcoming is mostly due to heavy spending, as the company pushes internationally, and also must increase capex for datacenters and other costs to keep up the robust growth in margin-friendly Amazon Web Services.
Traders and momentum investors will be fair to point out that revenues of $37.9 billion didn’t just beat the Street, but were a whopping 25% better year-over-year. That — along with a strategic acquisition of Whole Foods Market, Inc. (NASDAQ:WFM) that gives it yet another way to grow its massive e-tailing business — is reason to give Amazon stock the benefit of the doubt.
With AMZN shares starting to pare their losses to just 2% by midday, maybe they have a point.
Again, Amazon’s weak performance largely stemmed from costs related to keeping the growth ramp up.
AMZN faced cost pressure during the quarter to expand internationally as it invested in Prime Video and continued its launch of Global Video. In the near-term, Amazon will face higher logistics costs due to low product pricing and higher shipping costs. As more customers sign on for services, however, profitability should improve.
Amazon Web Services showed little change in the quarter, but operating margin fell — troublesome considering that AWS is Amazon’s little profit engine that could. The unit experienced a 71% increase in assets acquired under capital leases. AWS also required higher marketing spending both for itself, and in the face of increasing competition.
Microsoft Corporation’s (NASDAQ:MSFT) Azure grew 97% year-over-year in the most recent quarter. Alphabet Inc’s (NASDAQ:GOOGL) Google’s cloud services offering grew substantially. On its conference call, Alphabet did not specify how much Google Cloud made but did say that its GCP, or Google Cloud Platform, won three times more for new deals worth over $500,000 compared to last year.
Amazon’s AWS doesn’t have the open path to dominance that it seemingly had a couple of years ago.
Amazon expects seasonal weakness in the third quarter once again this year, ahead of the busy peak holiday quarter. Many of its new fulfillment centers will come online in the second half, which should support higher revenue growth beyond 2017.
Pricing for AWS is falling as the company rolls out new services. Cost efficiencies will decrease the margin deterioration the company experienced in Q2. Geographic expansion will also give cloud revenues a lift. In the last year-and-a-half, AWS customers migrated over 30 databases. The unit enjoyed big moves from customers including Ancestry.com and California Polytechnic State University. Shareholders should expect more sign-ups in Q3.
International expansion for AWS will also lead to sales growth. Amazon is opening up its cloud business to France, China and Hong Kong, among other countries.
The combination of lowering prices and adding functionality and innovation will attract more customers.
Bottom Line on AMZN Stock
Tech investors should keep a close watch on Amazon over the next few weeks. If the stock continues to decline, that may spark additional selling in a number of other expensive tech stocks.
At the least, expect increased volatility in AMZN stock as the market decides whether the long-term growth prospects are worth the premium price.
As of this writing, Chris Lau did not hold a position in any of the aforementioned securities.