Amazon (NASDAQ:AMZN) delivered a massive earnings beat July 30 and yet, AMZN stock gained less than 4% on the news. In the month of July, Amazon gained 10.6%, double the SPDR S&P 500 ETF Trust (NYSEARCA:SPY).
But most investors would probably view this performance as substandard, given the company’s growth potential.
Up 71% year to date, I don’t think there’s any question Amazon’s stock is having a fantastic year. Unfortunately, when you’ve delivered an annualized total return of 42.6% over the past five years, investor expectations get detached from reality.
Moving forward, it’s going to be tough for Amazon to generate substantial returns over the final five months of the year.
If I’m a long-term shareholder, that’s more than all right, because I know that Jeff Bezos isn’t thinking about Amazon’s share price in 2020. He’s thinking about how his company can rule the world in 2021 and beyond.
By Amazon’s standards, its stock had a mediocre July. Now that it’s in the past, here’s what to focus on for the remainder of the year, and beyond.
Advertising Continues to Build
Alliance Bernstein analysts Mark Shmulik and Nikhil Devnani wrote in a July 31 letter to clients that Amazon grew its advertising revenues by 50% in the second quarter. According to its quarterly report, the growth looks more like 41%, the fourth consecutive quarter with ad sales of 40% or more.
Whatever the number, advertising has become big business for the company. It currently has 7.8% market share of U.S. digital ad revenue, behind only Facebook (NASDAQ:FB) at 22.7% and Alphabet (NASDAQ:GOOG, NASDAQ:GOOGL) at 31.6%. If it keeps up 40%+ growth over the next four quarters, you can be sure Amazon’s market share should hit double digits.
As it is, eMarketer suggested in June that Amazon should generate $12.75 billion in ad revenue for all of 2020, giving it 9.5% market share. However, that’s based on 23.5% revenue growth in 2020. With its ad business generating $8.1 billion through the first half of 2020, and it generated $8.4 billion in ad revenue in the second half of 2019, it’s going to blow through eMarketer’s estimate.
So, any way you slice it, advertising is a significant growth engine that can’t be denied.
All Amazon Needs is Decent AWS Revenue
The company’s big moneymaker is Amazon Web Services (AWS), the provider of cloud computing services. In the second quarter, AWS’s revenues grew by 29% to $10.8 billion, while its operating income rose 58% to $3.4 billion.
That’s good news. The bad news is that it was the unit’s first quarterly growth of less than 30% since 2016. Further, the unit’s sales were $100 million lower than analyst expectations. Fortunately, its operating margin increased to 31.1%, 580 basis points higher than Q2 2019, and 100 basis points higher than Q1 2020.
So, even though business appears to be slowing, it’s making more from each of those dollars. As long as it can continue to do this, it ought to be able to lend a hand growing Amazon’s overall free cash flow (FCF).
In the trailing 12 months, Amazon’s FCF grew 27.6% to $31.9 billion or an FCF margin of 10.8% based on trailing 12-month revenue of $296.3 billion.
As AWS goes, so goes Amazon.
You’re Buying AMZN Stock for the Next 10 Years
My InvestorPlace colleague, Luke Lango, had this to say about Amazon, recently. I think it does a good job of cutting to the chase when it comes to AMZN stock and its short-term performance.
“In the big picture, Amazon’s strong quarter doesn’t really matter too much,” Lango wrote July 31. “You’re not buying AMZN stock for the quarter. You’re buying AMZN stock for the next 10 years, a stretch in which Amazon has an opportunity to create multiple huge technology businesses.”
I’ve already mentioned two, but there are many more, which is why I agree with Lango that Amazon is the market’s best growth story.
I might not like everything that Bezos or the company does, but I still believe the stock is going to $10,000.
For this reason, investors ought to forget about Amazon’s mediocre July, and think long-term. If you do, a decade from now you’ll be very happy that you’re still holding Amazon stock.
Will Ashworth has written about investments full-time since 2008. Publications where he’s appeared include InvestorPlace, The Motley Fool Canada, Investopedia, Kiplinger, and several others in both the U.S. and Canada. He particularly enjoys creating model portfolios that stand the test of time. He lives in Halifax, Nova Scotia. At the time of this writing Will Ashworth did not hold a position in any of the aforementioned securities.