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Amazon(NASDAQ: AMZN) has enjoyed quite a few rides over the last few years. The decline in stocks, once Wall Street darlings, has been dramatic.The stock has fallen 40% over the past year, and recently As you can see below, it has fallen more than 50% from its highs.
Stocks returning to 2018 levels are either a tremendous opportunity or a huge money trap.
how did we get here
Amazon benefited greatly from the pandemic, until it didn’t.
The boom in online shopping during the pandemic and monetary stimulus boosted sales and investor sentiment. Unfortunately, the pandemic had other effects.
Repercussions of the pandemic
2021 and 2022 saw some headwinds, including:
- Port bottlenecks causing logistical problems and increased costs.
- A tight labor market that requires contract bonuses and wage increases.
- Inflation and low consumer sentiment are weighing on profit margins.When
- And a strong US dollar (DXY) that crushed international gains.
Collectively, these challenges have added billions of dollars in costs and left two of Amazon’s three segments unprofitable.
Amazon operates three segments in North America, consisting of retail sales and subscriptions. International, which includes overseas regions. Amazon Web Services (AWS) consists of cloud services such as infrastructure, platform, and software. Only his AWS is profitable by Q3 2022.
The company has struggled to regain its footing, but there are some reasons for optimism among long-term investors. There is more to this discussion.
Explosive increase in service sales
When COVID-19 pushed people to shop online, Amazon saw a significant increase in sales. By the end of 2021, product sales will reach $242 billion, up 50% from 2019. Meanwhile, AWS surged as businesses benefited from hefty economic stimulus packages. 90% increase in service sales From 2019 to 2021, it reached $228 billion.
Over the last 12 months (TTM) from Q3 2022, Service sales exceeded product sales This remarkable trend deserves attention.
Service sales include AWS, advertising, subscriptions (such as Prime), and third-party sales services. Basically everything but online stores and physical stores. A sharp rise is shown below.
Data source: Amazon. Charts by author.
why is this important?
Selling services is far more desirable than selling products because it is significantly more profitable. For example, the AWS segment has an operating margin of 30%, while the North American and International segment combined operating margins were 3% and 1.5% in 2020 and 2021, respectively.
Discount retail sales are not the route to wealth. the service.
These returns are more predictable and consistent. This is especially important for long-term investors. This is because economic instability often appears first in consumer spending.
look to microsoft
Microsoft (MSFT) is a great example of a company moving from selling licensed products to selling subscription services. His CEO at Microsoft, when Satya Nadella took over, transformed the business into a cloud-based Software as a Service (SaaS) model. competitor players).
The proof is in Pudding, as Microsoft’s results were excellent. Profitability is excellent and investors can expect consistent results. Below are Microsoft’s stable service-based profit margins juxtaposed with Amazon’s erratic results.
Microsoft and Amazon are two very different companies, and Amazon needs product sales to drive other businesses like Prime and advertising. However, the move to rely more on services will help smooth out the outcome and increase profitability.
Speaking of advertising…
Amazon’s digital advertising business is strong in this regard.
Businesses bid on Amazon’s pay-per-click service to put their products at the center of Amazon’s website. Shown as “Sponsored Products” or “Sponsored Brands” when shopping. This is a great way to increase sales in a tough competitive environment.
Businesses need to manage their advertising budgets wisely, especially in this economy. This means targeting consumers who are ready to buy. Providers such as Alphabet (GOOG)(GOOGL) and Amazon do just that. Whether it’s a Google search or Amazon, if someone searches for “6ft HDMI cord” as I did recently, there’s a very good chance they’re ready to buy right away. Advertisers pay top dollar for these opportunities.
As you can see below, Amazon’s ad revenue has nearly tripled since 2019, and there’s a lot more potential.
Data source: Amazon. Charts by author.
Other initiatives such as “Buy with Prime” are coming. Advertising services will be a big part of Amazon’s long-term success.
Amazon cash flow problem
Free cash flow is a recent challenge, as shown below.
The above headwinds are a problem, but only part of the story. Capital expenditures (CAPEX) surged from $18.9 billion in 2019 to $40 billion in 2020 and nearly $66 billion above TTM.
The rapid growth in retail and AWS sales required these investments in physical and technical infrastructure. The bad news is that the need is layered with other headwinds.
Cash flow woes come at inconvenient times for investors, too. Companies like Alphabet, Google’s parent company, buy back large amounts of stock during periods of falling stock prices, which Amazon cannot take advantage of.
Fortunately, CAPEX is an investment in the future and should start declining on an absolute and revenue basis. We see an upward trend in free cash flow in 2023.
Are you buying Amazon stock?
Amazon stock has become a lightning rod these days. And for good reason. There are encouraging signs and warnings.
Logistics bottlenecks, rising labor costs, inflation and a strong dollar are all disappearing. Unfortunately, AWS growth is slowing, a recession looks imminent, and consumer sentiment is low. Times may be tough, but long-term investors can buy stocks at prices not seen in years.
one step ahead
If you’re doing long pulls in this game, it’s a good idea to be able to handle a 50% dip without worrying too much about it. – Charlie Munger.
…the secret to survival is knowing what to throw away and what to keep. – Gambler, Kenny Rogers
In my last article, New Year, New Strategy?Not actually; here’s why We saw that many of the best investments of the last two decades experienced sharp declines and violent recoveries. The key is owning great companies, keeping them for the long term, and adding to them as opportunities arise.
If the Amazon were a ship at sea, we would know it was hit by hurricanes, cyclones, whirlpools, crashed into harbors and hit by tsunamis. But investors should be proactive rather than reactive.
Amazon is the world’s leading cloud services provider, with over 200 million Prime subscribers, a burgeoning advertising business, and a dominator of the growing US online retail market. A long-term investor who can handle short-term volatility should consider accumulating his Amazon stock at these depressed prices.
