Better Growth Stock to Buy Right Now: Amazon or Alibaba?

Key Points

• Alibaba's cloud revenue accelerated to a growth rate of 26% year over year. But margins and free cash flow show the cost of that growth.

• Amazon benefits from three powerful catalysts, mitigating some of the risks of investing in the growth stock.

• Amazon shares are more expensive than Alibaba for a reason: It is a better business.

• 10 stocks we like better than Amazon ›

Investors looking for both strong business growth and massive addressable markets often end up at two familiar names: Amazon (NASDAQ: AMZN) and Alibaba (NYSE: BABA). Each has a powerful commerce engine, a fast-growing cloud platform, and a significant opportunity in AI infrastructure and applications.

But when you strip away headlines and focus on the operating results and the playbook for the next few years, one option stands out as the clear winner.

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Amazon: broad-based, profitable growth

Amazon's latest quarter showed healthy top-line growth and strong profit execution. Revenue rose double digits, with both its North America and international year-over-year growth rates in top-line revenue accelerating significantly, and Amazon Web Services (AWS) expanding at a rate of nearly 18% year over year. Operating income climbed sharply as the company continues to drive efficiency across fulfillment and cloud. It's the kind of combination long-term investors want: growth with expanding earnings power.

Furthermore, AWS's momentum and scale are extraordinary. The cloud-computing business's annualized revenue run rate is now just over $123 billion. The business has powerful momentum in AI. For generative AI solutions, specifically, Amazon CEO Andy Jassy said in its second-quarter earnings call that it is growing sales by a triple-digit year-over-year percentage and has "more demand than we have supplied for at the moment."

Highlighting the benefit of Amazon's scale, the cloud computing segment's operating margin remains robust -- at 32.9% (adjusted to exclude the impact of foreign exchange headwinds) in Q2 -- even as Amazon steps up investment in data centers, networking, and accelerators to meet AI demand.

Meanwhile, Amazon's online store segment, where the company records e-commerce sales, grew by 11% year over year in Q2 -- up from 5% growth in Q1. Similarly, the company's high-margin advertising business clearly accelerated because Amazon's other revenue segment, which primarily consists of advertising sales, grew 19% year over year in Q2 -- up from a growth rate of 4% in Q1.

Alibaba: A cheaper valuation -- but for a reason

Alibaba's latest quarter gave investors a clear (and bullish) data point: accelerated cloud growth and the stock ripped higher. Revenue in its cloud intelligence segment rose 26% year over year, powered by an eighth quarter in a row of triple-digit year-over-year growth in AI-related product revenue.

The overall picture of Alibaba's business, however, is more nuanced. Total revenue increased just 2% year over year, or 10% when excluding sales in the year-ago quarter from recently sold businesses. Further, Alibaba's adjusted earnings before interest, taxes, and amortization (EBITDA) fell 14% year over year as the e-commerce and cloud-computing company leaned into what it calls "quick commerce," or ultra-fast delivery, broader user experience investments, and AI. These heavy investments also meant that free cash flow went from positive in the year-ago quarter to negative.

A clear winner

Both stocks could end up being long-term winners. But Amazon ultimately offers the better risk-reward.

Alibaba is cheaper on traditional valuation multiples (but more expensive than it used to be after its recent sharp move higher) and is returning significant capital via buybacks and dividends. This lower valuation helps make up for the company's lower growth and some of the risks associated with China's weak macroeconomic backdrop. Indeed, given how cheap the stock's valuations is (it currently trades at just 15 times earnings), Alibaba could end up being a bargain in hindsight. But only if China's economy picks up speed and consumer and enterprise spending reaccelerate. If this happens, the upside in the stock price could be massive. But the company still has some things it needs to prove to investors to command a higher valuation multiple; it needs to demonstrate scalability, shown by operating margin expansion and free cash flow improvement, as Alibaba grows. We're not there yet.

Ultimately, Amazon offers the cleaner, more reliable setup. The company has three growth vectors that reinforce one another: retail, advertising, and cloud -- and each of these drivers will likely contribute substantially to Amazon's business in the coming years. Retail keeps getting faster and more convenient, ads help further monetize the company's e-commerce customers, and AWS offers investors a fast-growing, high-margin catalyst for the business. Together, Amazon's broad-based catalyst of scaled and profitable business segments provides investors with more certainty when thinking about the company's long-term potential.

If I had to pick just one of these two growth stocks today, I'd choose Amazon -- despite its higher valuation of about 35 times earnings. The operating momentum is better, the AI strategy is tied to an already scaled platform, and the cash generation gives the company room to invest through cycles. Alibaba is investable and improving, but the execution bar (and ultimately the risk) is higher.

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Daniel Sparks and his clients have no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Amazon. The Motley Fool recommends Alibaba Group. The Motley Fool has a disclosure policy.