Amazon’s ‘Safe’ Retail Business Earns Less Than AWS Does. Is the Stock Still a Good Buy for Cautious Investors?

Over the past few years, investors looking for a piece of the artificial intelligence (AI) pie without the roller-coaster ride have been seeking out one stock in particular: Amazon (NASDAQ:AMZN). The pitch was simple: Amazon owns the world's No. 1 cloud service provider -- Amazon Web Services (AWS) -- but it also is an e-commerce leader, selling everything from groceries to garden tools. This means this market giant doesn't depend on a single technology trend and instead generates reliable growth, thanks to e-commerce, quarter after quarter.

However, that pitch may need an update. E-commerce these days actually isn't Amazon's star business. Instead, it's AWS, a major player in the AI story and Amazon's biggest profit driver. Does this mean Amazon is no longer a no-brainer buy for cautious investors? Let's find out.

Image source: Getty Images.

Amazon's two engines

First, though, a quick update on the Amazon story so far. Amazon built its fortune on e-commerce, and that business remains central to the company's successes. Shoppers turn to Amazon for essentials and general merchandise, Prime members keep coming back for fast delivery, and millions of third-party sellers populate the Amazon marketplace. Along the way, Amazon added a high-margin advertising business that taps into all of the shopper traffic.

Then there's AWS, the unit that has become a growth machine over the years -- and the AI boom added significantly to this momentum. So Amazon offers investors a track record of revenue gains thanks to e-commerce, and a new chapter of growth at AWS is unfolding as we speak.

AWS' sales jumped 37% in the second quarter for the fastest growth rate in more than four years, and the segment just reached a $169 billion annualized revenue run rate. Importantly, the company says demand is soaring for both non-AI and AI services.

Now, here's where the story gets interesting. North America generated about $9 billion in operating income on $116 billion in sales. International earned $1.7 billion on more than $42 billion in sales. AWS, meanwhile, brought in $42 billion in sales and $16 billion in operating income. That means AWS made up just 21% of Amazon's sales but 60% of its operating income.

Of course, the e-commerce business remains an important part of the growth picture, with advertising revenue rising 26% to more than $19 billion in the quarter -- it's just not the profit engine.

What this means for cautious investors

Amazon's "safe" label deserves a closer look. Amazon's profits increasingly depend on continued demand for AI infrastructure, and the company is spending heavily to meet it. Amazon plans $220 billion in capital expenditures this year, and free cash flow for the trailing 12 months turned negative, at an outflow of $7.6 billion, compared with an inflow of more than $18 billion a year earlier. And the company says it may continue to face free cash flow headwinds until new data centers are up and running for a while.

Still, there's reason for optimism. Amazon chief Andy Jassy says that even with capex at current levels, Amazon won't have enough capacity to meet demand this year, and he expects the same next year. It will be important for investors to consider any updates to the capex and demand situation in the third-quarter earnings report, set for Oct. 29 after the market closes.

So, is Amazon still a good buy for cautious investors? Yes — as long as investors recognize AWS' key role in the earnings picture. An e-commerce business generating nearly $11 billion in quarterly operating income gives Amazon diversification few AI players can match.

Amazon also scores a win when it comes to valuation. It's trading at reasonable levels today, at 29x forward earnings estimates, down from more than 34x just a few months ago.

If you're a long-term investor who doesn't mind potential volatility around AI spending, Amazon looks like a fantastic buy. If you're truly risk-averse, but still like the Amazon story, consider starting with a smaller position and adding to it over time.

Adria Cimino has positions in Amazon. The Motley Fool has positions in and recommends Amazon. The Motley Fool has a disclosure policy.