2 No-Brainer Reasons Why Amazon Is a Must-Own Stock
Amazon (NASDAQ: AMZN) is one of the least understood big tech companies. Everyone is familiar with its e-commerce platform and most probably use it weekly. However, its e-commerce business isn't a primary profit driver.
This is why worrying about what China tariffs will do to Amazon's business isn't productive. There are other parts of Amazon's business that make the majority of the profits, and these will do just fine.
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AWS generates the majority of Amazon's operating profits
First, let's break down where Amazon's revenue comes from.
| Segment | Q1 Revenue | YOY Revenue Growth | Percentage of Total Revenue |
|---|---|---|---|
| Online stores | $57.4 billion | 5% | 37% |
| Third-party seller services | $36.5 billion | 6% | 23% |
| Amazon Web Services (AWS) | $29.3 billion | 17% | 19% |
| Advertising services | $13.9 billion | 18% | 9% |
| Subscription services | $11.7 billion | 9% | 8% |
| Physical stores | $5.5 billion | 6% | 4% |
| Other | $1.3 billion | 4% | 1% |
Data source: Amazon. Note: YOY = Year over year. Note: Percentages may not add up to 100% due to rounding errors.
As you can see, online stores and third-party seller services, which facilitate other sellers on Amazon's commerce platform, make up the majority of Amazon's revenue.
However, operating profits are a different story.
AWS alone accounted for 63% of operating profits in Q1. This is possible because AWS' operating margin was 40% in Q1, compared to a companywide operating margin of 12%.
So, as long as AWS is doing well, Amazon's profit picture will do well. Considering AWS grew 17% in the quarter, it's on the right track. Additionally, it's expected to continue putting up strong growth, as cloud computing is an important part of artificial intelligence (AI) infrastructure buildout.
Cloud computing is vital in AI because few companies have the resources or skillset to maintain a giant data center with high-powered computing equipment. So, they rent this computing power from providers like AWS. This growth is expected to continue for some time, as the demand far outweighs the capacity.
Tariffs are also not expected to affect this demand, so investors can rest easy about that fear.
AWS is my primary reason for buying Amazon stock, but another intriguing division exists.
Advertising is an important part of Amazon's business
Amazon's fastest-growing segment is advertising, which grew revenue 18% year over year in Q1. Unfortunately for investors, Amazon doesn't break out this division's operating margin, but you can use clues from other companies to determine this margin.
Two big tech companies with dominant ad platforms are Alphabet (NASDAQ: GOOG) (NASDAQ: GOOGL) and Meta Platforms (NASDAQ: META). Both companies get the majority of their revenue from ads, with Alphabet sourcing 77% of revenue from ads and Meta getting 98% from ads.
Consequently, you can examine both companies' operating margins to get an idea of what Amazon's advertising service divisions might produce as an operating margin.
GOOGL Operating Margin (Quarterly) data by YCharts
Both companies have consistently produced between 30% (Alphabet) and 40% (Meta) margins, so it's safe to assume that Amazon's ad service business likely has a margin profile around those figures.
If you take the conservative approach and give the ad service business a 30% operating margin, you can estimate that it generated $4.2 billion in operating profits. That would account for about 23% of Amazon's total operating profits.
This means that ad services and AWS combined made an estimated 86% of Amazon's operating profits in Q1. That's an impressive profit share, so investors need to understand that these two divisions steer Amazon's profits.
Advertising may not hold up as strongly as AWS, as ad budgets are known to get cut during an economic downturn. But Q1 growth figures were still strong, which might bode well for the rest of the year. Plus, if Chinese products are no longer priced to compete with products sourced from other locations, those companies may feel the need to advertise to promote their products, which could level out any headwinds caused by declining dollars from Chinese products.
We'll see how this shakes out throughout the year, but Amazon's two most important divisions are thriving now, so the stock should continue to do the same.
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Suzanne Frey, an executive at Alphabet, is a member of The Motley Fool's board of directors. Randi Zuckerberg, a former director of market development and spokeswoman for Facebook and sister to Meta Platforms CEO Mark Zuckerberg, is a member of The Motley Fool's board of directors. John Mackey, former CEO of Whole Foods Market, an Amazon subsidiary, is a member of The Motley Fool's board of directors. Keithen Drury has positions in Alphabet, Amazon, and Meta Platforms. The Motley Fool has positions in and recommends Alphabet, Amazon, and Meta Platforms. The Motley Fool has a disclosure policy.
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