Amazon Stock Fell After Earnings. Should Investors Be Worried?

Amazon (NASDAQ: AMZN) just delivered an impressive quarter. Its cloud business grew rapidly, operating income climbed, and its overall operating margin reached a record high.

Yet its stock fell after the earnings announcement. The reason comes down to a growing concern: Amazon is spending so much on artificial intelligence (AI) infrastructure that its free cash flow has turned negative.

I think the market's concern is understandable, but investors shouldn't confuse a cash-flow problem caused by heavy investment with a business that's losing its competitive edge. The important question is whether Amazon can turn today's spending into tomorrow's profits.

Here's what investors need to understand.

Image source: Getty Images.

AWS is delivering impressive growth

The strongest part of Amazon's latest results was undoubtedly Amazon Web Services (AWS).

Third-quarter revenue increased 39% year over year to $46 billion. That's its fastest growth in nearly five years, an impressive acceleration for a business already generating more than $180 billion in annualized revenue. Profitability was equally encouraging. AWS operating income climbed to $17.8 billion, compared with $11.4 billion a year earlier.

This matters because AWS is one of Amazon's most important profit engines. As businesses adopt AI and move more computing workloads to the cloud, they need access to powerful computing infrastructure. Amazon is well-positioned to benefit through its global data center network, established customer relationships, and growing range of cloud services.

The latest results suggest that AI demand is translating into real revenue and profits. That's a meaningful positive for Amazon's long-term prospects.

Why are investors worried about $42 billion?

AWS might be growing nicely, but Amazon is spending heavily to capture this opportunity. The company expects capital expenditures to reach approximately $220 billion in 2026. Much of this spending is going toward data centers, servers, networking equipment, and other infrastructure needed to support AI and cloud computing.

The consequences are already visible in its cash flow. Over the past 12 months, Amazon generated $168.3 billion in operating cash flow. But after accounting for capital expenditures, free cash flow turned negative at $42.4 billion. A year earlier, it was positive $14.8 billion. That's a substantial deterioration.

However, investors should understand the difference between spending money to run a business and investing money to expand it. Capital expenditure creates assets that can generate revenue over many years. Think of building a hotel: The construction costs are paid up front, but the hotel can generate income for decades. The investment makes sense if enough customers book rooms at profitable rates.

Amazon faces the same challenge. Its new data centers must attract paying customers and operate at sufficient utilization to justify their enormous up-front costs. If AI demand continues growing, today's spending could support years of future revenue and profits. But if demand disappoints, Amazon could end up with expensive infrastructure that takes much longer to generate attractive returns.

That's the risk investors are trying to assess.

The rest of the business is holding up

There are a few reasons not to view Amazon's results too negatively. Total third-quarter revenue increased 12% to $201.9 billion. The comparison was affected by Prime Day taking place in the second quarter this year rather than the third. Without that timing difference, revenue growth would have been approximately16%.

More importantly, operating income climbed to $28.1 billion from $17.4 billion a year earlier. Its operating margin reached 13.9%, a record high. That suggests Amazon's underlying operations are becoming more profitable even as its cash flow comes under pressure.

Overall, Amazon's business is not showing signs of widespread deterioration. The biggest concern remains whether its enormous AI investment will earn an adequate return.

What should investors watch going forward?

I wouldn't dismiss Amazon simply because free cash flow has turned negative. Its cloud business is accelerating, operating profitability is improving, and its scale gives it a competitive advantage in serving businesses that need computing infrastructure. But I wouldn't ignore the spending either. Three things deserve attention.

First, watch AWS revenue growth. Continued acceleration would suggest that Amazon's investments are meeting genuine customer demand. Second, monitor AWS operating margins. Revenue growth is encouraging, but investors need to know whether the business can maintain attractive profitability as it expands.

Finally, watch free cash flow. It doesn't need to recover immediately, given the scale of investment. But investors should eventually see evidence that today's spending is translating into stronger cash generation.

Amazon's latest results show a business with considerable growth potential, not one in decline. However, winning the AI race and generating attractive returns from it are two different things. For long-term investors, the second question matters just as much as the first.

Lawrence Nga has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Amazon. The Motley Fool has a disclosure policy.