Should you buy Amazon stock? 3-minute analysis

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Amazon stock dropped 13% last week after reporting Q3 earnings. That takes shares down 38% year to date and close to levels last seen in 2018.

Accounting for cash and debt, that gives an enterprise value of roughly 1.08 trillion dollars.

On its face, Q3 earnings didn’t look too bad. Revenue for all of Amazon’s businesses increased year on year.

Ecommerce revenue was up 7%, physical stores was up 10%, 3rd party seller services was up 18%, subscriptions was up 9%, Advertising was up 25% and AWS was up 27%.

As you can see from the chart, all these businesses contribute a significant amount of top line revenue.

The problem, however, was a sharp increase in expenses and a pessimistic guidance for the fourth quarter (typically Amazon’s strongest).

To be fair, Bezos did warn us about this when he tweeted:

"Yep, the probabilities in this economy tell you to batten down the hatches."

Crucially, operating income for Amazon Web Services was up only 11% year on year despite the 27% ramp in revenue. with operating margins dropping to 26%.

AWS is a cash machine and the jewel in Amazon’s crown so a deceleration in profitability affects the long-term valuation of Amazon’s stock.

For example, let’s say AWS revenue grows 15% a year for the next 10 years. An operating margin of 25% gets us to 77 billion in operating income in 10 years time.

When you apply a 25 x multiple to those earnings we are almost at 2 trillion for AWS alone which is an investment return of exactly 6% a year.

But that is a conservative estimate for AWS growth and crucially that doesn’t include any of Amazon’s other big businesses, ecommerce, 3rd party services, subscriptions and advertising.

These are all powerful, multi-billion dollar businesses which benefit from Amazon’s impressive infrastructure and economies of scale.

In other words, Amazon stock may not look cheap, but it has built a strong moat that the competition will find hard to replicate. This is a business that is still investing for growth has multiple opportunities to become even more powerful.