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Why Amazon's Earnings Report Was More Amazing Than You Think

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Why Amazon's Earnings Report Was More Amazing Than You Think

The Results

On Thursday after-hours, Amazon.com, Inc. (NASDAQ: AMZN) soared more than +10% after reporting Q4 earnings. The rally put Amazon above the elite $1 trillion valuation threshold once again, a watermark shared by several other Titan portfolio companies.

From the stock price performance, you might imagine Amazon absolutely crushed the quarter (and they did, in many important respects) but there's far more to the story here than you might think. But first: the headline good news.  

The Profit Surprise

However, what may surprise you is that revenue only exceeded estimates by approximately 2%.  How can this be?

In short, our team of hedge fund analysts at Titan believe much of the outperformance on the profitability side came from the rapid pace of growth in Amazon's still-nascent advertising business.

We've been tracking a noticeable acceleration in advertising density on Amazon's e-commerce platform throughout the back half of 2019, and that seems to have flowed directly into Amazon's bottom line profits in Q4, catching analysts (who may not have been focusing very much on a <10% revenue segment) off guard.

This is a phenomenon commonly referred to amongst investors as…

Operating Leverage 101

When a small, but high-margin business gets weaved into the business model of a large, but low-margin business, that can have an extremely dramatic impact on financial outcomes.

Take advertising for example.  Although Amazon doesn't break out their advertising business specifically, assuming that segment occupies the majority of Amazon's "other" revenue line, at typical advertising margins, that segment could have wound up contributing the majority (i.e., 50%+) of Amazon's operating profits in the fourth quarter.

That's what we believe to be the beauty of Amazon's scale-driven business model. The more scale they attain, the stronger the operating leverage they will benefit from as they layer in new, high-margin business segments.

As these high-margin businesses throw off tremendous cash flow, Amazon becomes increasingly able to reinvest in their core platforms and customer experiences.
In this particular quarter, the operating leverage came from a surge in the advertising business at a time when analysts were all laser-focused on the incremental expenses coming out of Amazon's roll-out of its new one-day free shipping initiative.  

Color us unsurprised at the street's surprise here.

The Takeaway

Aside from the big Q4 profit beat, we generally pleased with the rest of the earnings report.

In other words, we would not be surprised to see Amazon exceed the high end of the $1 billion+ wide operating profit range they put out for next quarter.

The stabilization around growth in AWS (Amazon's cloud services business and other major profit contributor) was also a nice to see as we believe many investors had been seeking clarity around the trajectory of AWS amidst noise of increasing competition from Microsoft Corporation's (NASDAQ: MSFT) Azure and GCP.

On net, we felt like Q4 was solid, although the outsized stock price reaction seems to suggest a bit of a relief rally baked in.  We'll continue to keep our eyes trained in on Amazon's growth trajectory, particularly in the all-important cloud and all-too-overlooked advertising segments in the coming quarters.

Disclosure: We own Amazon's stock on behalf of clients at Titan. We initiated the position in February 2018.

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This should not be considered an offer, solicitation of an offer, or advice to buy or sell securities. Statements made herein may be outdated and subsequent events may have occurred, information may have changed, that could make any statement in these materials inaccurate or incomplete. The media presented may contain certain forward-looking or promissory language regarding the performance of Titan Invest or a company; these statements should not be relied upon to make an investment decision. Before investing, consider your investment objectives as certain investments are not suitable for all investors. Past performance is no guarantee of future results.  Prospective clients must refer to our website, and in particular, our Advisory Agreement for a complete description of Titan’s objectives and investment strategies. See full disclosures on Titan's website (www.titanvest.com) regarding Titan Research.

Photo by Christian Wiediger on Unsplash

 

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