3 Reasons Why Amazon Stock is Dropping

Amazon reported a decline in third-quarter earnings after the market closed on Thursday. The e-commerce giant recorded a profit of $2.1 billion which came out to $4.23 per share. The earnings number fell short of analysts’ expectations for an EPS of $4.59 per share. During the same quarter in 2018, earnings were $5.75 per share. This was the first time Amazon’s earnings have declined on a year-over-year basis since June 2017.

In terms of revenue, Amazon comfortably beat expectations. The company recorded sales of $69.98 billion, which was higher than the $68.83 billion that was expected. In the same quarter in 2018, Amazon had recorded $56.58 billion in sales.

Earnings season is a time when investors pay close attention to hits and misses. When a company reports lower revenue and/or earnings, it can indicate an underlying problem(s) that will affect the company’s short- or long-term growth.

So the two questions on investor's minds are why did Amazon miss on earnings, and how concerned should investors be? Here a few reasons and explanations for why they should not be that concerning.

Amazon is spending a lot of money on one-day delivery

Amazon has unapologetically put revenue growth ahead of profits. The company’s move towards one-day delivery for Prime members is a great example of this. However, this is costing the company money. And Amazon indicated that they anticipate to be spending even more money during the upcoming holiday season.

“We are ramping up to make our 25th holiday season the best ever for Prime customers — with millions of products available for free one-day delivery,” Amazon Chief Executive Jeff Bezos said in Thursday’s earnings announcement. “Customers love the transition of Prime from two days to one day — they’ve already ordered billions of items with free one-day delivery this year. It’s a big investment, and it’s the right long-term decision for customers.”

How concerned should you be? I don’t think you need to be very concerned. The question you have to ask yourself is whether or not Amazon will start suffering a decline in revenue. Based on the traffic I see from Prime trucks in my neighborhood, I don’t see that as being very likely. And prior to the second quarter of this year, Amazon had been reporting record profits. For all of 2018, Amazon reported a record $10 billion in profits. However, this number was more than three times its previous annual record. The company also had reported record quarterly profits in the four quarters that preceded this year’s second-quarter downturn.

The bottom line, Amazon is a money-making machine and I don’t see that changing.

 

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Amazon Web Services (AWS) is showing decelerating growth

In their earnings report, Amazon reported that AWS (their cloud computing division) increased revenue by 35% in the third quarter. While the revenue from AWS is growing faster than at Amazon.com (which grew at 24%), the revenue growth was down from 35% in the second quarter. The 35% also marked the lowest growth for the division in over five years.

How concerned should investors be? Slightly. This is because AWS has been the cash cow for Amazon in terms of operating income over the past four years. In the third quarter, AWS operating income was $2.26 billion which was 9% higher on a year-over-year basis. However, the percentage gain of 8.9% works out to the slowest growth in four-and-a-half years. Still AWS remains the dominant player in the cloud infrastructure and advertising revenue growth is accelerating faster than expected.

The bottom line, AWS remains the go-to company as tech startups look to go public. As long as that trend continues, the long-term outlook remains solid.

Amazon is under regulatory scrutiny

As reported by Lisa Lacy of Adweek, anti-trust action against Amazon will be the topic of conversation as the United States moves into an election year. Sen. Elizabeth Warren, a leading contender for the Democratic nomination has a plan to break up Amazon. Warren’s plan would cut off Amazon’s Marketplace and Basics line of products from the rest of the company. In Warren’s outlook, this would undo the “damage” done by the acquisitions of Whole Foods and Zappos that Warren deems anti-competitive.  

However, Lacy reports a more likely outcome would be to see AWS spun off as a separate company. This is the opinion of NYU marketing professor Scott Galloway and Atlantic writer Franklin Foer. Ultimately this will be Amazon’s decision. However, one reason the spin-off may happen is as a preemptive strike against regulators.

“If the writing is on the wall and pressure is building for regulatory action … then (Amazon) might decide to do it in a way they can control,” says Matthew Wilson, an associate professor of political science at Southern Methodist University.

How concerned should investors be? This may be the most troublesome long-term issue. Amazon has changed the retail model to one where the line between convenience and immediacy is blurred. At the same time, the more Amazon expands, the more consumers are realizing how much of their privacy they have conceded.

At issue is Amazon’s use of the data it has on its third-party sellers as well as the increasing encroachment of Amazon’s digital assistant Alexa into consumer’s lives. For example, Alexa can theoretically become part of a refrigerator that knows if perishable items, such as milk or eggs are going to go bad and reorders them automatically from Whole Foods. No action is needed by the consumer, but the consumer also loses the choice of buying those items from other retailers.

The bottom line, Amazon may look like a very different company in a year’s time. This would be the largest obstacle to growth.