Why Amazon.com Inc.'s Earnings Miss May Be a Good Thing

Amazon.com (AMZN -1.64%) saw its stock fall a bit on third-quarter earnings, which were, according to management, "lumpy."

In this segment from Industry Focus: Tech, Motley Fool analyst Dylan Lewis and contributor Daniel Sparks explain why the results were lower than market expectations, what Amazon's third-quarter investments mean for the company's long-term growth plans and how long-term investors should feel about the company in light of this.

A full transcript follows the video.

This podcast was recorded on Nov. 4, 2016.

Dylan Lewis: Daniel, turning our focus over to Amazon. Numbers, debatably good, debatably bad. The top line was fine, revenue came in at $32.7 billion, which was slightly up on estimates. EPS clocked in at $0.52, well below analysts expectations of $0.82 per share. These results kind of surprised the market, and the stock sold off 3-4%, and it's held there since then. I think that people have gotten used to seeing solid earnings come in for Amazon, and were taken aback because it seemed like they decided to outlay a lot of internal investments this quarter, and that wound up coming down and hurting them on the bottom line.

Daniel Sparks: Yeah, is kind of the opposite scenario from Twitter. We see higher costs, but a really long-term focus toward expanding margins, because these are the types of investments that, as they're really investing in the fulfillment centers and the different areas of the business, Amazon very much so has a long-term focus on expanding margins. We've seen that play out in the past. I think, as these costs ramp up a little bit, investors remember the days of the past, when Amazon was never reporting consistent earnings. That could bring up some memories of that. That could be why, some of the bear sentiment toward the stock, after seeing these lower-than-expected earnings.

Lewis: And in fairness, Q3 2015, the company posted $0.17 in GAAP earnings, they posted $0.52 this quarter. That's over 200% growth. This is moving in the right direction. I think there were just some decisions that the company made to invest in itself and build out some of its strengths a little bit more, and that caused things to not look quite as rosy on the bottom line this quarter. 

So, that investment came, it looked like, from about three different parts. We had digital content, and that's the Prime video, and strengthening the ecosystem there, building out their original offerings. Right now, they're in four countries: the U.S., the U.K., Germany and Japan. It seems like they might be entering India with Prime video sometime soon. This strategy there, and I think where you're seeing a lot of the spending, is in content creation. That's in their Amazon Studios segment. The idea there is, they're going to hold the worldwide rights to that content, and be able to freely repurpose it or distribute it in other countries, as opposed to licensing content and being in a third-party relationship and having limited rights. That's a good strategy. It winds up being more expensive to create content yourself, naturally. But having the flexibility to do what you want with it, especially as you're looking to grow your global footprint, is pretty important, I think.

Sparks: Yeah. These investments, you see this in their guidance going into the 4th quarter, they're estimating between $0-1.25 billion in operating income, which is down from $2.2 billion in the same quarter in 2015. Again, it's not just this quarter going into Q4, these investments play out. They're going to cost a lot of money, and I think that's why investors are a little bit concerned, but investors should really keep in mind how Amazon has done historically with these investments. We all know, these fulfillment centers are necessary. Every winter, we hear about these issues with getting shipments to customers, this huge influx of Amazon orders comes in for the holidays.

Lewis: Yeah, the company added 18 fulfillment centers in Q3. Looks like they're going to add five more in October. For 2016, they're planning to add 26. These are the types of things that cost you a decent amount of money up front, but are necessary for strengthening the business and making sure your core competencies and competitive advantages stay that way. Right?

Sparks: Correct.

Lewis: And one of the other areas that we saw some upfront investment going was in Prime benefits. Looking at things like Amazon Fresh, which is their produce in grocery delivery, and Prime Now, some of the same-day delivery service stuff they're looking to roll out. Again, these are things that strengthen their ecosystem, make the Prime membership seem even more valuable, and keep people loyal to the Amazon brand. I'm not too worried about that. Obviously, the numbers were jolting, and I think it might have been better for management to telegraph this a little so it didn't seem quite as lumpy. I think they said the conference call like four times, "Results were very lumpy." I think that's why we saw this market reaction, because a lot of people were a little bit surprised that things weren't smoother.