Amazon's Rare Revenue Miss Belies Its Soaring Profitability

Expectations were high going into Amazon's (AMZN -0.14%) third-quarter financial report, but investors also had some trepidation. During the recent market carnage, tech shares have taken it on the nose, moving into correction territory. Over the past month, Amazon shares had shed as much as 17% of their value before recouping some of those losses just prior to its earnings release.

Skittish investors sold off the stock after Amazon posted a rare revenue miss when it released earnings after markets closed on Thursday, but I think they're missing the big picture. Let's look a little deeper into the numbers to see why those who are selling are making a big mistake.

Image source: Amazon.

Most companies would kill for numbers like these

Data source: Amazon's Third-Quarter Financial Report.

For the third quarter, Amazon reported revenue of $56.6 billion, up 29% year over year, just shy of the high end of the company's forecast and analysts' consensus estimates of around $57 billion. Operating income of $3.7 billion was well above Amazon's guidance of $1.4 billion to $2.4 billion and grew tenfold from the prior-year quarter. Net income of $2.8 billion resulted in earnings per share of $5.75, soaring past analysts' expectations for $3.10.

Though revenue growth slowed from the 34% pace Amazon achieved during the prior-year quarter, the organization exhibited strength across its operating segments. Sales in North America climbed 35% year over year, to $34.3 billion, and international sales of $15.5 billion improved 13% against the prior-year quarter. Amazon Web Services (AWS) continued to steal the show, as revenue from the cloud-computing division jumped 46% year over year, to $6.7 billion.

Ongoing profit improvement

Data source: Amazon.com. Third-Quarter Financial Report.

Profitability improved across the board year over year, and Amazon continued the significant improvement in operating margin I noted last quarter, which was the biggest contributor to the company's soaring profitability. Segment operating margin in North America improved 13-fold, to 5.9% from 0.4% in the year-ago quarter.

While the international segment has yet to produce an operating profit, operating loss margins improved from -6.8% to -2.5%. AWS also was more profitable: Operating profit margin increasing from 25% of sales to 31%. Improvements in each area helped drop more profit to the bottom line.

What's in store for the important holiday quarter?

For the fourth quarter, Amazon is forecasting sales in a range of $66.5 billion to $72.5 billion, which would represent year-over-year growth of between 10% and 20%. This includes an unfavorable impact of approximately 80 basis points from foreign exchange rates. The company also is anticipating operating income of between $2.1 billion and $3.6 billion, which would result in year-over-year growth ranging from flat to an increase of 71%.

To put this in perspective of Wall Street's expectations (though we won't be beholden to it), analysts' consensus estimates are calling for revenue of $73.89 billion, or 22% growth, and earnings per share of $5.92, up 174% compared to the prior-year quarter. 

Amazon's lower revenue growth and conservative holiday guidance appear to have put off some short-sighted investors. Significant opportunities remain for the company in cloud computing, e-commerce, advertising, and business-to-business (B2B) commerce -- as well as for the improvement of profit margins. With that many ways to win, investors should see this revenue miss for what it is -- a minor speed bump.