Before Amazon (NASDAQ:AMZN) reported its third-quarter earnings results on Oct. 25, I wrote about why investors should expect its revenue growth to slow. As the e-commerce giant moves past the first year since its Whole Foods acquisition, reaches a saturation point for Prime members in the U.S., and succumbs to the law of large numbers, its days of 30% to 40% top-line growth are likely over.
Indeed, Amazon confirmed just that when its Q3 report came out, as it forecast revenue growth for the current quarter in the 10% to 20% range. The stock plummeted as a result, falling 14% over a two-day span.
There are, however, reasons for investors to remain confident in the stock. Profits ramped up to $5.75 a share from $0.52 per share a year ago, and management gave a few hints on the earnings call about how profitability would continue to accelerate thanks to investments it has made in recent years. Here are three key reasons Amazon's earnings growth may just be kicking off.
1. Employee growth is slowing
For most companies, a surge in hiring often precedes a jump in revenue, as the organization brings on the employees it requires in order to manufacture more product or respond to rising demand. That pattern has historically held true at Amazon, where hiring sprees have gone toward staffing new fulfillment centers, or scaling up Amazon Web Services, its cloud computing division.
Headcount at Amazon jumped 48% in 2016, and another 38% in 2017, excluding the Whole Foods acquisition. Those new employees helped drive revenue increases of 27% in 2016 -- its fastest pace since 2012 -- and 31% in 2017 (26% after factoring out the impact of the Whole Foods purchase).
However, over the last four quarters, Amazon's headcount has only increased 13% to 613,000, a sign that its latest growth cycle is coming to a close. CFO Brian Olsavsky explained how the deceleration in hiring would impact the bottom line:
"We've looked to really leverage our investment from the last couple of years, and as we funded and invested in a lot of new areas, AWS, devices, digital content, We've had a lot of movement within the company that has filled a lot of these roles ... Again, the theme here is going to be banking some of the investments from prior years and looking to gain greater control."
The key there -- and an idea that Olsavsky returned to repeatedly during the call -- is banking Amazon's previous investments, as the company has already hired much of the staff it will need. Another way to see the impact of slowing headcount growth is in its general and administrative expenses -- the category that includes the salaries of company managers -- which increased just 8.4% to $1.04 billion in the quarter.
2. Fulfillment center growth is also moderating
For years, Amazon's profits were muted because of the company's rapid expansion of its fulfillment center footprint, which was necessary in order to provide the fast, free delivery promised to Prime members. From 2015 to 2017, for example, the company's square footage in domestic fulfillment centers and data centers nearly doubled to 131.4 million. However, Amazon's pace of warehouse expansion also seems to be slowing down.
Olsavsky highlighted this shift on the call, noting that fulfillment center and shipping area square footage had grown by more than 30% in both 2016 and 2017 in order to keep up with the growth of the Fulfillment by Amazon program, which provides shipping for third-party vendors. However, this year, square footage has only grown by about 15%. The company no longer needs to expand capacity so rapidly to meet demand.
3. AWS is scaling up
Amazon Web Services has by far been the company's most profitable segment since Amazon broke out its numbers in 2015. That year, it had an operating margin of 19%, which rose to 25% in 2016. After a pause in growth last year, that margin has been widening again in 2018. It surged to 31% in the most recent quarter as the unit generated $2.1 billion in operating income, more than North American e-commerce did.
Again, Olsavsky credited previous infrastructure investments for the margin expansions, and noted that efficiencies in Amazon's data centers also help the e-commerce division, which is AWS' biggest customer. He also noted that capital leases, which include spending on its data centers, only increased 9% over the last four quarters, compared to 69% growth in 2017. Once again, Amazon seems to be reaching the point in terms of data center capacity where it no longer needs to invest in aggressive growth and can instead reap the benefits of that infrastructure.
What it means for investors
Amazon's surge in profits caught analysts off-guard, and even Olsavsky acknowledged that the results deviated from his own estimates. The company has crushed analysts' consensus forecasts over the last four quarters, beating them by an average of 90%. Admittedly, it does have a pattern of giving conservative earnings guidance, especially for the fourth quarter, as the vast majority of sales in that period come in its second half -- peak holiday shopping season. That suggests it's a good bet that Amazon will beat the analysts' consensus of $5.52 this quarter, especially as the benefits from the earlier investments discussed above are likely to persist.
Though Amazon's era of surging revenue growth is coming to end, the investments that drove the top-line rapidly higher now seem to be feeding the bottom line. As its intensive investment phase comes to a close, Amazon could have significant profit growth ahead.