It's no secret that Amazon.com (NASDAQ:AMZN) has been a growth machine over the years. Prior to the recent downdraft in the market, the stock seemed to be ready for another epic run. But while recent headlines have focused on how the company is handling external forces, there's a not-so-subtle transformation occurring internally. Over the next few years, investors shouldn't be worrying if the massive retailer can keep up its revenue growth; they should be enjoying a services company with serious cash flow.

Amazon fulfillment services

Amazon fulfillment services

(Image credit: Amazon.com)

One of these things is not like the other

Amazon seems to be taking a page out of Apple's playbook. It's been noted repeatedly that Apple is moving beyond the iPhone into services. On the other hand, while Amazon Web Services (AWS) gets a lot of press, most people associate Amazon with retail. But the company is becoming less reliant on product sales -- and it's much further along in changing its business model than its peer.

For most companies with a product focus, the end-of-the-calendar-year quarter is the largest revenue contributor. If either Apple or Amazon are going to transform their business model, it makes sense to look at the most challenging quarter to accomplish this feat. Looking at Amazon's fourth quarter over the last several years, the pathway is clear.

Quarter

Product Sales

Services Sales

Products as % of total revenue

Services as % of total revenue

Q4 2016

$30.6 billion

$13.1 billion

70%

30%

Q4 2017

$41.3 billion

$19.1 billion

68.4%

31.6%

Q4 2018

$44.7 billion

$27.7 billion

61.8%

38.2%

Q4 2019

$50.5 billion

$36.9 billion

57.8%

42.2%

(Source: Amazon quarterly earnings for Q4 2016, 2017, 2018, and 2019 -- percentages author's calculation)

Even during the holiday quarter, when Amazon seems to dominate product sales, the company's services business is growing much faster. As a quick point of comparison, in Apple's holiday quarter, products made up 86.2% of the company's total revenue, compared to 87.1% last year. Apple's much-hyped services business moved up from 12.9% to 13.8% of the company's total revenue. In case there's any question about Apple's results, CEO Tim Cook put those thoughts to rest in the earnings call by saying, "Our record performance was fueled by iPhone."

Though AWS' growth is well-known, the company's service offerings go beyond this business. The key to understanding Amazon as an investment is seeing that products are today, but services are tomorrow.

4 times 30

It's relatively easy to make a comparison between AWS and Apple's services business. AWS generated almost $10 billion in revenue last quarter, whereas Apple's services business posted $12.7 billion in revenue. However, there are two significant differences between these two businesses.

First, AWS grew revenue by almost 34% over the year-ago quarter, whereas Apple Services grew by just under 17%. Second, while Apple has another fast-growing business with wearables, home, and accessories, this division is still heavily reliant on two products: Apple Watch and AirPods. On the flip side, beyond AWS, Amazon's "other" business (think advertising) grew revenue by more than 40% annually. The company also generated 30%-plus revenue growth from its subscription services and third-party seller services.

With four different divisions growing revenue by more than 30%, Amazon's future growth is high-margin and diversified. In fact, Amazon's improved gross margin was made up of three main driving forces: The company attracted more third-party sellers, AWS had a strong quarter, and the company spent less than expected on the transition from two-day shipping to one-day.

Amazon's third-party business is far more impressive than some investors give the company credit for. In 2018, the company reported that third-party sellers generated 58% of the company's physical gross merchandise sales. Amazon's revenue growth gets significant scrutiny, yet there is another number that may be a better indicator of Amazon's future trajectory.

Show me the money

For many years, investors were asked to believe in Amazon's future as it lost money to expand. Today, the story is very different. Amazon's service businesses are cash-flow machines.

Cash is something that Apple and Amazon have in common. Apple has clearly stated that it expects to reach a cash-neutral position over time. In short, Apple expects to spend enough on dividends and share repurchases to bring its net cash balance to essentially zero. The company generates huge free cash flow, so it will continue paying dividends and buying back stock but without keeping a huge net cash balance. Amazon on the other hand, hasn't really commented on what it plans to do with its cash.

Company

Amazon net cash*

Apple net cash*

Quarter ending in December 2017

$6.2 billion

$174.7 billion

Quarter ending in December 2018

$17.8 billion

$142.3 billion

Quarter ending in December 2019

$31.6 billion

$103.8 billion

(Source: Amazon and Apple quarterly earnings. * Net cash position equals cash and investments minus long-term debt.)

It seems clear that Amazon's net cash position has jumped over the last few years. In the meantime, Apple has been spending its cash on dividends and share repurchases. While Amazon's net cash has increased by a compound annual growth rate of almost 126% over the past two years, the stock has increased an average of more than 27% per year during that same time frame.

By comparison, Apple's cash has declined by almost 23% annually over the past two years. In the meantime, the company's stock price has increased at an annual compound growth rate of just under 30%. Apple has spent billions buying back stock and theoretically increasing the value of its remaining shares. In the meantime, Amazon's shares increased by less than 2% over the last three years. Faster net cash growth, almost the same stock price increase, and without a share buyback, Amazon seems like a clear winner.

What's next?

Amazon Web Services is a significant growth driver, but investors shouldn't overlook the importance of advertising and third-party services -- Amazon has multiple service businesses growing at 30% or more. The strength of Amazon's services businesses gives the company a twofold advantage. First, service profits can help subsidize its products business. Second, the less Amazon relies on its own physical product sales, the easier it will be for it to expand its margins. Though the transition to one-day shipping is helping the company's online sales improve, its services should be the driving force behind margin, earnings, and cash flow.

With the services business generating more than 42% of total revenue today, compared to 30% just a few years ago, it seems the magical 50% of revenue is just around the corner. Once services takes over the lion's share of revenue, the company's revenue growth could accelerate. Long-term investors should take advantage of this recent downdraft to snap up the shares as Amazon moves beyond the store.