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The 1 Thing You Should Know Before You Buy Amazon

By Adria Cimino – May 30, 2020 at 9:30AM

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Amazon is known for selling groceries, books, and movies -- but its cloud computing business is a key profit driver.

Amazon.com (AMZN 1.20%) stock, up 33.2% since the start of the year, has been one of the market winners in 2020. Investors flocked to buy the shares as consumers flocked to the retail giant to buy essentials during the coronavirus pandemic. When most of us think of Amazon and its revenue potential, we think of this demand for general merchandise or groceries on the e-commerce site -- or even new signups to its Prime membership program.

But a big part of Amazon's revenue growth has to do with its cloud computing business, Amazon Web Services (AWS). The one thing you should know before buying Amazon shares is this: AWS operating income made up about 77% of Amazon's overall operating income in the first quarter. That's up from a 50% share of overall income in the same period a year ago.

Even if AWS' percentage contribution to operating income doesn't move any higher, it still will remain a key profit driver. Why? Let's take a look at AWS' market share and the demand for cloud computing services.

A person's hands are shown on a laptop with a cloud image above them.

Image source: Getty Images.

Market leader

AWS holds a nearly 48% share of the worldwide infrastructure-as-a-service (IaaS) public cloud market, making it the market leader, according to a Gartner report from July 2019. Microsoft (MSFT -0.20%) is in the second position, with about 16% of the market. In a separate report last November, Gartner predicted the global public cloud services market would grow 17% this year to reach $266.4 billion.

But that was before the coronavirus pandemic. Though the outbreak halted certain large projects, demand for general cloud computing services climbed as many companies shifted to remote working. Spending on cloud infrastructure services reached a record in the first quarter, rising 34% to $31 billion, according to Canalys.

As workers continue to telecommute during the next stages of the coronavirus crisis and some continue working from home even beyond the crisis, AWS may benefit from higher demand. And once business is back to normal, some of those postponed projects will start coming through as well.

Though the future looks bright for AWS, and therefore for Amazon, there are still a couple of points to watch. Industries most hurt by the coronavirus crisis, such as travel-related or retail companies, may delay spending on cloud infrastructure projects. This could impact AWS and its rivals.

Microsoft jumps ahead

And speaking of rivals, one, in particular, is catching up. While AWS holds the largest share of the market, Microsoft has jumped ahead when it comes to sales and growth rate. Microsoft's commercial cloud revenue jumped 39% in the most recent quarter to more than $13 billion, while AWS' revenue rose 33% to about $10 billion. And though AWS has been growing sales more than 30% each quarter over the past year, it posted quarterly sales gains of as much as 49% back in 2018.

While it's important to keep an eye on those elements, for now, I don't see them darkening AWS' future. It's not uncommon for a player that has been around for a while to see growth slow from the earlier ramp-up stages. (AWS launched in 2006, while Microsoft started its cloud computing business in 2010.) And increases in cloud infrastructure spending offer room for a few players to flourish.

As for AWS, with double-digit growth quarter after quarter and a lead in market share, I expect the business to be a significant contributor to Amazon's profit well into the future. And that's great news for Amazon's stock price.

John Mackey, CEO of Whole Foods Market, an Amazon subsidiary, is a member of The Motley Fool's board of directors. Teresa Kersten, an employee of LinkedIn, a Microsoft subsidiary, is a member of The Motley Fool's board of directors. Adria Cimino has no position in any of the stocks mentioned. The Motley Fool recommends Gartner. The Motley Fool owns shares of and recommends Amazon and Microsoft and recommends the following options: long January 2021 $85 calls on Microsoft, short January 2021 $115 calls on Microsoft, short January 2022 $1940 calls on Amazon, and long January 2022 $1920 calls on Amazon. The Motley Fool has a disclosure policy.

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