Amazon's (AMZN 0.23%) third-quarter report sent its stock tumbling on Thursday, October 27, after the company posted weak fourth-quarter guidance. The quarter itself was not too bad. Revenue increased 15% year over year, a strong showing in this economy, and smack in the middle of its guidance for 13% to 17%. Operating income of $2.5 billion came in on the high side of expectations, which were $0 to $3.5 billion. Amazon Web Services' (AWS) growth began to decelerate after many quarters of steady growth, which is a natural outgrowth of clients decreasing spending.
Management is guiding for revenue to increase by 2% to 8% in the fourth quarter. The fourth quarter includes the all-important holiday spending season, and analysts were expecting more, so this was disappointing.
But management isn't sweating. It has many plans in place to drive sales this season, and it's focused on the customer experience. Let's see why this is a Buffett stock and how that's playing out right now.
What makes Amazon a Buffett company?
Warren Buffett has given many, many sage pieces of advice over the years about how to invest wisely. There is no magic formula that he uses to buy stocks or acquire companies for his holding company Berkshire Hathaway (BRK.A 0.55%) (BRK.B 0.50%), but we can get a picture of what he thinks are key features of an investment-worthy candidate.
One of those features is its moat. A moat is a competitive advantage, or basically anything about the business that allows it to stand out from its competitors and protect its business. He qualifies that with an extra detail: "Long-term competitive advantage in a stable industry is what we seek in a business."
With a whopping 38% of all e-commerce sales, a number that has mostly held steady over the past few years despite an onslaught of new companies with an e-commerce presence, Amazon dominates e-commerce. Its more than 200 million Prime members, who pay $139 annually, rely on it for a massive amount of needs, and other companies that have tried to challenge it have so far come nowhere near real competition. Walmart, for example, has launched its own annual service and makes up 6.3% of the e-commerce market share. Buffett, or likely one of his investment managers, bought Amazon shares in 2019. Since the "stable business" is part of the equation, Buffett may not have considered Amazon a buy before e-commerce proved its business value.
Amazon continued to plow investments into the customer experience in the third quarter, and while it may struggle in the coming months, these investments are what help its moat stay wide. As CFO Brian Olsavsky put it on the third-quarter conference call, "We remain heads-down focused on driving a fantastic customer experience, and we believe putting customers first is the only reliable way to create lasting value for shareholders."
But there's more.
New ways to make even more money
Buffett has expanded his own company for decades. Investors talk about what stocks he buys for Berkshire Hathaway, but what Buffett really likes to do is acquire whole businesses if he thinks they're great. Did you know that Berkshire Hathaway owns 65 companies? That's more than the stocks it owns, which are around 40. Some of the companies you might recognize are the Duracell battery company and Benjamin Moore paints.
This is what Buffett says about expanding a business:
There's no rule that you have to invest money where you've earned it. Indeed, it's often a mistake to do so. Truly great businesses, earning huge returns on tangible assets, can't, for any extended period, reinvest a large portion of their earnings internally at high rates of return.
Amazon follows this model very closely. It uses its huge e-commerce business to fund other businesses, which are often more profitable than its core business. AWS is the most obvious example. AWS has been providing most of the company's operating income for a while.
The company has also made many whole acquisitions, such as the pending purchase of iRobot. Some of these acquisitions are integrated into the Amazon platform, such as MGM studios, whose film library has been added to the Prime library. iRobot is an example of a whole company Amazon will leave to run on its own.
Can Amazon keep growing?
Buffett invests in companies that he believes offer high potential for long-term gains. He has said that his favorite holding period is "forever." Amazon's moat and ability to expand into new areas can give investors confidence that it has plans to grow for the foreseeable future. Amazon stock is down 44% this year, and investors can see the drop as an opportunity to buy shares.