Ever wonder why it's hard to identify good stocks? Best-selling author Nate Silver might say it has something to do with differentiating the "signal" from the "noise" -- things that matter and things that don't.
As Silver wrote, "Distinguishing the signal from the noise requires both scientific knowledge and self-knowledge: the serenity to accept the things we cannot predict, the courage to predict the things we can, and the wisdom to know the difference."
To understand why Amazon (AMZN -0.89%) stock has been a great investment, investors need to parse the signal from the noise. And in this article, I'll give you one noise-quieting chart that will help predict where the stock goes from here.
Here's the chart you need to see
My favorite chart for Amazon has two things on it: the stock price and trailing-12-month operating income. Operating income is the profit the core business earns, before factoring in other expenses the company might have.
When you look at the 10-year chart for Amazon, the correlation between the stock price and the company's operating income is simply too strong to ignore.
The chart does not show a perfect one-to-one relationship between these two factors. Amazon stock is up about 800% over the last 10 years, whereas its operating income is up a far bigger 2,700%. But the chart does show that when Amazon's operating income is going up, its stock price usually follows suit.
Driving operating income higher over the past decade is Amazon Web Services (AWS), the company's cloud-computing platform that launched in 2006. In 2013, revenue from AWS was so small Amazon didn't even break the number out in its annual report. But in the first half of 2023, the $43.5 billion of net sales for AWS accounted for nearly 17% of total net sales for the company.
More importantly, AWS generated $10.5 billion of operating income in the first half of 2023 -- that's 84% of Amazon's total operating income.
The takeaway is clear: Amazon's operating income has soared 2,700% in the last decade thanks to the stellar adoption of AWS.
If not for that business, returns for Amazon stock likely would have been quite different these past 10 years. This is why investors need to know what's going to happen with AWS from here.
What's next for AWS?
While the artificial intelligence (AI) buzz is relatively young in the investing world, AI and machine-learning advancements have been growing beneath the surface for years. And Amazon CEO Andy Jassy actually attributes a lot of growth of AWS to the AI trend in recent years.
I personally believe that AI is overhyped -- Wall Street has a consistent track record of irrational exuberance. That said, there is plenty of substance in this secular growth trend. At its core, AI is about making sense of massive amounts of data, and the business world is always trying to be more data driven.
The AI market will grow at a compound annual rate of over 37% from now through 2030, reaching $1.8 trillion, according to Grand View Research. I have no idea how precise this prediction will be -- the forecast could be overly optimistic. But even if it's just directionally correct, the AI trend alone provides plenty of logs to throw on the fire for AWS.
In other words, I'm optimistic that AWS has room for growth throughout this decade, and if AWS grows, so too should Amazon's operating income, which makes the stock a buy.
Indeed, 2023 is already signaling a solid outlook for AWS. As of the end of the second quarter, the company had $132.1 billion in remaining performance obligations, which are mostly related to AWS. This is how much money it expects will come in over the next few years just from existing cloud-computing agreements.
Remaining performance obligations for AWS in Q2 increased $12 billion from the previous quarter and $32 billion from the prior-year period. This growth is quite strong as it is. As the AI trend heats up, it could get even better.
There will be plenty of noise in coming quarter and years for Amazon -- it's a big company, and it's followed by many analysts and investors. But to me, the growth in AWS is the one signal that investors can't afford to lose sight of.