Despite Amazon (AMZN 3.43%) being a behemoth $1.65 trillion company at the end of January, the fourth quarter results released on Feb. 1 were so impressive that the stock rose nearly 8% the next day, adding another $125 billion to its market cap.
For reference, that's like adding another business the size of Lowe's or UPS to its market cap. Despite this jump, I think it's just the beginning for Amazon's stock, as there was a lot of promising news in this report.
Amazon's services are becoming a bigger part of the picture
Amazon is slowly becoming a service-based company rather than an e-commerce store. Although revenues from its online stores grew at a respectable 9% pace to $70.5 billion, its service divisions fared much better.
| Service Division | Q4 Revenue Growth (YOY) | Revenue |
|---|---|---|
| Third-party seller services | 20% | $43.6 billion |
| Advertising services | 27% | $14.7 billion |
| Subscription services | 14% | $10.5 billion |
| Amazon Web Services | 13% | $24.2 billion |
Data source: Amazon.
Combined, its services division had $83 billion in revenue, exceeding its online stores. Additionally, these services have higher margins than e-commerce, so Amazon's earnings exploded higher in Q4: Net income was $10.6 billion compared to just $278 million last year. The biggest contributor was Amazon Web Services (AWS), its cloud computing division. Although this segment used to provide Amazon with incredible revenue growth, its biggest contribution now is operating income growth. AWS's operating income rose by 38% year over year to $7.2 billion -- a margin of 30%.
Management said revenue growth may accelerate in the year as artificial intelligence (AI) workloads are causing revenue to accelerate. This would be huge news for Amazon investors, as an increased growth rate from AWS would dramatically expand its profits due to its high margins.
But perhaps the most important service segment for Amazon is its ad business. Even in 2022 and 2023, when the ad market was weak, Amazon's ad business never grew at less than a 22% rate on a currency-neutral basis. This shows the demand for ads on Amazon's platforms is massive, and the segment will continue to be an area to watch in 2024.
Business is good for Amazon, and 2024 is expected to be another strong year.
Amazon's stock looks expensive on a price-to-earnings basis
For the first quarter, Amazon's management expects revenue growth of about 10.5% and operating income of around $10 billion. Both figures were great guidance and show how well Amazon is doing.
However, some investors may look at Amazon's stock valuation and think it's too high, especially based on its price-to-earnings (P/E) ratio.
AMZN PE Ratio data by YCharts.
However, it would be a mistake to gauge Amazon's stock this way. Although Amazon has posted strong profits, it hasn't yet optimized all of its expenses.
On the Q4 earnings conference call, analysts asked if CEO Andy Jassy is using 2018's operating margins as a "North Star" for the company to return to. In 2018, Amazon's North American business (everything in North America, excluding AWS) posted operating income of $7.3 billion with a margin of 5.1%. In 2023, Amazon's operating income was $14.9 billion, but its margin was only 4.2%.
Jassy downplayed the idea that the company was trying to return to 2018's margins, as he believes it can achieve better than that. So, Amazon is growing and improving its margins, making the P/E ratio less meaningful.
As Amazon moves toward maximum profitability, its P/E ratio will drop. But until that time comes, it's better not to use it.
Amazon's business is moving in the right direction, and I'm confident 2024 will be an even better year (mostly because of tailwinds in the AWS business driven by AI). As a result, I'm still a buyer of Amazon's stock despite its recent large one-day movement.
