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3 Reasons to Buy the Recent Amazon Drop

By Chad Henage - Feb 13, 2014 at 10:00PM

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When a high flying company disappoints investors, it could either be the beginning of the end or a buying opportunity. There are at least 3 reasons to think Amazon's recent decline could be an opportunity for long-term investors.

For most companies a 20% increase in revenue, and a huge jump in earnings would be enough to send the stock flying. However, (AMZN -1.85%) isn't just an everyday company. Apparently investors were none too happy with the company's results and the stock dropped more than 10% on the news. That being said, there are at least three reasons investors should consider this drop as an opportunity to buy the shares.

This is what real growth is supposed to look like
For the better part of the last few years, Amazon has traded revenue growth for free cash flow. This follows a similar pattern of competitors like Netflix (NFLX -1.85%) as the streaming video company fights with Amazon's Instant Video for viewers.

Netflix is profitable in its core business of DVD mailers and domestic streaming, but every time the company expands into a new part of the world, earnings and cash flow take a hit. That being said, with an operating margin of 7%, Netflix seems to be doing fairly well.

On the complete opposite end of the spectrum is Amazon's competitor eBay (EBAY -1.88%), which sticks to its Marketplaces and PayPal business. These highly profitable businesses contribute to eBay's nearly 23% operating margin and cash flow that is the envy of many retailers.

Amazon's domestic operating margin declined sequentially from 5% at the end of 2012, to just under 3% in the third quarter of 2013. Over the all-important 2013 holiday quarter, Amazon not only increased sales by 20%, but the company's domestic operating margin increased to just under 5%. When a company reverses a four quarter margin decline, and maintains significant sales growth, this seems like one good reason to buy Amazon's recent drop in price.

The business no one talks about could drive Amazon's sales growth
Believe it or not, Amazon's traditional retail business performance is the second reason to buy the recent dip in the company's shares. In fact, the sale of physical goods is one of Amazon's fastest growing businesses.

Prior to the holiday quarter, Amazon generated about 66% of its domestic revenue from electronics and general merchandise sales. In the last quarter, this percentage ticked up to nearly 70% of domestic revenue. This higher percentage is important because while overall sales growth was 20%, the domestic electronics and general merchandise business grew revenue by 25%.

Given that this division posted the second-fastest revenue growth rate in the whole company, investors shouldn't discount the importance of Amazon selling physical goods.

A web of opportunity
The third reason to buy the recent dip in Amazon's stock price is the company's fast growing Web Services business. On the domestic front, Web Services represents less than 8% of domestic revenue, but with revenue growth of 52% this number is slowly increasing.

On the international front, Web Services is less than 1% of revenue, but this division posted 25% year-over-year revenue growth. In both the domestic and international divisions, Web Services was easily Amazon's fastest growing business.

According to IDC research, worldwide public cloud services revenue is a $130 billion a year business and is growing at a double-digit growth rate. Given that Amazon's combined "Other" category (in which Web Services is included) generated less than $4 billion in the last 12 months, you get an idea of how massive the opportunity is.

Netflix has a huge opportunity itself, as the worldwide streaming video market is expected to hit $35 billion in revenue by 2018. eBay's PayPal unit is hoping to continue taking market share in the worldwide payments market, which is worth hundreds of billions of dollars.

The difference between these two companies and Amazon is Amazon is already dominant in the sale of physical goods, and the domestic retail market alone is worth at least $600 billion. The bottom line is Amazon has massive growth opportunities in both retail sales and web services.

While Netflix may take a large part of the worldwide streaming business, this pales in comparison to Amazon's potential in just retail sales. eBay and PayPal may continue to grow quickly in retail sales and payments, but eBay's Marketplaces business is largely predicated on someone else selling their goods.

Amazon can control its own destiny in two huge markets. The company is growing fast, and with better margins than before. If Amazon can continue to grow both its retail sales and Web Services business at a significant rate, today could represent a rare buying opportunity for long-term investors.

Chad Henage has no position in any stocks mentioned. The Motley Fool recommends, eBay, and Netflix. The Motley Fool owns shares of, eBay, and Netflix. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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