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Amazon.com Inc. Earnings Preview: All Eyes Are on AWS

By Timothy Green - Oct 19, 2015 at 5:57PM

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The cloud computing business is turning into Amazon's crown jewel, and it will need to keep up its exceptional growth to satiate investors.

Online retailer and cloud computing giant Amazon.com ( AMZN -0.18% ) is set to report its third-quarter results after market close on Thursday, Oct. 22. Last time around, it managed to handily beat analyst estimates for both revenue and earnings, with the stock soaring as a result. Over the past three months, shares of Amazon have gained about 18%. Here's what investors should keep an eye on when Amazon reports its third-quarter results.

What analysts are expecting
Analysts expect to see revenue of $24.91 billion during the third quarter, a 21% year-over-year increase. Amazon posted 20% revenue growth during the second quarter, although foreign exchange rates had a significant negative impact. Excluding these effects, Amazon's revenue grew by 27% year over year. Guidance for the third quarter is for revenue between $23.3 billion and $25.5 billion, which represents year-over-year growth of 13%  to 24%.

Image source: Amazon.com.

Amazon expects its operating income to come in between a loss of $480 million and a gain of $70 million during the third quarter, an improvement compared to a $544 million operating loss during the third quarter of 2014. Analysts are forecasting a net loss of $0.13 per share, compared to a loss of $0.95 per share during the third quarter of last year.

The company managed to beat analyst estimates during the second quarter thanks to strong growth and improved profitability in both the North American retail segment and the AWS segment. North American retail sales rose by 25.5% year over year, with segment operating income more than doubling. Meanwhile, AWS revenue jumped 81.5%, with segment operating income increasing by a factor of five. AWS managed an operating margin of 21.4%, although it should be noted that stock-based compensation is not allocated to Amazon's segments.

Growth and profitability
As always, Amazon's revenue growth will likely trump profitability in terms of importance for investors. During the second quarter, it squeezed out a $92 million net profit, an improvement year over year but negligible given its quarterly revenue in excess of $23 billion.

It's unlikely that there will be any big surprises from Amazon's retail business. The North American segment has been reliably growing quarter after quarter, and profitability in the segment has been improving. This profitability may not stick around. Amazon isn't shy about investing in new initiatives that drive down profitability in the short term. But investors seem to care more about revenue growth than anything else.

The International segment is suffering from currency issues, stunting growth and leading to bigger losses compared to last year. During the second quarter, the unfavorable impact from currency knocked off $1.39 billion of revenue, a significant percentage of the $7.6 billion Amazon generated abroad. Many companies with International operations are suffering in the same way, and it's hard to say when things will get better.

All eyes will almost certainly be on AWS. Amazon's cloud computing segment managed to grow revenue by 81.5% year over year during the second quarter, an acceleration compared to the first quarter, when the segment posted growth of 49%. AWS revenue actually decreased sequentially from the first quarter of 2014 to the second quarter of 2014, likely due to price cuts, meaning that the rapid growth during the second quarter of 2015 may be partly due to an easy comparison. Assuming 80% annual growth going forward may end up being overly optimistic.

Regardless, AWS is growing extremely fast, and investors will expect continued rapid growth going forward. Amazon is facing plenty of competition, including Microsoft's Azure cloud platform and Oracle, which stated a few months ago that it was willing to compete with AWS on price. So far, though, competition seems to be having little effect on the growth of AWS.

With Amazon's stock price based on the long-term potential of the company and increasingly on the long-term potential of AWS, it's safe to say that revenue growth will continue to be the most important factor for investors.

This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium advisory service. We’re motley! Questioning an investing thesis – even one of our own – helps us all think critically about investing and make decisions that help us become smarter, happier, and richer.

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