Amazon.com, Inc. (Nasdaq: AMZN) shares just hit an all-time high, threatening to breach $1,500 a share. AMZN stock can’t stop and won’t stop rallying.
Driven by meteoric revenue growth and expanding profits — Amazon earned a record $1.9 billion in the fourth quarter — Wall Street can’t help but be impressed. It’s a rare breed of company indeed that, in a $60 billion quarter, is still growing revenue 38 percent a year.
But as great as Amazon’s numbers were, and earnings per share growth over 150 percent is pretty good too, there’s one threat that the market doesn’t often acknowledge: Amazon Web Services (AWS).
[See: 7 Stocks Primed for an Amazon Buyout.]
AWS is Amazon’s Sword of Damocles. As an Amazon shareholder, it’s easy to lose humility with the stock up more than five-fold in the last five years. Add to that a broader stock market that’s been in rally mode for nine years — and hasn’t seen so much as a 5 percent pullback in 20 months — and most investors are probably more complacent than they should be.
But as most owners of AMZN stock will know, much of the stock’s impressive rally has been driven by AWS, Amazon’s market-leading cloud computing division, which has been growing like a weed.
Financial commentators are quick to point to the success of AWS as a reason to be bullish on Amazon stock. AWS provides two major tailwinds for Amazon.
— It’s large enough to pull Amazon’s overall revenue growth up with it. AWS posted revenue of $5.1 billion in Q4, up 45 percent year-over-year. This helped the company’s overall revenue to grow by 38 percent a year. Without AWS, Amazon’s overall growth would not be quite as impressive over the years.
— AWS’ huge margins give Amazon cash to innovate. This is the far larger point. In 2017, AWS posted operating income of $4.33 billion, or more than 105 percent of Amazon’s operating income as a company, which was $4.1 billion. Because AWS is such a cash cow, the rest of the company is able to operate at a loss.
If you think about it, this latter point actually makes AWS’s effect on Amazon’s revenue growth even more profound: Since AWS makes so much money, the company can price items on Amazon.com to sell for breakeven or at a loss, which obviously attracts more customers, and thus helps revenue growth.
This translates to other industries as well. Why did grocery stocks get hammered when Amazon bought Whole Foods in 2017? In part, because Kroger ( KR) and The Fresh Market don’t have a $20 billion cloud computing business with insane margins. If they buy an orange for 60 cents, they need to sell at 61 cents or more to make a profit. Not Amazon.
This cycle — Amazon CEO Jeff Bezos likes to think of such a self-reinforcing cycle as a “flywheel” — works great, as long as AWS continues to grow and maintain its massive margins.
And that is the crucial and unexamined assumption that has driven AMZN stock to meteoric levels: That AWS will remain dominant in perpetuity.
In the ancient Greek parable, an admirer of the king and tyrant Dionysius, Damocles, fawns over the king’s great power. The king invites him to swap positions with him for a day, and allows Damocles to feast and enjoy the fruits of power, but with a sword constantly hanging over his head, held by a single string of horse’s hair.
[See: 7 of the Best Stocks to Buy for 2018.]
AWS bears great fruits for Amazon shareholders, and is currently the cloud market leader. But a decline in its dominance could bring Amazon stock crashing down. Even a notable deceleration in its growth rate could be enough for Wall Street to start worrying and selling.
The cloud area is becoming more fiercely competitive by the day, with both Microsoft Corp. ( MSFT) and Alphabet ( GOOG, GOOGL) devoting serious resources and effort to growing their own cloud offerings.
Do not take AWS for granted, and remember that with companies, as with people, their greatest strengths can often also be their greatest weaknesses.
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Amazon.com, Inc.’s Achilles’ Heel: As Goes AWS, So Goes AMZN Stock originally appeared on usnews.com
