Predicting the movements of any particular stock is challenging, but historically it’s been easier with Amazon (NASDAQ: AMZN) stock. A pattern emerged years ago showing a strong correlation between Amazon’s price per share and its operating profit.
It might seem like calculating a business’ profits is a straightforward process. But in reality, there are multiple ways of looking at things. There are widely used accounting methods that take everything into account. But some businesses make long-term strategical moves that reduce accounting profits right now. Adjusting for these kind of things can paint a more accurate picture of the company. This is why multiple profit metrics are relevant to investors.
For Amazon, the operating profit metric looks at what the business is earning before factoring in other things such as interest expenses and taxes. Over the last decade, when operating profit rises, Amazon stock goes up most of the time, and vice versa, as the chart below shows.
In recent weeks, Amazon stock has plunged about 20%, and I’m sure that investors want to know what will happen next. Well, I’d say the next big move for Amazon stock will be predicted by forecasting the next big move for its operating income. And here’s what we can know about that right now.
Where are profits headed?
In the first half of 2024, Amazon had operating income of nearly $30 billion. This is an incredible 141% increase from the same period of 2023. And it’s worth noting that operating income over the last 12 months is at an all-time high.
As has long been the case, most of Amazon’s operating profit comes from Amazon Web Services (AWS). In the second quarter of 2024, AWS had an operating profit of $10.5 billion, which was 84% of the company’s total Q2 operating profit. Therefore, it stands to reason that if an investor can predict what will happen with Amazon’s AWS, they can predict what will happen with its overall operating profit.
On that note, I want to start by considering the revenue potential here. Amazon’s AWS is one of the top cloud computing platforms in the world. Research from firms Mordor Intelligence, MarketsandMarkets, Grand View Research, and Fortune Business Insights predict compound annual growth for the industry between 15% and 21% through 2028 and longer.
The point isn’t which research firm gets it exactly right. The point is that virtually all experts expect double-digit industry growth for a long time, which is a tremendous tailwind for growth for Amazon’s AWS.
Drilling down into the details of Amazon’s report, however, AWS growth may be about to slow down. It’s not normally in the press release. But in official quarterly filings, the company provides its remaining performance obligations, much of which is related to AWS. This is essentially future revenue under contract. Big growth from one quarter to the next can signal revenue growth for AWS in the near future.
At the end of Q2, Amazon had commitments of $157 billion compared to commitments of $158 billion in the first quarter. For perspective, that’s a drop of $1 billion compared with a $10 billion jump in the same period of last year. It’s not a foolproof predictor, but it could signal slowing AWS growth in the near term even though it has a strong industry tailwind.
Turning to profitability, Amazon’s management said it expects its expenses for AWS to go up in the back half of 2024 compared to the first half, specifically due to ongoing investments in artificial intelligence (AI). AI applications require specific hardware that the company has been buying in recent quarters, and it’s a cost that’s still going up.
These investments could impact the profitability of Amazon’s AWS in coming quarters. Considering all of these things together, it’s possible that Amazon’s operating income is plateauing for the time being.
What it means for Amazon stock
Assuming growth for Amazon’s AWS slows and its AI-related expenses rise, I believe it’s fair to assume that the company’s operating profit growth stalls. It’s important for investors to keep things in perspective — operating profit is at an all-time high and it’s an incredible amount of money at nearly $55 billion annually. But if the growth slows, I’d expect this to impact Amazon stock.
Over the next year or so, I predict that Amazon stock will remain largely where it is today. Keep in mind that it’s still up about 15% over the past year even after its 20% drop from highs. That’s still a healthy recent gain that shareholders should be content with.
I wouldn’t expect hot near-term gains for Amazon stock. That said, remember that the long-term outlook for cloud computing is still quite good. So within the next few years, I’d expect AWS to heat back up, leading to new highs for Amazon stock. It may just be an exercise of patience for shareholders.
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Prediction: This Will Be Amazon Stock’s Next Move was originally published by The Motley Fool
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