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  • Amazon reported record profits in 2018, earning $10.1 billion in net income compared to just $3 billion in 2017.

  • Considering the company hardly had any annual profit until 2016, this represents major growth.

  • Whether that's gap earnings, operating income, free cash flow, this company hit an inflection point at the beginning of 2018.

  • It's one of the reasons that the stock materially outperformed the market.

  • Traditionally, Amazon has funneled most of its money straight back into the company itself, leading to meager earnings compared to other tech giants like Apple or Google.

  • But in spite of this strategy, Amazon has been making enough lately that there's still money left after all of its expenses on inventory, fulfillment centers and people.

  • Amazon still doesn't have the types of profits that other big tech companies do, say a Google or an Apple or a Microsoft.

  • But significantly more than they ever have in the past and it really allows them to do much more experimentation with the core business.

  • So what's changed?

  • Though Amazon has long dominated the U.S. e-commerce market, online sales are not actually the biggest moneymaker for the company.

  • Its e-commerce division isn't even profitable internationally.

  • Instead, Amazon Web Services, or AWS, has generated the majority of the company's operating income since 2016.

  • AWS is Amazon's cloud computing division, comprised of a huge network of servers providing processing and storage solutions for companies, government agencies and individuals.

  • What that did for Amazon is it turned Amazon into a technology company as well as being an e-commerce and retailer.

  • Its clients, which include Netflix, Airbnb and Yelp, are charged for their volume of usage, the features they subscribe to, and the services they use.

  • AWS really started to grow about four or five years ago and became a significant force in computing.

  • Amazon Web Services continues to get bigger as a percentage of overall revenue and it's a highly profitable business by Amazon's standards.

  • But by most corporate standards, it's doing something like 30 percent operating margins.

  • In 2018, AWS brought in 7.3 billion dollars in operating income and 25.7 billion dollars in revenue which, for reference, is more than both McDonald's and Macy's.

  • In this last quarter, AWS was 58 percent of total operating profit for Amazon.

  • So it's still clearly the profit driver for the overall company.

  • In fact in 2017, AWS was actually more than 100 percent of Amazon's operating profit.

  • So without AWS, Amazon would not have been making any money.

  • But though it's a huge reason behind Amazon's recent profitability, other areas of the company are seeing major growth as well.

  • The fastest growing division of Amazon is its other category, comprised mainly of its advertising business.

  • It grew 95 percent in the fourth quarter of 2018 and brought in $10.1 billion in revenue for the year overall.

  • As Amazon has become the center of commerce for a lot of businesses, it's becoming a huge advertising play as well.

  • They don't break out the profits of this, but looking at comps like Facebook and Google, it's almost certainly also in that 30 percent operating margin range.

  • If advertising continues to grow at this rate, some analysts even predict it will be more profitable than AWS by 2021.

  • The last segment experiencing major growth is the third-party marketplace.

  • While Amazon traditionally buys products in bulk from wholesalers and sells them at a slight markup, in the third-party marketplace outside companies pay Amazon to sell their goods using its platform.

  • Amazon takes about a 15 to 20 percent cut of the sales, while also collecting fees for things like storage and shipping.

  • While Amazon generates significantly less revenue from third-party merchants than from products it sells, margins are much higher, making it more profitable than the traditional model.

  • If you assume even a small 5 percent margin, you're talking about potentially two billion dollars in profit just from third-party contributing to overall Amazon.

  • Today, more than half of all goods sold come from third-party sellers, and more and more businesses are signing up.

  • Sales of third-party seller services rose 34 percent in 2018 to 42.7 billion dollars.

  • You really have to be on Amazon, unless you are going to go it alone.

  • Amazon is the only place where you can instantly get scale without having to do all of the marketing yourself.

  • Amazon smart speakers also have analysts excited.

  • The last thing I find really interesting is Alexa.

  • So you now have an installed base of over 100 million of these voice-activated devices.

  • Over time, you'll find yourself increasingly turning to Alexa, and say "Alexa, order more coffee."

  • And it's one of those things that will accelerate the move of Amazon into two places, the pantry and into the refrigerator.

  • The boom in all these categories, from Alexa to cloud computing, advertising and third-party seller divisions, raises the question of how the company should be valued.

  • At the size of the company now, well over 200 billion dollars in annual revenue, it's just really hard to grow at 20 plus percent.

  • So that means these investors who have expected high growth repeatedly every quarter are now looking at a company with slowing growth but lots of profitability.

  • There's clearly some consternation in the investor community as to how to value Amazon today.

Amazon reported record profits in 2018, earning $10.1 billion in net income compared to just $3 billion in 2017.

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    Fibby posted on 2019/12/11
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