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How Amazon
Is Constructing
Its Profitability
by Brick
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Company, etc.G
Will
Amazon
ever be
consistently
profitable?

June 20, 2016

| About: AMZN +0%

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Just a year ago, the question will Amazon (NASDAQ:AMZN) ever be profitable might not have had

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a clear answer. The e-tailers struggles with high shipping costs are well known and continue to

plague profitability even now. Though overall revenues hit $107 billion in the last fiscal, the margins
in retail both domestic and International were wafer thin.

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Suddenly, out of nowhere, Amazon Web Services (AWS) quickly took center stage as a much more
profitable segment of its business, and Amazon is now a consistently profitable company. Does it

matter that retail is still touch and go? Of course, it does. But the magnitude of negative impact has

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AMZN Price Chart

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been greatly reduced by the profitability of AWS so much so that it is now the higher earner of the

500

two in terms of operating income.

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How is that significant to an investor?

Amazons valuation is already high, so isnt

AWS just filling the upside gap at this point?

The answer to that would have to be a yes,
but AWS is not the only one pulling its own

weight. As the worlds largest online retailer

pushes into more countries and more markets,

it is gradually building a portfolio of products and services that will serve the long-term goal of
profitability.

The new profitability equation

Lets take AWS as our first case in point. Conceptualized in 2003 by two employees looking to

reduce IT infrastructure costs, the service came into public view a few years later. From that time,

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and within a span of 10 years, it has grown from a cost center to a profit making unit that makes
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even Amazons core retail business look bad.
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Company,
etc.Gocrown, generating $604 million in operating income
Today,
AWS
is the
biggest
jewel
in Amazons

this past quarter alone. Thats more than what both domestic and retail divisions put together
brought in.

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But thats just the first chapter in Amazons profitability story. The next member of the portfolio I
mentioned is Amazon Prime.

When Prime was launched in 2005 in the U.S. and subsequently to the U.K., Germany and

Canada no one expected it to become the huge success that it is today. Of course, Amazon plays

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its cards close to its chest, but several educated estimates put its user base at somewhere around

46 million members as of January 2016. At the current $99 fee, that translates into $4.6 billion every
year.

Not an exact number by any means but accurate enough for the purpose of building this case.
As such, Prime has been one of its most outrageously successful initiatives in retail. But it's not

sitting on its laurels. As an example, lets take its planned launch of a paid music streaming service.

This is separate from Amazon Prime Music, which is offered along with Prime Video on the standard
membership and will be in direct competition with products like Apple (NASDAQ:AAPL) Music and
Spotify.

The new service will be charged at $9.99 a month, and do you know why it's doing that? The

royalties it currently pays to provide free streaming music to Prime customers on the Amazon Echo

need to be offset in some way, and spinning off music as an independent paid service is possibly the
best way to do that.

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And that brings us to the Amazon Echo family of smart home appliances. Not many people

understood what the Echo was when Amazon launched it to early users in 2014 and to everyone
else in 2015, but today it has a user base of over 3 million and counting.

At $179.99 for the Echo edition, $129.99 for the Tap version and $79.99 for the Dot model, we can

assume minimum revenue earned of about $300 million since its public launch a year ago. And with
the introduction of the Smart Home Skills API, we can expect a slew of new apps that interact with
our homes in intelligent ways. With these extended possibilities, sales can be expected to show
continued strong growth over the next several quarters.
The investment angle
These additional revenue streams that Amazon is continually creating all serve one purpose: to

bolster the companys bottom line profitability until it figures out the shipping puzzle. Shipping costs

continue to grow as retail top line grows, and Amazon needs these monies to stay profitable through
that journey.

As of now, AWS is its biggest net income earner and could well start to rival retail incomes over the
next decade. It is already the largest provider of cloud Infrastructure-as-a-Service in the world, and
with enterprise-level companies like Intuit (NASDAQ:INTU), Netflix (NASDAQ:NFLX), Comcast
(NASDAQ:CMCSA), Airbnb, Yelp (NYSE:YELP), Pinterest and Nasa already on board, theyre

growing this business not only with attractive entry pricing, but an expanding range of value-added
services that further fuel its top line income.

Its doubtful if Amazon will ever report stand-alone numbers for Prime memberships, but even

conservative estimates show that its contribution to overall revenue is not insignificant by any means.
And with newer product lines like the Echo and paid streaming music being added to the fold and
doing extremely well, its only a matter of time before they start contributing to the top and bottom
lines in a meaningful ways.

As Amazon continues its pursuit of innovative ways to bring down its shipping costs and turn its retail
business into a consistently profitable unit, these younger revenue streams are what our eyes
should be firmly fixed on.

From an investment perspective, these initiatives give Amazon the time it needs to resolve its retail

profitability issues. If youre going to put money into Amazon, I would advise a dollar-cost averaging

approach over a two- to three-year time frame. The biggest benefit of doing that with a growth stock
is that it will help keep your cost basis down as much as possible even as your total returns keep
growing in lockstep with stock prices.

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For example, if you had purchased 10 shares per month on the eighth/ninth of each month over the
past five months, this is what your returns might look like:

Under this scenario, your cost per share over the period will have been $608.71 against the current

price of $706.39. As current share price changes over time, so will your returns but as long as the
stock keeps rising, so will the value you hold.

Obviously, this is an overly simplistic way of calculating your return on investment since it doesnt
take other factors into consideration, but it gives you a good idea of how the highly disciplined
method of dollar-cost averaging can keep your returns high and your costs low.

For a growth stock with a such a high P/E ratio, this is probably one of the better investment
strategies to follow long term.

Disclosure: I/we have no positions in any stocks mentioned and no plans to initiate any positions
within the next 72 hours.

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