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This Is the Biggest Risk for Amazon Stock

Tom Taulli

For holders of Amazon (NASDAQ:AMZN) stock, it’s been a disappointing 2019. The return of AMZN stock was about 23%, which underperformed the 35.2% gain by the NASDAQ. And  Amazon stock greatly lagged Apple (NASDAQ:AAPL) and Microsoft (NASDAQ:MSFT) in 2019.

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That performance, though, is not necessarily something to panic over.  AMZN stock has been a standout over the long-term. For the past 15 years, its average annual return was about 28%.

Yet the performance of AMZN stock in 2019 should still be a warning sign, and it’s apparent that Wall Street is getting a bit antsy about the company.

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First of all, the company is stretched, with investments in a myriad of categories like streaming, healthcare, groceries, devices, apparel, and lending/payments. So far, Jeff Bezos has been able to somehow manage the complexities,  but it won’t get any easier for him. History shows that AMZN’s management will ultimately get overwhelmed, as happened to conglomerates like GE (NYSE:GE).

And with Amazon’s annual revenues over $230 billion, it is getting harder for the company to prevent its growth from slowing. Interestingly, as the company has become larger, it has become more vulnerable to potential antitrust actions.

AWS

So what is the biggest risk facing AMZN stock?  Well, it could easily be the company’s cloud business, which it calls Amazon Web Services or AWS.  Over the past ten years, AWS has been the biggest positive contributor to Amazon’s profits. In fact, if Amazon did not get into the cloud business, the company would be much smaller today.  Note that AWS currently accounts for 70% of the company’s operating income. In other words, AWS has masked the low margins of the company’s core e-commerce business while enabling AMZN to invest in new categories.

But there are some danger signs emerging  for  AWS.  Just look at the competition.  Nowadays AWS must take on numerous rivals like SAP (NYSE:SAP), Oracle (NYSE:ORCL), IBM (NYSE:IBM), MSFT and Alphabet (NASDAQ:GOOGL, NASDAQ:GOOG).  All of those companies have the resources to put up a tough fight against AWS, as they all have substantial capital, technical talent, global customer bases and extensive product lines.

Because of all that, Amazon is starting to lose some of its advantages. AWS’ offerings now look comparable to those of  Microsoft’s Azure, for example,. Consider that MSFT recently won a coveted $10 billion cloud contract with the US. Department of Defense. No doubt, this will likely lead to other major contracts for Azure. According to Wedbush analyst Dan Ives: “Microsoft remains in an enviable position heading into 2020 on the heels of its cloud success as it continues to fire on all cylinders around its Office 365 and Azure strategic vision.”


Microsoft, along with other mega tech operators, also can be price competitive, since it has other high-margin businesses.

And, in an ominous development for AMZN stock,  AWS’ margins and growth are both slowing. In Q3, its growth came in at about 35%, versus  the 40%+ rate that it was generating not long ago. Its margins fell from 31.1% in Q3 of 2018 to 25.1% in Q3 of 2019.

On the earnings call, there was little explanation for the weakening of AWS. But it does seem like a good bet that the competition is starting to take a toll.

The Bottom Line on AMZN Stock

Again, there’s probably no reason to panic. AWS still throws off substantial cash flows, and its growth is still fairly strong, given its large revenue base.

But in the tech world, things can go sideways fast. And given the fact that AMZN stock fetches a high valuation and relies heavily on AWS, the unit’s unexpected deceleration could be a big-time problem for Amazon stock.  Thus, it’s a good idea to be cautious on AMZN and keep an eye on how its business progresses.

Tom Taulli is the author of the book, Artificial Intelligence Basics: A Non-Technical IntroductionFollow him on Twitter at @ttaulli. As of this writing, he did not hold a position in any of the aforementioned securities.

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