5 Things To Watch When Amazon Reports Earnings On Thursday

Amazon is expected to report EPS of $0.76 on $32.66 billion in revenue. EPS comparisons to last year mean little, since Amazon just started trying to become profitable about three quarters ago. Nevertheless, its revenue growth is incredibly impressive for a company this size, with expected growth of 28.7% year-over-year, from the $25.36 billion it showed during last year's Q3.

Just when you think Amazon might be slowing, it picks up the pace of growth yet again. Q2's revenue growth in North America was 28%, compared to 26% during Q1. Operating margins were also up in North America, from 3.4% in Q1 to 3.9% in Q2, an improvement of 50 basis points. Revenue growth in North America came largely from increased unit sales, which reflects a simple truth—Amazon keeps managing to sell more and more products.

According to recent reports , Amazon is becoming the new Google (NASDAQ:GOOGL) for online product searches, supplanting the search engine giant for many consumers. Over 55% of Americans now turn to Amazon first, compared to 27% who start the product hunt using conventional search engines. The trend clearly favors Amazon; Last year 'just' 44% of first product searches started with Amazon.

Internationally, Amazon is expected to top $10 billion in quarterly sales for the first time. That's even better news than it seems for future sales. Here's why: while this division likely remains in the red because of high infrastructure expenses—which last quarter were $9.75 billion for the full site, domestic and international—overseas operations and potential sales haven't yet matured. Therefore, infrastructure is still a developing line item. With already slim margins from retail sales, a hallmark of the retail sector, that puts Amazon in the red, but only for now. As Amazon's international business continues to develop, it's a good bet that profitability from this sector won't be out of reach for very long.

One interesting driver could come from India where Flipkart, currently the leading e-commerce site on the subcontinent, and Walmart (NYSE:WMT) have been talking about partnering, in order to block Amazon from taking over India's emerging, and potentially lucrative, market. In response, Jeff Bezos, Amazon's CEO, has pledged to invest an additional $3 billion in developing AMZN's business in India.

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For Amazon's bottom line, Amazon Web Services (AWS) is the gift that keeps on giving. Amazon was famously one of the first companies to jump on the cloud computing bandwagon, which now pays hefty dividends for the company. Last quarter, revenue from AWS was almost $2.9 billion, or 9.5% of the company's total revenue. AWS's contribution to the corporate bottom line is astonishingly disproportional—it represents 55% of the total operating income of the entire business. Chalk this up to the gaping difference in operating margins between the retail and cloud businesses. In stark contrast to the low single digit margins of its retail business, AWS' margins are significantly higher—closer to 25%.

This is probably the most underappreciated segment of Amazon's business. Its Prime Video service, bundled with the regular Prime membership—but available also as a stand-alone item since April—has perhaps been a little late to the streaming-on-demand party, but is nevertheless a player now. Up until now, Netflix (NASDAQ:NFLX) has been the leader in this category, but Amazon is gaining significant traction and quickly, particularly when it comes to customer satisfaction. Responses to a recent survey of overall customer satisfaction showed Amazon with 58% of customers who responded that they were "highly satisfied" with the service, compared to Netflix's 59% customer satisfaction rate.

During the company's last conference call, Brian Olsavsky, Amazon's CFO, said the company will double its investment in video, while tripling the amount of original content it provides. Expenses for "Content and Technologies" amounted to $3.8 billion last quarter, proving that Amazon isn't at all satisfied with playing second fiddle to Netflix. Amazon Studios, which produces Amazon's original programming, has released such shows as the critically acclaimed Transparent, which debuted in September 2014 and won five Emmys during its first season alone, The Man In The High Castle which debuted in 2015 to universal praise and has been renewed for a second season which will be released in early December, as well as the highly anticipated Good Girls Revolt which will be released on Friday.

Amazon's business is built on its ability to deliver physical products quickly and efficiently. The latest advance in Amazon shipping innovation is a dedicated air cargo network. Indeed, Amazon is rolling out a fleet of its own. In August it unveiled Amazon One , a leased Boeing (NYSE:BA) 767-300 which will deliver orders within the US, allowing the company to expand its one- and and two-day delivery capabilities. According to Amazon's plan, the network will eventually have a fleet of 40 planes, 11 of which will be dedicated deliveries. Add that to the maritime shipping license recently granted to the company by the Federal Maritime Commission, and it's clear that a grand shipping scheme is beginning to take shape.

Conclusion

Our position on Amazon hasn't changed since last quarter. We continue to believe it is a truly stellar company with plenty of room to grow within every single segment of its business. At $835.18 at yesterday's close, we also believe it's priced accordingly.

The current P/E ratio is 207, but is expected to fall to 78 based on predicted one-year-forward earnings. Meaning next year's expected earnings, at the stock's current price, would lower the P/E ratio by almost two thirds. The question is, will the share price track accordingly and keep the P/E ratio in the hundreds, or will the price stagnate and let the P/E ratio catch up through increased earnings?

Amazon is one of the most difficult companies on which to offer predictions because of its valuation. On the one hand, the growth prospects are potentially significant. On the other hand, it's expensive (as evident by its currently lofty P/E).

Nevertheless, at this time last year, Amazon shares were trading for about $530. Two years ago, in September, the price was around $320. That’s a breathtaking 56% rise in share price on top of an already stupendous 67% rise. While more growth in share price is certainly possible, the meteoric ascent described above is likely closer to the end of its trajectory than to its beginning. In our view, Amazon is now a classic case of higher risk for higher reward. If your risk-tolerance allows, it could still be a buy.

Written By: Investing.com