Friday, Jan 31st 2020

Amazon Q4 Earnings: Operating Leverage 101


The Results

On Thursday after hours, Amazon soared more than +10% after reporting Q4 earnings. The rally put Amazon above the elite $1 trillion valuation threshold once again, a watermark shared by several other Titan portfolio companies.

From the stock price performance, you might imagine Amazon absolutely crushed the quarter (and they did, in many important respects) but there's far more to the story here than you might think.

But first: the headline good news.

The Profit Surprise

Q4 represented an absolute blowout quarter for Amazon from a profitability perspective, with operating income and earnings per share exceeding analyst estimates by an incredible 44% and 60%, respectively.

However, what may surprise you is that revenue only exceeded estimates by approximately 2%.

How can this be?

In short, we believe much of the outperformance on the profitability side came from the rapid pace of growth in Amazon's still-nascent advertising business.

We've been tracking a noticeable acceleration in advertising density on Amazon's e-commerce platform throughout the back half of 2019, and that seems to have flowed directly into Amazon's bottom line profits in Q4, catching analysts (who may not have been focusing very much on a <10% revenue segment) off guard.

This is a phenomenon commonly referred to amongst investors as…

Operating Leverage 101

When a small, but high-margin business gets weaved into the business model of a large, but low-margin business, that can have an extremely dramatic impact on financial outcomes.

Take advertising for example. Although Amazon doesn't break out their advertising business specifically, assuming that segment occupies the majority of Amazon's "other" revenue line, at typical advertising margins, that segment could have wound up contributing the majority of Amazon's operating profits in the fourth quarter.

That's when advertising is still less than 10% of Amazon's overall business from a revenue perspective!

That's what we believe to be the beauty of Amazon's scale-driven business model. The more scale they attain, the stronger the operating leverage they will benefit from as they layer in new, high-margin business segments.

As these high-margin businesses throw off tremendous cash flow, Amazon becomes increasingly able to reinvest in their core platforms and customer experiences.

In this particular quarter, the operating leverage came from a surge in the advertising business at a time when analysts were all laser-focused on the incremental expenses coming out of Amazon's roll-out of its new one-day free shipping initiative.

Color us unsurprised at the street's surprise here.

The Takeaway

Aside from the big Q4 profit beat, we generally pleased with the rest of the earnings report.

While the forward operating income guidance of $3-4.2 billion felt a little light to us (especially after adjusting for a change in fixed asset depreciation methodology), Amazon historically has been quite conservative in its first quarter guidance.

In other words, we would not be surprised to see Amazon exceed the high end of the $1 billion+ wide operating profit range they put out for next quarter.

The stabilization around growth in AWS (Amazon's cloud services business and other major profit contributor) was also a nice to see as we believe many investors had been seeking clarity around the trajectory of AWS amidst noise of increasing competition from Microsoft's Azure and GCP.

On net, we felt like Q4 was solid, although the outsized stock price reaction seems to suggest a bit of a relief rally baked in. We'll continue to keep our eyes trained in on Amazon's growth trajectory, particularly in the all-important cloud and all-too-overlooked advertising segments in the coming quarters.

As of this writing, AMZN was a portfolio holding of Titan. This security may cease to be a portfolio holding at some point in the future.
Back to Research ↗

Learn with titan

Investment articles and resources

Become the smartest investor you've ever been through straightforward, easy-to-read investment articles.

What Is the Price-to-Earnings (P/E) Ratio? Definition & Examples

Examples of How to Short a Stock

What Is the Debt-to-Equity Ratio?

What Are Inverse ETFs and How Do They Work?

Let's Get Started

Ready to become a client?

Create an account with us in two minutes.

Or scan to get the app

We're building the best investment platform, ever

Titan Global Capital Management USA, Inc ("Titan") is an investment adviser registered with the Securities and Exchange Commission (“SEC”). By using this website, you accept our Terms of Use and Privacy Policy. Titan’s investment advisory services are available only to residents of the United States in jurisdictions where Titan is registered. Nothing on this website should be considered an offer, solicitation of an offer, or advice to buy or sell securities. Past performance is no guarantee of future results. Any historical returns, expected returns [or probability projections] are hypothetical in nature and may not reflect actual future performance. Account holdings are for illustrative purposes only and are not investment recommendations. The content on this website is for informational purposes only and does not constitute a comprehensive description of Titan’s investment advisory services.

Refer to Titan's Program Brochure for more information. Certain investments are not suitable for all investors. Before investing, consider your investment objectives and Titan’s fees. The rate of return on investments can vary widely over time, especially for long term investments. Investment losses are possible, including the potential loss of all amounts invested. The introducing Broker Dealer is Titan Global Technologies LLC, a registered broker-dealer and member FINRA/SIPC. Brokerage services are provided to Titan Clients by Apex Clearing, an SEC registered broker-dealer and member FINRA/SIPC. For more information, see our disclosures. Contact: 508 LaGuardia Place NY, NY 10012. Information provided by Titan Support is for informational and general educational purposes only and is not investment or financial advice. Check the background of these firms on FINRA's BrokerCheck.

© Copyright 2022 Titan Global Capital Management, Inc. All Rights Reserved.