It turns out that even powerful Amazon (AMZN -0.39%) is not immune to the negative effects of inflation and rising interest rates. For example, quarterly revenue growth rates for the North American and international e-commerce segments peaked in the first quarter of 2021. Worse, both e-commerce companies had an unprofitable fourth quarter of 2022.
As for Amazon Web Services (AWS), revenue has plummeted over the past few years amid increased competition and the law of large numbers, which dictates that the larger a company, the harder it is to match previous growth rates grows.
For example, in the fourth quarter of 2018, AWS grew revenue 45% year over year, and in the fourth quarter of 2022, the cloud unit delivered just 20% year-over-year revenue growth. Additionally, AWS operating income declined 2% year over year in its most recent fourth quarter.
With Amazon’s primary growth drivers giving investors little to get excited about since the first quarter of 2021, investors have been intrigued by the growth potential of Amazon’s burgeoning digital advertising business. However since alphabets (NASDAQ:GOOGL) (NASDAQ: GOOD) Google ad business and metaplatforms (NASDAQ:META) Family of app companies, including Facebook, have dominated the online advertising industry for about a decade, raising questions about whether Amazon’s advertising business is worth investors’ attention as a potential long-term growth engine.
Let’s take a look.
His advertising unit takes part
According to an Axios article citing statistics from Insider Intelligence, in 2022, Google and Meta together achieved less than 50% market share for the first time in eight years. These stats show that both companies are losing market share, and the main reason for this is Amazon, which ended 2022 with a 7.3% digital ad market share. Still, analysts are predicting that its share will skyrocket to nearly 13% by 2024, closing the gap to Meta’s projected 17.9% share — down from the 19.6% market share that Meta achieved in 2022.
Many advertisers gravitate towards Amazon ads as it is the most effective and cheapest way to advertise online.
According to a Feedvisor report, citing a 2020 survey of over 1,000 brands, 36% of all brands say Amazon gets the highest return on media spend, followed by paid social at 29% and Google at 27%. Even better, 59% of brands on Amazon’s e-commerce marketplace say they get the highest return on media spend, followed by Google at 22% and paid social at 17%.
As for the cost, according to a report by According to ecommerce analytics firm Sellics, Amazon ads are 68% cheaper than Google, 44% cheaper than Facebook, 79% cheaper than Instagram, and 13% cheaper than its ecommerce competitor Walmart (NYSE: WMT).
Why investors are interested in his ad unit
While Alphabet’s advertising unit and Meta’s advertising lost about 4% in revenue year over year in the fourth quarter, Amazon’s advertising unit returned 19% year over year, despite an advertising market that global media company Magna Global looks set to slow further into 2023. And only the 20% revenue growth in the AWS segment was better for it in the fourth quarter. However, the main reason investors are showing strong interest in the ad segment is that it’s probably the most profitable part of its business.
While the company doesn’t disclose the profitability of its ads business, analysts have roughly calculated the profitability Amazon generates from advertising by comparing it to the profitability of Google and Meta’s advertising units and making a few assumptions. Most analysts conclude that Amazon’s advertising unit is more profitable than AWS.
In addition, AWS also requires significant capital investments, long-term investments in property, equipment, land, computers and software required to operate the cloud business. In his fourth-quarter 2021 earnings call, Chief Financial Officer Brian Olsavsky announced for the first time that nearly 40% of his capital expenditures will go towards supporting AWS.
Assuming that’s true; In 2022, $25 billion in capital expenditures went into supporting AWS, while AWS had just $22.84 billion in operating income for the same year. Amazon likely uses all of the AWS segment’s operating income to pay for the cloud entity’s capital expenditures. As such, AWS currently has weak free cash flow. And if you assume advertising is a less capital-intensive business, it produces better free cash flow than AWS.
However you choose to analyze it, advertising is a fast-growing, profitable growth engine for Amazon that may already be its most valuable business.
A foggy short-term future
Amazon shareholders should understand that a recession would not benefit any of its businesses, including advertising, which essentially depends on the health of its e-commerce markets.
Let’s say you want to invest in Amazon stock for its long-term advertising potential. Be aware that things can get a lot worse before they get better, and the ad business won’t step in to save the day.
As the economy normalizes over the next year or two, the advertising business is likely to become its main growth engine and a strong thesis to become a shareholder.
Suzanne Frey, an executive at Alphabet, is a member of The Motley Fool’s board of directors. John Mackey, former CEO of Whole Foods Market, an Amazon subsidiary, is a member of The Motley Fool’s board of directors. Randi Zuckerberg, a former director of market development and spokeswoman for Facebook and sister of Mark Zuckerberg, CEO of Meta Platforms, is a member of The Motley Fool’s board of directors. Rob Starks Jr. has positions at Alphabet and Amazon.com. The Motley Fool has positions in and recommends Alphabet, Amazon.com, Meta Platforms, and Walmart. The Motley Fool has a disclosure policy.
