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Amazon Just Posted a Record Profit Margin: 3 Reasons It Will Get Even Better

Gone are the days when Amazon (NASDAQ: AMZN) was just a company operating at breakeven, surrounded by doubts over whether it would ever be profitable.

Today, the company is an absolute profit-generating machine. Amazon finished 2020 with $21.3 billion in net income, making it one of the most profitable companies in the world, and in the first quarter of this year, the company posted a bottom-line result of $8.1 billion, setting a new quarterly record. At a net margin of 7.5%, the quarter also represented its highest profit margin in more than a decade.

Those results are no accident. They're the outcome of the years of investment, a reputation for great customer satisfaction, and the build-out of a series of competitive advantages that has unlocked high-growth, high-margin businesses.

While there's no doubting Amazon's profit potential now, its margin is still going to keep expanding. Here are three reasons why.

Image source: Amazon.

1. Its third-party marketplace keeps growing

Amazon started out as a direct e-commerce seller. That business is still its biggest source of revenue, but it's a low-profit one. Costs are high in direct e-commerce, and the company competes against a wide range of both brick-and-mortar retailers and e-commerce companies.

Its third-party marketplace is the real profit driver for its marketplace. Amazon provides services like fulfillment for vendors who want to sell on its platform and charges a commission for each sale. Since its launch in 1999, that business has become larger than its first-party sales, and in the first quarter, 55% of units sold on Amazon were from third-party sellers.

It's not clear how much profit Amazon makes on its third-party sales, but the margins are significantly better as the marketplace leverages the company's competitive advantages, including Amazon's huge customer base, high traffic, and logistics network. It also has no real direct competitor as a marketplace. While Etsy has made itself a home for artisans, and Walmart is building out its own e-commerce platform, Amazon is by far the leading option and the first place most online sellers go. Amazon has also spent $45.4 billion on capital expenditures in the past year, much of it going to logistics to improve capacity and shipping speeds. That will only make the platform more appealing to third-party sellers.

Thanks to those advantages, the marketplace should only gain more share of the overall e-commerce business, generating more profits.

2. Advertising is a juggernaut

Amazon launched its advertising business in 2008 and didn't ramp it up until recent years. It's now the third-biggest digital advertising business behind Alphabet and Facebook, and advertising complements the marketplace in many ways as it helps sellers boost sales.

In the first quarter, sales from Amazon's "other" category, which is primarily made up of advertising, jumped 77% to $6.9 billion. This is high-margin revenue for the company as the infrastructure to sell ads is already there. It's just leveraging the traffic already coming to its website and the sellers who are already doing business on its platform.

On the earnings call, CFO Brian Olsavsky said traffic has been strong, but he also credited the advertising team for rolling out new products and increasing relevancy and conversions.

Digital advertising more broadly is experiencing a boom as strong earnings reports from Alphabet and Facebook this quarter have illustrated. Screen time has surged during the pandemic, and businesses are hungry to capitalize on the economic reopening -- that should lead to strong advertising demand at least through the rest of the year.

3. AWS is still a beast

Amazon helped pioneer cloud infrastructure services with Amazon Web Services, which has been a key driver of the company's profits for close to a decade. While more attention has been given to the e-commerce side of the business recently, AWS continues to grow and churn out increasing profits, showing no signs of slowing down.

In the first quarter, the cloud computing division saw revenue grow 32% year over year to $13.5 billion, and its operating income rose 35% to $4.2 billion.

Olsavsky highlighted momentum at AWS and said it was seeing growth accelerate across a broad range of customers, including new commitments with sports leagues like the National Hockey League and the PGA Tour, Walt Disney to help power Disney+, automakers like Torc robotics, and telecoms like DISH Network.

While Amazon has more competition in cloud infrastructure than it once did, the industry is growing briskly and generates high margins, so it will continue to be a long-term profit driver for the company.

Amazon is likely to face some headwinds later this year as the economic reopening will be a challenge for e-commerce, but its momentum across a number of businesses keeps snowballing. For the second quarter, the company is calling for 27% revenue growth at the midpoint of its $110 billion to $116 billion range, and operating income should land between $4.5 billion and $8.0 billion. Based on its recent performance and momentum, the tech giant could fly past that forecast once again.

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John Mackey, 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 to its CEO, Mark Zuckerberg, is a member of The Motley Fool's board of directors. Suzanne Frey, an executive at Alphabet, is a member of The Motley Fool’s board of directors. Jeremy Bowman owns shares of Amazon, Facebook, and Walt Disney. The Motley Fool owns shares of and recommends Alphabet (A shares), Alphabet (C shares), Amazon, Etsy, Facebook, and Walt Disney. The Motley Fool recommends the following options: long January 2022 $1920.0 calls on Amazon and short January 2022 $1940.0 calls on Amazon. The Motley Fool has a disclosure policy.


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