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Amazon's retail business is nice. But the catalysts investors should be watching are AWS and advertising.
As of last quarter, demand for AWS services exceeded supply.
A small position in the stock ahead of earnings might make sense.
Amazon (NASDAQ: AMZN) reports earnings on Thursday, Oct. 30, after the close. Some may be tempted to guess the stock's next move. But that's not the right game. Earnings-day reactions are notoriously unpredictable; just a single negative surprise on a key metric like revenue, margin, or guidance can spark a sell-off. Of course, things can go the other way, too.
The better question is whether the setup looks attractive for long-term investors at today's price. Amazon runs one massive online retail business and two high-margin operations: AWS and advertising. If those two pillars are growing at healthy clips and the price of the stock is reasonable (I believe it is), a small position in the stock may make sense -- even if the post-report stock price move is unpredictable.
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Image source: Amazon.com.
Amazon's most recent quarter showed steady operating momentum. Second-quarter net sales rose to $167.7 billion, up about 13% year over year. Amazon Web Services (AWS) revenue increased 17.5% to $30.9 billion, and management called out solid traction in both generative AI and non-generative AI workloads.
Amazon CFO Brian Olsavsky explained the strength of AI as a demand driver for Amazon's cloud-computing AWS business in the company's second-quarter earnings call:
During the second quarter, we continue to see growth in both our generative AI and non-generative AI businesses as companies turn their attention to newer initiatives, bring more workloads to the cloud, restart or accelerate existing migrations from on-premise to the cloud and tap into the power of generative AI.
Though still a small business relative to the rest of Amazon's sprawling operation, advertising grew about 23% year over year -- another sign that brand dollars continue shifting toward Amazon's properties and advertising platforms.
Operating income for the quarter reached $19.2 billion, up from $14.7 billion a year earlier. As usual, AWS was the main profit driver; the segment accounted for 53% of the quarter's total operating income.
The main focus when Amazon reports earnings will probably be AWS, given the company's momentum in AI.
"In the rapidly evolving world of generative AI," explained Amazon CEO Andy Jassy in the company's second-quarter earnings call, "AWS continues to build a large, fast-growing, triple-digit year-over-year percentage multibillion-dollar business with more demand than we have supplied for at the moment."
But this growth comes at a massive cost. The company's AWS capital expenditures have soared recently, weighing on free cash flow. For instance, Amazon's trailing-12-month free cash flow is $18.2 billion, down from $53 billion in the year-ago quarter.
With big investments like this, it raises the bar regarding what investors expect from AWS. If there's no acceleration in the business over the next year, shares could be punished.
Fortunately, the stock's underperformance this year relative to the S&P 500, even as sales growth and profits have improved, has left it more reasonably valued. As of this writing, Amazon trades around 34 times earnings and roughly 29 times forward earnings. Price-to-sales is about 3.6. For a business with double-digit revenue growth, improving operating income, and fast-growing high-margin segments (AWS and advertising) that could help lift the company's operating margin over time, this isn't a bad price to pay.
Of course, while it's great that demand for AWS is so high, the company's inability to meet supply is a key risk to consider. If the company can't ramp up its services to capitalize on soaring demand, the important segment may not be able to generate enough profits to justify its large capital expenditures. Additionally, heavier capital spending to address its constraints could further pressure free cash flow. Another risk is that any weakness in the U.S. consumer could show up quickly in retail sales and advertising demand.
Ultimately, the investment case for Amazon today rests on whether AWS and advertising can keep compounding while the company's retail business continues to scale. If investors believe these growth levers are here to stay, then shares are probably a good buy now.
At the stock's current valuation, I think the overall risk-reward is attractive. But we're far from bargain territory. For this reason, investors may want to keep any positions in the stock small.
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*Stock Advisor returns as of October 20, 2025
Daniel Sparks and his clients have no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Amazon. The Motley Fool has a disclosure policy.
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