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December 20, 2015

One Large Cap Tech Stock That Should Be in Everyone’s Portfolio

I hear these words a lot: “I just don’t get it, how can Amazon keep going up when it loses money every year?”

That’s a reasonable question to ask.

Amazon is an extraordinary business, but perhaps not for the reasons you might think. Yes, you can order just about anything you might need, and have it shipped to you just about anywhere in the world.

In some major cities, you can receive your package in less than 24 hours. Where I live, in Tokyo, if I order something at 8 a.m. it arrives usually by 5 p.m. the same day. While impressive, that’s not what makes Amazon special.

The company is so unique because it has never strayed from its core operating principle. Build scale… Be ruthless on operating expenses. Deliver a fantastic customer experience… Plow any earnings right back into the business… Continue to innovate…

Amazon has never allowed itself to get caught up in the quarterly earnings game on Wall Street. CEO Jeff Bezos understood from the beginning that as long as the company stayed true to its principles, the stock price would take care of itself. He most certainly has been right.

That last piece of Amazon’s operating principle – continue to innovate – is what drives the company’s success as a business and an investment.

What many people don’t know about Amazon is that it is more than the world’s e-commerce site. It is also the largest cloud service provider in the world.

The company’s Amazon Web Services (AWS) division rents out computing power, data storage, and servers to people and companies that want to deliver a service or application in the cloud. Companies that use AWS benefit greatly as they do not have to build out and manage their own data centers. Instead, they can simply lease AWS services for a fraction of the cost.

AWS was established in August 2006, but Amazon didn’t start breaking out the segment’s revenues until 2014. What the market learned at that time was extraordinary. AWS revenues were already at $1 billion a quarter. Today, they’re more than $2 billion… and still growing (see chart below).

What is even more significant than the rapid revenue growth is the amount of operating income that AWS generates. AWS accounts for about 8% of Amazon’s revenue… but 52% of the company’s operating income.

With all that momentum, AWS is now the fastest growing enterprise technology company ever. It is currently valued at about $160 billion, more than half of Amazon’s total value of $312 billion. That makes it the profit engine that allows Amazon to continue to invest in growing its e-commerce business, which runs at extremely low margins. And that e-commerce business continues to lead the market, growing strong double digits year after year.

Amazon’s dominance in e-commerce is hard to overestimate. In the United States, 7% of the total retail market is now conducted via e-commerce… and that number is growing every year.

By 2016, Amazon will have more than 15% of that market, or about $52 billion.

Part of that growth is thanks to Amazon’s knack for introducing new ways to reach its customers.

Amazon recently released “Echo,” an Internet-connected device – it looks like a sound speaker – that will transform the way people shop. Simply say, “Alexa,” and Echo comes to life, asking you how it can help. It can search the Internet for you, play you a song, or order a book through your Amazon account.

The company also introduced the “Dash” button. This is a physical, Internet-connected button you’d place somewhere in your house. And each time you push it, it automatically re-orders a specific product for you. For example, you’d stick a laundry detergent Dash button next to your washing machine. Now, whenever you’re low on detergent, you simply press the button and your order will be at your door in no time.

Amazon is also doing some futuristic things with transportation. For suburban and rural areas, Amazon has already announced its Amazon Prime Air service. The goal is to deliver packages in 30 minutes or less. The delivery vehicles are unmanned aerial vehicles, otherwise known as drones. I can tell you, the technology is very real, and Amazon is already testing its second generation of delivery drone technology.

Furthermore, it is expected that the Federal Aviation Administration will approve regulations permitting drone delivery services by June 2016. So certain areas of the U.S. could begin seeing Amazon Prime Air service before the end of next year.

To help reach that goal, Amazon has added 21 new logistics facilities around the world in the last 12 months. This is an increase of 14% from the previous year. In total, Amazon has 173 global logistics facilities, 104 of which are in North America.

Amazon’s logistics goal is incredible actually. In dense, urban areas where there are a lot of Amazon Prime members, the goal is to be able to deliver packages within a day and for certain items within an hour.

The strategic play by Amazon is easy to see. By deploying its own delivery services in urban areas and rural areas, it is able to remove the middleman. This will help expand Amazon’s profit margins and free cash flow, and it gives even more flexibility to reinvest and innovate.

The bigger and potentially more interesting story is Amazon’s challenge to UPS, FedEx, DHL, and the U.S. Postal Service.

Amazon had a fantastic 2015, more than doubling its stock price from around $300 to about $650. But it’s not done yet…

Amazon’s e-commerce and AWS divisions are slated for continued growth. And it continues to innovate in new business areas, specifically transportation and logistics. That makes it a stock every serious technology investor should own.

It’s not an investment that’s going to double in the next 12 months. But as a long-term holding, Amazon is an absolute must-own large-cap technology stock.

Courtesy of Jeff Brown for Bonner & Partners

The views and opinions expressed herein are the author's own, and do not necessarily reflect those of EconMatters. © EconMatters All Rights Reserved | Facebook | Twitter | Free Email | Kindle

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