People think of Amazon as an e-commerce company, but 74% of its profits come from e-commerce.

Amazon (AMZN -0.69%) is a technology powerhouse. Founded in 1994, it has amassed a valuation of $1.5 trillion in the 30 years since.

The company originally sold books online, but has expanded to include an estimated 12 million products in its catalog. In 2023, Amazon will account for 37.6% of all American e-commerce, light years ahead of second place. walmart It was 6.3%.

But here's the problem. Online sales, along with all but one other business, accounted for a portion of Amazon's operating profit through the first quarter of 2023 (ending September 30). It did not contribute to operating profit at all in 2022.

Below, we'll explain where Amazon generates the vast majority of its profits. This is an area that all investors should pay close attention to in the future.

E-commerce remains Amazon's largest segment

Before we dive into Amazon's profitability, let's take a look at where that revenue comes from. Although the company remains focused on its e-commerce business, it has expanded significantly over the years to include operations in cloud computing, digital advertising, robotics, and streaming.

Amazon generated $143.1 billion in total revenue in its most recent third quarter. Its earnings are:

Data source: Amazon.

As you can see, online sales remained Amazon's largest source of revenue. The second biggest factor was the fees charged to third-party sellers on Amazon's platform.

Advertising services are becoming increasingly important as Amazon explores new ways to sell digital ad spots to businesses on its website and through streaming platforms like Prime and Twitch. Advertising services revenue increased 25% year-over-year in the third quarter, the fastest growing rate of any segment.

But the most important business may be Amazon Web Services (AWS). It is the world's largest cloud computing platform, offering hundreds of digital solutions to businesses. It can help you store data, host digital sales channels, develop software, and even build artificial intelligence (AI) applications. The latter could be Amazon's biggest financial opportunity in history.

Most of Amazon's operating profit comes from AWS

For reporting purposes, Amazon divides its business into two categories: net sales of products and net sales of services. However, this alone does not tell us exactly where the profits are coming from. Therefore, the company has more granularity by dividing its financials into his three categories: North American sales, international sales, and AWS.

As mentioned earlier, Amazon has seven major business segments. North American and international sales aggregate the financial results of six of these companies, while AWS financials are reported separately. There's a good reason for that.

In the first three quarters of 2023, AWS achieved operating profit of $17.4 billion. By comparison, operating income from North America and international sales was just $6.1 billion.

Remember, while AWS revenue was only 16.1% of Amazon's total revenue, it accounted for a whopping 74% of the company's overall operating profit.

Cloud computing delivers high operating margins because selling digital services is a scalable business model. A single data center can serve the needs of thousands of businesses around the world, harnessing its computing power to run digital operations. AWS had an operating margin of 30.3% in the third quarter, but the operating margin for North America and international sales combined was just 1.8%.

Amazon must operate on razor-thin profit margins to sell its e-commerce division's products at low prices. Given that this is the company's largest source of revenue, it can drag down the performance of smaller divisions, even if they are profitable themselves.

North American and international sales in 2022 resulted in an operating loss of $10.6 billion, so AWS accounted for 100% of Amazon's operating profit for the year.

Amazon's stock price is incredibly low based on certain valuation criteria.

AWS' growing presence, especially in the artificial intelligence space, is a big reason why investors want to own Amazon stock. The platform now offers its own competing AI data center chips. Nvidia, we also developed a series of extensive language models in-house. This means that a company has access to all the hardware and software needed to build his AI applications on AWS.

Additionally, Amazon recently invested $4 billion in leading AI startup Anthropic. The company plans to use AWS as its primary cloud provider and Amazon's data center chips to train future models, especially as Nvidia faces supply constraints. There is a possibility that you will try it.

Amazon is scheduled to report its official full-year 2023 results in early February, with total sales expected to be $517 billion. Considering Amazon's current valuation of $1.5 trillion, the company's stock trades at just 2.7x price-to-sales (P/S).

It's very cheap compared to that microsoft The P/S ratio is 12.7. The company is home to Azure, the world's second-largest cloud platform, and has a growing focus on AI. Even though Amazon has higher revenues, Microsoft deserves a premium because it is more profitable overall. double Amount of income. I don't think Amazon's P/S ratio deserves to trade at such a steep 79% discount to Microsoft's P/S ratio.

In fact, based on the P/S metric, Amazon is the cheapest of all the “Magnificent Seven” technology giants.

Data by YCharts

Personally, I think the valuation gap could start to close in 2024 as AWS ramps up its AI efforts, which could pave the way for Amazon stock to move higher. .

The technology could add between $7 trillion and $200 trillion to the global economy over the next decade, depending on Wall Street's forecasts. As such, AWS will likely continue to make up a large portion of Amazon's operating profits, potentially making his AWS even more important to the company overall.