(Bloomberg) — Amazon.com Inc.’s run as one of the best stocks this year will likely come down to the performance of a single business line: cloud computing.
That’s the lesson, at least, from the results delivered by Alphabet Inc. and Microsoft Corp. this week. The Windows software maker rode its Azure cloud-services business to a 3.1% gain on Wednesday, while Google’s parent suffered its biggest stock drop in more than three years after cloud sales marred otherwise strong results. Amazon sank 5.6% in a broad tech rout ahead of its earnings due on Thursday afternoon.
The divergence shows how central cloud computing has become for the tech behemoths following a rally this year that stretched valuations, contributing to an environment where any disappointments are being punished severely.
“I am a bit more nervous about Amazon now,” said Dan Eye, chief investment officer at Fort Pitt Capital Group. “Given where tech valuations are, you have to be selective. I’ve always been a bit cautious on Amazon since it runs such thin margins, and it seems fair to think that if it is also seeing some weakness with its cloud, that that will really show up in its operating margins.”
When Amazon reports third-quarter results, Amazon Web Services sales are expected to have expanded 12% to about $23 billion from the same period a year ago, according to the average of analyst estimates compiled by Bloomberg. Overall, Amazon is projected to deliver earnings per share of 58 cents on revenue of $142 billion, respective increases of 236% and 11%.
Compared with Alphabet, the stakes in cloud computing are even higher for Amazon, which relied on AWS for about 17% of sales and nearly three-fourths of its $7.7 billion in operating profit in the second quarter. By contrast, Google Cloud accounts for just 11% of Alphabet’s sales and the unit became profitable for the first time this year.
Amazon shares have rallied 45% this year, adding almost $400 billion in market value, as cost-cutting efforts have helped boost profits. But it’s come under pressure in recent weeks as traders have soured on more expensive growth stocks amid soaring US Treasury yields and geopolitical strife. Amazon’s price relative to projected earnings has come down, but at about 32 times it still trades at a big premium to the Nasdaq 100 at 22 times.
Despite the stock’s selloff on Wednesday, Timothy Ghriskey, senior portfolio strategist at Ingalls & Snyder, expects Amazon to deliver results more in line with Microsoft than Alphabet.
“Microsoft’s report speaks well for Amazon because both saw a slowing in cloud growth around the same time, so this suggests Amazon will also see a re-acceleration,” said Ghriskey. “That’s obviously very positive, especially since cloud is such a profitable business.”
Consumer spending has also held up better than expected, a potential tailwind for Amazon’s e-commerce business, according to Bill Stone, chief investment officer at the Glenview Trust Co. Amazon’s latest Prime Day event in October lifted shares and yielded positive comments from analysts.
And, though Alphabet’s cloud revenue fell short, search advertising brought in more than analysts expected. That should bode well for Amazon’s own ad business.
Ultimately, the recent weakness in Amazon shares around earnings could provide a good buying opportunity, according to analysts at Baird and Evercore ISI.
“We particularly like the risk-reward heading into the Q3 EPS print, given reasonably low expectations,” Evercore ISI’s Mark Mahaney wrote in a note, reiterating that Amazon is a top pick in the internet sector.
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Alphabet tumbled 9.5% on Wednesday, erasing about $180 billion from the Google parent’s market value, after the company’s cloud unit reported a smaller-than-expected profit. The loss was the biggest single-session market value wipeout for the search giant and the fourth-largest market value destruction ever among S&P 500 companies.
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–With assistance from Tom Contiliano and Subrat Patnaik.
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