Signs of Evolution in, Inc. (NASDAQ:AMZN), Inc. (NASDAQ:AMZN) dropped to a new multi-month low on Friday based on Q4 revenue guidance that came materially under analyst assumptions for the new quarter. In addition, the company broke an important streak by guiding its earnings estimates below analyst expectations for the first time this year.

If you want to really break things down, the AWS growth slowed, but the company was able to increase margins in that segment. Still, the fact that it is now starting to have to reach for higher fruit on the tree is a measure of the difficulty of growth for this segment. And that’s unlikely to change as a new theme for the company going forward., Inc. (NASDAQ:AMZN) grew Q3 sales 29% to $56.6 billion, which was towards the high end of its $54-57.5 billion forecast, but missed sell-side estimates by 0.8%. Weakness came from the international segment, due to the strong dollar and tough comparisons from lapping the Souq acquisition and a shift in the Diwali holiday into the fourth quarter.

In addition, operating income grew 973% to $3.7 billion, which was well above $1.4-2.4 billion guidance.


Breaking it Down

As noted above, while the company’s market-leading cloud-computing business Amazon Web Services’ (AWS) growth slowed a bit sequentially, margins were better than expected, expanding 560 basis points to 31.1%. AWS profit accounted for 56% of the company’s third-quarter operating income versus 337% of profit one year ago, meaning AWS is no longer subsidizing the rest of the company. What’s more, the high-margin advertising business still represents a large opportunity and grew 123% to $2.5 billion.

However, guidance for the holiday quarter has caused some consternation. Amazon called for fourth-quarter revenue growth to slow to 10-20% to $66.5-72.5 billion, almost 6% below consensus at the midpoint. Amazon tends to guide conservatively, so consensus is still near the high end of the company’s wide forecast.

Retailers have been forced to beef up their online efforts as Amazon has taken significant market share in the retail sector. Amazon reportedly accounts for nearly half of eCommerce sales in the US and 5% of all retail sales.

Q4 operating income of $2.1-3.6 billion was 27% below consensus, but the company tends to surpass its profit guidance so it may very well report profit above the consensus from yesterday, which was nearly $4 billion. The company’s increase to a $15 hourly wage for all employees weighed on the bottom line, but the company did not quantify that impact.

After years of growing the height and width of the flower stem, AMZN’s story is finally becoming more about the blooming of the profit flower than about the expansion of the revenue stem. The transition from growth to value can be a difficult one for investors – Apple stock lost nearly 50% of its value between late 2012 and early 2013 as it became apparent that profits would fall 2013.

The outlook is still quite promising right now given AMZN’s dominant market position in strong secular growth businesses (eCommerce and cloud computing) that are generating more recurring, high-margin services revenue. While the stock may appear expensive with an $810 billion market value at 64x next year’s earnings, it trades at less than 20x free cash flow per share estimates for next year.

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