2 Reasons Why Amazon Stock Could Keep Falling

Shares in e-commerce and cloud computing juggernaut Amazon (AMZN 1.74%) have fallen by more than 50% since their peak in late 2021. Amazon’s market cap has fallen below $1 trillion, and while sales continue to grow, profit and free cash flow have fallen off a cliff. For the trailing 12-month period, even the most optimistic free cash flow metric Amazon reports was a loss of $19.7 billion.

While some are betting on the stock making a comeback, there are some reasons to believe it will continue to suffer in 2023. While it’s hard to say whether Amazon is a good long-term investment, it’s looking pretty dicey in the short-term. Here’s why.

1. A struggling retail business

Amazon’s retail side — which includes direct sales, third-party business, Prime, advertising, and essentially anything that isn’t Amazon Web Services (AWS) — has some issues.

The company built too much during the pandemic to meet strong demand, and now it’s struggling with excess capacity, an uneven environment for consumer spending, and competition from traditional retailers like Walmart and Goal who have spent the pandemic investing heavily in e-commerce.

Amazon’s North America and International segments combined generated more than $300 billion in revenue for the first nine months of 2022, but both segments lost money on an operating basis. Combined, Amazon posted an operating loss of more than $8.1 billion.

During that nine-month period, these two segments included $9.5 billion in advertising revenue, which is believed to be a high-margin revenue stream; $8.9 billion in revenue from subscription services like Prime and $28.7 billion in revenue from third-party seller services. These sources are growing faster than online sales revenue, and yet both segments are now posting big losses.

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Amazon’s fast-growing advertising business gets a lot of attention, but it hasn’t improved the bottom line at all. In my opinion, it doesn’t make sense to treat Amazon’s advertising activities as a separate business, as they are closely related to the retail business. All that ad revenue just seems to subsidize losses elsewhere.

It’s great that Amazon figured out how to generate billions in ad revenue, but ads have done absolutely nothing to improve the profitability of its retail business. As consumers retreat, Amazon’s retail business could weigh on profits for much of 2023.

2. A potential AWS slowdown

AWS is an incredible business. It’s the dominant provider of cloud infrastructure services and is still growing rapidly and producing sky-high profit margins. For the first nine months of 2022, AWS revenue increased 32% to $58.7 billion and operating income increased 30% to $17.6 billion.

Over the long term, the cloud infrastructure industry should continue to grow at a healthy pace. Aside from the fact that newer companies are naturally cloud-first, large companies have many on-premises workloads that could move to the cloud over time. AWS is tailor-made for the largest companies and will likely win a lion’s share of these deals.

In the short term, however, a slowdown is quite possible. A possible recession next year will put many companies in cost-cutting or survival mode. Start-ups that have not previously given any thought to rising cloud computing bills will now take a closer look and work on cost optimization. Companies that like to talk about “digital transformation” will slow down or put those plans on hold.

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Amazon’s market cap — nearly $900 billion — is largely based on assumptions of continued rapid growth and strong profitability from AWS. If that growth slows and margins shrink while companies cut costs, the stock market could reconsider the company’s premium valuation. The stock is already down more than 50% from its all-time high, but the valuation is still extreme.

Based on the median analyst estimate for 2023, Amazon stock is trading at more than 50 times earnings. This estimate has wide error bars, but it’s hard to argue that the stock is cheap. If AWS shows signs of slowing demand over the next few quarters, the bottom for the stock could be quite a bit lower.

John Mackey, CEO of Whole Foods Market, an Amazon subsidiary, is a member of The Motley Fool’s board of directors. Timothy Green has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Amazon.com, Target, and Walmart. The Motley Fool has a disclosure policy.