Amazon.com (AMZN 2.52%) is a giant internet retailer. It has also evolved over time to provide cloud computing and other technology services. The historical view of the company, however, needs to be considered carefully when you examine Amazon as it exists today. Simply put, don't buy this stock for its retail business. Here's why.
Amazon is a giant, complex company
The first thing to recognize about Amazon is its size. With a $1.3 trillion market cap, it eclipses almost all other companies. Indeed, there are only a handful of companies that play in the same market cap area. And with second-quarter sales of $134 billion, there's a lot of revenue being generated by Amazon's collection of businesses.
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That's actually important to dig into. For starters, the company breaks the top line of its income statement down into two components: product sales and service sales. Product sales in the second quarter totaled $59 billion while service sales were notably larger at $75 billion. While Amazon started its life as a book retailer, selling physical products most certainly isn't the company's biggest business today.
That statement isn't meant to suggest that Amazon isn't an important online retailer. Clearly it is still a giant retailer with a huge presence. And its influence in the retail sector is just as giant as its business. But there's some more to understand here.
Amazon's retail business isn't the profit machine you may think
So far the top line is all we've examined here. But retailers have to buy the products they sell before they generate revenue by selling them. That's generally known as cost of goods sold. Amazon defines cost of goods sold as:
Cost of sales primarily consists of the purchase price of consumer products, inbound and outbound shipping costs, including costs related to sortation and delivery centers and where we are the transportation service provider, and digital media content costs where we record revenue gross, including video and music.
Most of that is typical for a retailer. The complexity comes in with the digital content. But, in fairness, that content is used to attract Amazon Prime subscribers, which includes free shipping on purchased products. So, in many ways, it is akin to a promotional expense. Spending less on content might result in customers leaving the Prime service and, thus, buying fewer items from Amazon. In the second quarter, Amazon's cost of goods sold was $69 billion.
Now put those two numbers together and you can see that retail isn't exactly Amazon's best business. The math is, roughly, $59 billion in product revenue and $69 billion in costs, which is negative $10 billion. If all Amazon did was retail, it would be wildly unprofitable. The saving grace is that the company's services more than make up for the awful financial dynamics on the retail side of the business.
Amazon still needs the retail business
From a simplistic point of view, the easy reaction is that Amazon should stop wasting its time being a retailer. That's not realistic because of the intertwining of the businesses. And, in some ways, the retail arm is a bit of a loss leader for the company's wider technology offering.
Retail is still a vital component of Amazon's operations. But if you are looking to buy the stock, you should think of the company as a technology services company and not a retailer.
