Amazon (AMZN) has surged since the end of 2014 and, with equities benchmarks showing rising bearish volatility, there is a growing risk that technology stocks will become vulnerable at these elevated levels. As a result, Amazon has recently fallen to near-term lows at $1,719 per share.

But this weakness has created a new buying opportunity for portfolio strategies which seek to build tech exposure using shares of AMZN. Key event risks can be found near-term, and Amazon’s next earnings figures could reveal potential weaknesses in the company. But as a market leader in cloud services and e-commerce, Amazon remains attractive for investors based on the company’s long-term outlook for growth and earnings.

(Source: YCharts)

Amazon’s revenue in its cloud services segment has shown strong evidence of expansion over the previous three quarters. Earnings metrics have benefited from massive increases in global enterprise adoption of the company’s cloud resources. Amazon has responded by adding services and new product features in order to continue attracting customers while growing the institutional client base.

(Source: Zacks)

Cloud services and the advertising business make up two of Amazon’s highest-margin segments, and it will be important for investors to continue watching for evidence of growth in these areas as a signal for potential appreciation in share prices. Amazon has adapted its advertising tools to make them more user-friendly for retail customers, and we may start to see constructive evidence of these changes in coming earnings reports.

According to analyst estimates, Amazon’s advertising business is currently worth between $150 billion and $190 billion. Piper Jaffray expects Amazon’s 2018 ad revenue figures to double by 2020 (to $16 billion), aided in large part by growth in margins. If these estimates turn out to be accurate, advertising income might actually surpass the income generated by Amazon Web Services during that time.

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As the market’s current leader in cloud, investors continue watching for growth in AWS. Rising competition, however, could eat into Amazon’s market share in these areas. During the second quarter, Amazon cloud services grew by 49% on an annualized basis. AWS continues to be a source of margin strength for the company, but increased competition from Microsoft (MSFT) remains a threat which would create pricing pressures for its offerings.

As the company continues to command greater dominance in search, revenues from the advertising segment may turn out to be the greatest beneficiary of Amazon’s improved margin activity. Positive results in these areas should stoke market confidence, as questions still remain with respect to the efficiency of how Amazon is investing its cash and other resources.

(Source: NASDAQ)

Of course, this will be reflected in the next quarterly report and Amazon is scheduled to release earnings on October 25th. For the third quarter, the company is expected to show earnings of $3.29. If realized, this would mark an annualized increase of 532.69% (relatively to the earnings performance of $0.52 posted during the same period last year). This will include earnings generated by the company’s Whole Foods business, which was purchased in 2017.

Over the last four quarters, Amazon has managed to beat market expectations on every occasion. So, while annualized gains of +500% may seem unlikely, this would actually represent a decline on a quarterly basis. Ultimately, this suggests the company will not encounter difficulties in matching the market’s seemingly lofty expectations for earnings. One issue which would negatively impact these expectations, however, is the rising cost of shipping (which may have reached $10 billion in 2017). But the fees generated by Prime memberships offset many of these costs and this should support the outlook for the quarter.

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Revenues are currently expected to come in at $57.10 billion. If realized, this would mark a substantial increase (30.54%) from the $43.74 billion in revenues posted during the same period last year. Here, there may be greater potential for a disappointment, as Amazon failed to match analyst sales estimates during the second quarter. Revenue disappointments remain unlikely as the company also managed to beat revenue expectations in each of the previous five quarters.

(Source: Zacks)

Supporting this bullish outlook, we have the market’s sales estimates looking strong for both the most recent quarter and for the full-year period. Currently, the analyst consensus shows expected gains of 30.23% in sales growth for the third quarter. This is likely to be followed by an even better sales performance for the full-year period (at 31.75%). Estimates show that Amazon Prime memberships in the U.S. may be flattening near 85 million households, but these elevated numbers suggest that the market’s current sales expectations remain attainable.

(Source: Zacks)

In this last chart, we can see that the market tends to respond well to upside surprises in Amazon earnings reports. The gains generated on these occasions far outweigh the losses which have accumulated in cases where Amazon missed analyst estimates. Recent declines in the broader market have disproportionately weighed on technology stocks, and AMZN has fallen to near-term lows at $1,719 per share. Key event risks remain, but this recent weakness has created a buying opportunity for portfolio strategies. Of course, AMZN is a stock which does not pay dividends, so portfolio strategies implementing positions in the stock should consider the use of options when building exposure.

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Disclosure: I am/we are long AMZN, MSFT.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.



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