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AWS is a major part of Amazon’s overall picture

The reason why I think Amazon has more to gain from its cloud computing investment is the position of Amazon Web Services (AWS) within Amazon as a whole. In Q2, AWS accounted for about 21% of Amazon’s total revenue. However, AWS produced 60% of Amazon’s operating profits.

That’s a natural result of the fact that e-commerce and retail generally are relatively low-margin businesses; AWS’ operating margin is far higher. This magnifies the effect that revenue growth from AWS has on the overall company’s profitability. So its net sales rose 20 year over year in Q2, but its operating income increased by 43%. As Amazon continues to invest big time in AWS, its added capacity will translate directly into impressive revenue growth and even larger profit growth.

Amazon Stock Quote

NASDAQ: AMZN

Amazon

Premium Feature

Moneyball Superscore

87/100

Today’s Change

(3.29%) $8.37

Current Price

$262.43

Key Data Points

Market Cap

$2.8TMarket cap calculated using publicly traded s outstanding only. Does not include unlisted, private, or dual-class non-traded s. Implied market cap may vary.

Day’s Range

$256.00 – $262.80

52wk Range

$196.00 – $287.20

Volume

34.8M

Avg Vol

39.1M

Gross Margin

50.77%

wise, Alphabet is benefiting from Google Cloud’s growth, but not to the same degree. The company’s core business is advertising from its Google family of products, and that already has a pretty strong operating margin.

Companywide, Alphabet had an operating margin of 34% in Q2. Google Cloud did slightly better, with a 36% operating margin, but since it’s already pretty close to the company’s overall margin, it doesn’t have the outsized effect on profits that AWS has on Amazon.

But don’t disregard Google Cloud, either. Google Cloud’s revenue growth in Q2 was 82% year over year, while AWS’s was 37%. That mismatch shows how Alphabet is rapidly expanding its cloud segment. However, it’s doing so off a much smaller base. Amazon is the world’s largest cloud infrastructure provider, with a 28% market as of Q2. While No. 3 Alphabet is slowly cutting into that lead, it still accounts for just 15% of the market. Google Cloud booked $24.8 billion in revenue in Q2, while AWS booked $42.2 billion.

Alphabet Stock Quote

NASDAQ: GOOG

Alphabet

Today’s Change

(0.87%) $3.00

Current Price

$347.86

Key Data Points

Market Cap

$4.2TMarket cap calculated using publicly traded s outstanding only. Does not include unlisted, private, or dual-class non-traded s. Implied market cap may vary.

Day’s Range

$346.88 – $351.06

52wk Range

$240.75 – $404.47

Volume

11.1M

Avg Vol

17.7M

Gross Margin

60.94%

Dividend Yield

0.25%

While AWS’ margins may have a bigger impact on Alphabet’s bottom line, Google Cloud’s pure growth nearly overcomes that advantage. As a result, I think both of these stocks could be excellent buys, as each has something special going for it in the cloud segment. And given the scale of their spending to expand their respective cloud segments, there’s a lot more growth to come for each of them.

But is there a discrepancy that an investor can take advantage of from a valuation perspective?

Amazon and Alphabet trade at about the same valuation

Both Amazon and Alphabet have seen several of their investments in outside companies rise in value recently, so their earnings per metrics are skewed by these gains. Measuring them based on their operating profits strips out the impact of those gains.

GOOG Operating PE Ratio data by YCharts.

Ever since Alphabet’s rally started last year, these two have traded at nearly the same operating P/E ratio, and that’s still the case today. As a result, there isn’t much of an advantage to choosing one or the other based solely on valuation.

So if you’re trying to pick between them as investments, the choice boils down to personal preferences and whether you prefer raw revenue growth or outsize profit growth. I’m in the latter camp, so I’m choosing Amazon. But this is really splitting hairs — Alphabet is also a worthy investment.