Most people know Amazon for their online shopping platform. However, in recent years, their biggest drivers of profitability for the company have actually come from their AWS and advertising services. The company has many other initiatives they have started to help bolster their bottom line for years to come. Given all of the positives of the business, the question is why is their free cash flow so low? The past couple of years have seen a massive increase in capital expenditures from Amazon. This coming year alone, they are planning to spend approximately $200 billion, primarily on data centers. Whether or not this spending will pay off is the primary question investors should be asking themselves before considering an investment in Amazon.
What Amazon is doing well
E-Commerce
Amazon is most well-known for their wildly successful e-commerce business. They have approximately 315 million active users, of which, 260 million are Amazon Prime members. This conversion is very high and signals the relative benefits people get from their Prime membership. For those that don’t know, Amazon Prime gives you reduced or free shipping as well as faster delivery times. Sometimes, these deliveries can be as fast as same-day or next-day delivery. Their logistics and supply chain network are top of the line and are exceptionally difficult to replicate. Even if other companies wanted to offer same-day delivery, they either couldn’t, or it would cost an exorbitant amount in shipping costs. There is also the frequency in which existing customers order packages from Amazon. The average customer orders 84 packages a year from Amazon, or roughly, one order every four days. This data confirms that people are heavily reliant on Amazon for many of their daily or near-daily purchases, due to the extreme convenience that Amazon can provide.
Cloud Computing(AWS)
AWS, or Amazon Web Services, is the leading cloud computing provider for companies and enterprises worldwide. The company is on pace for roughly $150 billion in revenue from their AWS segment this year, and as of last quarter grew their cloud revenue by 28% YoY. This was an acceleration of cloud computing growth from the prior quarter. Some large companies that are users of AWS include: Netflix, BMW, Mercedes-Benz, Capital One, JPMorgan Chase, Adidas, and Pfizer, just to name a few. With large, well-financed companies like these, Amazon has created a steady recurring revenue from their cloud business. The cloud industry is particularly sticky as well, since in order for a company to change cloud providers, it would need to perform a massive and very expensive overhaul.
Advertising
Their advertising business has also grown at an impressive rate, 24% this previous year, and continues to contribute a lot to their bottom line profitability. Sellers know that hundreds of millions of people use Amazon on a near-daily basis. This provides Amazon with the ability to sell advertising space effectively. Not many platforms can say they have the same level of traffic that Amazon does. It is also especially helpful that when consumers are already on Amazon’s app, they are already prepared to shop, which makes the conversion rate that much better for the sellers. In fact, Amazon’s conversion rate is generally around 10%. This is significantly better than traditional e-commerce websites which generally convert at around 1 or 2%. Due to the disparity between the average e-commerce conversion rate and Amazon’s conversion rate, they are able to charge a premium to people who want advertising for their product.
New Initiatives
Some of the new initiatives in the AI era for Amazon are very promising. One of the most promising aspects to this is their Trainium AI chip. The Trainium chip provides a cheaper alternative to general purpose GPU’s, which can run up to $40,000. Their chip business is already producing revenue of $20 billion a year and growing at a triple digit percentage rate. Amazon is then able to also be less reliant on NVIDIA and other chip makers and use their own in-house products for their AI initiatives. This can potentially save them billions of dollars a year, as well as add a new revenue stream generating billions a year.
Another initiative that looks very promising for Amazon is their robotics division. This increase in robotics usage will help their E-commerce operation, as efficiency will increase over time. In fact, Amazon claims its robotics fleet helps improve their supply chain efficiency by 25%. This is a massive boost to their efficiency, given the scale of their business, this translates to billions in increased savings. Currently, projected to save up to $4 billion in costs this year.
Risks to investment thesis
Capital Expenditures
Currently, Amazon is spending the most on Capital expenditures out of any company in the S&P 500. This year, they are expected to spend $200 billion, most of which will be going toward data center buildout for their AWS expansion. This $200 billion exceeds their operating cash flow, which was, in the most recent year, about $148 billion. This $52 billion difference is either met by using cash from the balance sheet, issuing stock, or by taking on more debt. Based on these options, you would need to be able to see a return on investment with increased efficiency in their operations or new revenue streams. The problem is that this is likely a minimum of a few years away from actually being able to see if the spending is justified. One thing to look at to determine whether or not the capital expenditures are worth it is the growth of AWS
International Growth
At the moment, Amazon is growing internationally, but this can all be deterred if a country decides to prefer their own e-commerce solution. The threat of anti-monopoly against Amazon, specifically in non-U.S. countries, is large. If this were to play out, Amazon would be forced to either comply with the updated rules and regulations that the government puts in place, or they will be forced to run their business in other countries, thereby leaving them with less potential revenue.
International Competitors in the U.S.
One threat to Amazon currently is the existence of other e-commerce sites that offer cheaper alternatives. Many consumers will seek out the cheapest option, and oftentimes, companies like Temu can offer the product but at a cheaper price. If Temu becomes more reliable in their quality, this can impact the overall market share that Amazon currently exerts in the U.S.
Valuation
Since Amazon is currently spending so much on capital expenditures relative to their own history, I think it makes more sense to evaluate their business on a price to operating cash flow basis. Their current trailing price to operating cash flow is around 17.42, which is substantially lower than their 10 year median of 25.47. This discount to historical average makes a bit of sense, as we don’t know what the ROI on their large investments will be like. If you believe that they are making good investments for their future, and will see a healthy return on investment, then this valuation is particularly attractive relative to their own history. If you believe that AWS growth will continue to accelerate, or at least maintain the level of growth it exhibited in Q1 of 2026, then this would make it a very ideal level to acquire shares.
How to tell if all of this spending is worth it?
Given the $200 billion in capital expenditures, let’s calculate what the required growth rate will be in order for this investment to be considered worthwhile. For this, we are going to assume that $140 billion, or 70%, of the capital expenditures are going towards AWS. In order for it to generate a 10% annual return, we will need to see a $14 billion increase in operating income per year once the investments mature. Assuming a 5 year time horizon to see the investment mature, we will need to look at the current inputs for Amazon. Currently, the company generates around $150 billion in revenue with AWS, at a 38% operating income, giving it approximately $57 billion in operating income from the AWS segment. Assuming this, by 2031, Amazon will need to be generating an operating income of at least $71 billion and increasing at a rate of $14 billion a year subsequently in order for this to be considered a good investment. In my opinion, I think this is very achievable, and why I think Amazon shares are attractive at today’s current price of $238 per share.