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Amazon’s Hidden Cash Machines

Douglas is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

Amazon (NASDAQ: AMZN) is most recognizable as the world’s leading online retailer and as the company that got into the tablet market via the e-reader. It is the company’s less known sources of revenue, however, that make it a gem despite a fairly rich valuation – the company is trading at a forward P/E of 127. While one of these sources is not likely to exist for much longer, there are two that should be formidable growth drivers for the business well into the future. Based on the strength of each of these “hidden” cash machines, the stock is a buy for your core portfolio.

The Sales Tax Loophole

Since the advent of ecommerce, online retailers have enjoyed the advantage of not having to charge their customers sales tax. This has provided companies like Amazon with a significant pricing advantage relative to traditional brick and mortar businesses. While many customers report that sales tax avoidance is not a primary draw of the web-based retailer, lower prices is a critical draw; the lack of sales tax helps this phenomenon.

There is evidence, however, that the sales tax factor is not critical to the company’s success. In a recent interview, Topeka Capital Market’s Victor Anthony explained to Jeff Macke that there is “no material difference between revenue growth rates in markets where Amazon is taxed and not taxed.” This is good news for Amazon as more and more states have begun collecting sales tax from the retailer, with the loophole expected to be fully closed within the next several years.

Streaming Video is Primed

Amazon has dedicated significant time and resources to building out the content and quality it offers through its Amazon Prime service. At $79 per year, the streaming video option is less expensive than that offered by Netflix (NASDAQ: NFLX), Apple (NASDAQ: AAPL) or what is expected when Coinstar’s (NASDAQ: OUTR) Redbox rolls out its own streaming service in partnership with Verizon Communications (NYSE: VZ). Possibly more important than price to consumers, content is a critical factor that Amazon has also focused on by forging some important relationships.

Netflix, which has come under criticism ever since its ill-advised pricing change, is still considered the leader in the industry. With activist investor Carl Icahn joining the Board, the belief is that Netflix is looking for a large corporate parent. With increased financial backing and an image enhancement, Netflix might become interesting again; but as things stand, the company is losing ground. Apple TV remains unproven and it is impossible to predict where the Redbox service will fit in the mix. This landscape is favorable for Amazon to begin to generate major revenue from this area.

Head in the Clouds

The final hidden source of revenue for Amazon is through its Amazon Web Services (AWS) division. AWS has quietly become one of the most significant players in cloud computing, all while the company remains fairly hushed about the division’s success. The secret to Amazon’s success in this area is in renting data storage and server time to users who wish to avoid the costs of traditional infrastructure. As I explained in a different piece of the subject: “There are countless examples of fledgling technology companies that are skipping the expense of developing internal systems and instead turning to services like AWS to cut costs and do some of the heavy lifting. Instagram, for example, which sold for roughly $1 billion less than two years after its founding, did the bulk of its development in the cloud.”

The Trade

While there is no argument that many of Amazon’s valuation metrics classify it as “expensive,” the growth prospects for the company, as well as the above three revenue sources, make the stock very attractive. The tax loophole will close, but streaming video and cloud solutions remain in their respective infancies and have untold upside. Given the totality of the circumstances, Amazon belongs in your core portfolio.

Mr. Ehrman has no positions in the stocks mentioned above. The Motley Fool owns shares of Apple, Amazon.com, and Netflix. Motley Fool newsletter services recommend Apple, Amazon.com, and Netflix. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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