Better Buy: Amazon.com vs. Facebook

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Amazon (NASDAQ: AMZN) and Facebook (NASDAQ: FB) are among the most closely watched tech stocks in the U.S. Amazon owns the world's top e-commerce platform and its biggest cloud infrastructure platform, and Facebook owns the world's largest social network. The two companies account for the first half of the high-growth "FANG" cohort, which also includes Netflix and Alphabet's Google.

Amazon's stock slipped 21% over the past six months, as its sales growth missed expectations for two straight quarters. Facebook's stock has fallen 38% over the same period as its sales growth decelerated and it also missed estimates over the past two quarters. However, Facebook's decline was exacerbated by a series of privacy and security debacles, along with serious questions about the company's ethics.

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I personally own shares of both Amazon and Facebook, and I still have faith in their long-term growth strategies. But is either stock a better buy at these levels? Let's compare the two businesses to find out.

How do Amazon and Facebook make money?

Amazon generates its revenue from three main businesses -- its North American unit, its international unit, and the Amazon Web Services (AWS) cloud platform. The company's North American unit generated 61% of its sales last quarter, its international unit generated 27%, and AWS accounted for the remaining 12%.

Amazon's North American and international divisions have much lower margins than AWS. AWS accounted for 56% of Amazon's operating profits last quarter and offset the weaker growth of its North American unit as well as an operating loss at its international unit. In other words, Amazon's high-margin cloud unit allows it to operate its marketplaces at lower margins and pursue a wide variety of loss-leading strategies to expand its ecosystem.

Facebook's business is more straightforward -- it generated 99% of its revenues from online ads last quarter, with the remaining sliver coming from payments and other fees. Ninety-two percent of that revenue came from mobile ads, compared to 88% in the prior-year quarter.

Which company is growing faster?

Amazon and Facebook both dominate their respective markets and consistently generate double-digit sales growth. But over the past year, both companies' sales growth slowed down:

Company

Q1 2018

Q2 2018

Q3 2018

Amazon

43%

39%

29%

Facebook

49%

42%

33%

Amazon's slowdown last quarter stemmed from the weaker growth of its international business (which faced currency headwinds), an accounting change in Amazon Prime's revenue recognition, and the lapping of the Whole Foods Market acquisition that boosted total company sales in previous quarters. On the bright side, Amazon's advertising business is now the third-largest online ad platform in the U.S. after Google and Facebook, and it could become a major pillar of growth over the next few years.

Facebook's revenue deceleration was caused by its higher dependence on geographic regions with lower monetization rates, data privacy initiatives throttling its growth in ad prices, and the ongoing expansion of Facebook Stories -- which displaces some of its ad impression opportunities. However, the growth of Instagram's ad revenues could offset those declines over the long term. Facebook also has plenty of other irons in the fire -- including the monetization of WhatsApp, the expansion of its video platform Watch, and the evolution of Messenger into an ecosystem of smaller apps.

Amazon generates a lower operating margin than Facebook, but that figure expanded year over year as Facebook's contracted last quarter:

Company

Q3 2017 Operating Margin

Q3 2018 Operating Margin

Amazon

0.8%

6.6%

Facebook

49.6%

42.1%

Amazon's operating margin expanded year over year as the profitability of its North American unit improved (partly aided by its higher-margin advertising business), losses at its international unit narrowed, and AWS continued to gain new customers and add new services.

Facebook's operating margin slid as its user growth in the more profitable U.S. and Canadian region flattened out and it increased its dependence on lower-margin regions. Meanwhile, Facebook's expenses jumped as the organization tried to simultaneously expand its ecosystem and apply tighter privacy and security controls.

Analysts expect Amazon's revenue and earnings to rise 20% and 35%, respectively, next year. Those are still solid growth rates, but the stock isn't cheap at 60 times forward earnings.

Facebook's revenue is expected to climb 25% next year, but its earnings could rise only 2% due to all the aforementioned headwinds. However, the stock is arguably cheaper at 19 times forward earnings, which could make it a bargain if growth accelerates again. Facebook has also been buying back billions of dollars of stock over the past year -- which could be a sign of a near-term bottom.

The winner: Amazon

Amazon is the pricier stock, but its margins are expanding and it isn't stuck in a negative news cycle like Facebook. So if I had to start a position at these prices, I'd pick Amazon over Facebook, even though I think both stocks should head higher over the long term.

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John Mackey, CEO of Whole Foods Market, an Amazon subsidiary, is a member of The Motley Fool’s board of directors. Suzanne Frey, an executive at Alphabet, is a member of The Motley Fool’s board of directors. Leo Sun owns shares of Amazon and Facebook. The Motley Fool owns shares of and recommends Alphabet (A shares), Alphabet (C shares), Amazon, Facebook, and Netflix. The Motley Fool has a disclosure policy.