Amazon ( AMZN) plunged 17% Wednesday as investors fled the e-tailer's costly free shipping plan.

Shares of the largest Internet retailer dropped $5.78 to $27.81, setting a three-year low. Wall Street sees the company's hefty spending and narrow margins as hoisting a red flag over the Seattle-based company.

Operating expenses in the latest quarter jumped 34% from a year ago to $464 million, led by gains in fulfillment, marketing and technology, the company said. Profit dropped 58% from a year earlier. After sending the stock down 11% in postclose action Tuesday, investors renewed their selling amid a flurry of negative research notes Wednesday morning.

"Investments in two new categories (toys and groceries), free shipping, and lower prices, should all weigh on gross margins, as the company continues its attempt at differentiation in e-commerce," writes RBC Capital Markets analyst Jordan Rohan, who rates Amazon as sector perform, in a note to clients. "We remain on the sidelines on shares of AMZN, as the margin improvement story we would like to see has not developed." He lowered his price target from $32 to $31.

Amazon's decline underscores the impatience of investors in the tech sector in light of worries about a possible economic slowdown. Last week, Yahoo! ( YHOO) cratered after the most popular Internet site said much-anticipated improvements to its search engine would be delayed. Google ( GOOG) posted a blowout second quarter, but its shares have been flat, in part as investors quail at the hefty multiples tech companies continue to fetch despite their inconsistent results.

Amazon has been spending freely on costly initiatives such as Amazon Prime, which allows customers to pay $79 a year in exchange for free shipping. Amazon also is spending on technical improvements to its site to make it more attractive to consumers.

"We agree with most everything the company is doing with its customer experience -- Prime, digital, lower prices, etc. -- but until the revenue and cash flow begin to show from new initiatives, we do not believe investors will pay up for the stock," says Scott Devitt, an analyst with Stifel Nicolaus who rates Amazon a hold, in a note to clients today. "Also, it appears that investors are not particularly interested in this sector at the moment due to the perception of an increasing risk of macroeconomic challenges (slowdown or recession) having an impact on U.S consumer spending." His firm makes a market in Amazon shares.

Some Wall Street analysts say they aren't ready to thrown in the towel on Seattle-based Amazon yet. Deutsche Bank's Jeetil Patel, who maintained his hold rating, says he finds some signs of improvement and believes that Amazon is faring better than rival eBay ( EBAY).

Even so, some Amazon moves -- notably its recent entry into the low-margin grocery business -- have puzzled Wall Street.

During last night's conference call, Chief Executive Jeffrey Bezos pointed to Amazon Prime's growing popularity and said that these customers bought more with the company than they would have otherwise. As for groceries, Bezos says that the company's huge size offers advantages in that businesses as well.

"We don't just carry a few flavors of Jell-O," he says. "We carry all 80."