According to Gartner, the global cloud computing market will continue growing at a 17.5% annual rate over the next decade. Given its current size of $397 billion, this means it will be more than a trillion-dollar industry within the next 5 years.
For investors, this type of growth and scale means there are many different investment opportunities:
- Mega-cap tech companies building the cloud infrastructure layer.
- Companies building more targeted, software-based services on top of these platforms and infrastructure.
This type of growth means there are plenty of opportunities for investors in cloud computing. This report will provide a broad overview of the industry, examine some of the most promising niches, and then provide some insight on some of the most intriguing stocks in the sector: Google (GOOGL), Microsoft (MSFT), Workday (WDAY), Veeva Systems (VEEV), and SAP (SAP).
What is Cloud Computing?
At one time, heavy computing power was an expensive and rare asset only available to big corporations and universities. Heavy computing power is a term used to describe all the processing power from servers in data centers that are necessary to operate the cloud. And, technologies of the future like AI, ML, virtual reality will all require even more processing power.
As costs have fallen over the past couple of decades, it’s increasingly become a commodity in that the cost of distribution is more than the cost of production. Now, even distribution costs have also declined while capacity is improving.
Due to these developments, any business can access this heavy computing power and leverage technology to achieve their goals at much less cost. All types of applications requiring computing power are now done through the cloud. Examples include web and application hosting on AWS or Azure, customer relationship management salesforce with Salesforce, or storing photos and videos with Google Drive or Dropbox.
As the costs have dropped, the market has expanded. And, it’s enabled developers to build applications on top of these cloud platforms and applications.
It’s also had notable real-world impacts. For example, the majority of apps and services on smartphones are enabled by cloud computing. The cost of startups has also precipitously declined. Previously, companies would have to invest significant sums in buying or renting servers. Now, companies can access these on a “per-use” basis, turning IT into a flexible cost rather than a fixed cost.
Benefits of Cloud Computing
Cloud computing makes a company’s IT, technology, and operations more powerful, agile, and flexible by enabling the delivery of enterprise-level solutions on demand to increase customer engagement and improve operational efficiency.
Cloud computing encompasses a wide variety of categories. Now, all types of IT services are available on the cloud, from basic infrastructures such as compute and storage to application development platforms and specific software applications. These services are hosted remotely and accessible through the Internet.
Cloud computing enables companies to scale their IT stack with minimal difficulty. Before, IT services required servers, equipment, and people to operate and manage which was a capital and time-intensive process. For many firms, this constrained growth due to the cost, complexity, and challenge of scaling IT resources.
Now, these services can be scaled according to need in a frictionless manager. As a result, employees can use and operate enterprise-level software on a per-user or per-use basis. Future disruptive technologies are being built on top of and integrated with existing cloud services. Notable examples include autonomous driving and artificial intelligence.
In addition to the attractive economics of cloud computing, cloud systems require less upkeep as maintenance and security needs are handled by cloud computing providers. Therefore, companies have less need for dedicated IT personnel who would spend time on adding new servers and upgrading equipment.
Over time, cloud systems have evolved and the number of use cases has rapidly multiplied. The three major categories of cloud computing are Software as a Service (SaaS), Platform as a Service (PAAS), and Infrastructure as a Service (IaaS).
See the table below for information on each:
|Software as a Service (Saas)||Software Applications over a Network||Slack, email, MS Office|
|Platform as a Service (PaaS)||Developer Environment over a Network||Windows Azure, Google App Engine|
|Infrastructure as a Service (IaaS)||IT resources provided over a network connection||AWS, Google Cloud|
Every cloud computing company falls into one of these three categories. However, PaaS and IaaS are dominated by large companies, while most startups fall into the SaaS category.
This is due to the economies of scale and network effects of these businesses. More users mean more demand for services which leads to more data and iterations to improve the product. This scale leads to lower costs and higher barriers to entry. As a result, these businesses tend to have high rates of recurring revenue and impressive gross margins which have been rewarded by the market over the last decade with high multiples.
Early Stages of Growth
Given the quantitative and qualitative advantages of cloud computing, it’s not surprising that companies are migrating to these platforms, services, and applications. Companies no longer have a choice and must do so to remain competitive.
However, this process remains in its early stages. As of February 2021, 92% of S&P 500 companies had a job posting for a “cloud migration” specialist, indicating that cloud spending remains a priority. Even despite its impressive growth, the average IT environment today, is still majority non-cloud, although it’s expected to shrink in the years ahead.
Further, many types of investments made by companies come with uncertainty in terms of getting a return on investment. Cloud spending is an exception as costs go down but capabilities increase.
Investing in Cloud Computing
In 2022, the cloud computing industry is estimated to be worth just under $400 billion and cross the trillion-dollar threshold by 2026. Investors have many choices when it comes to investing in the sector. One option is to buy a broad cloud computing ETF like the WisdomTree Cloud Computing ETF (WCLD) or the Global X Cloud Computing ETF (CLOU).
Another route is to invest in cloud infrastructure stocks like GOOGL, Amazon (AMZN), or MSFT. These companies are the leaders in the industry and are unlikely to be disrupted given their scale and early-mover advantage. The vast majority of cloud applications are built on top of these platforms, so these companies will benefit from the industry’s overall growth. Another approach is to focus on the PaaS or SaaS companies that are building more targeted solutions for their customers.
Below, we will analyze 5 cloud computing stocks that are a representative sample of the total industry:
GOOGL is the clear leader when it comes to online search with over 80% market share. From this, it derives strong revenue growth and cash flow by selling ads. Using its search proceeds, Google has made investments to grow in new areas. Among these, Google Cloud is one of its most successful bets.
Google Cloud is the third largest cloud provider in the world with an 8% market share trailing only Microsoft’s Azure and Amazon’s AWS. However, it’s the 2nd fastest-growing major cloud provider with a 45% growth rate. Interestingly, Google Cloud is built on the same infrastructure that it uses for the delivery of its own products and services such as Gmail, YouTube, Google Docs, etc.
Google Cloud counts a large number of premier companies as customers including Shopify (SHOP), Paypal (PYPL), Twitter (TWTR), and Goldman Sachs (GS). It’s also been aggressively making partnerships with telehealth companies to deploy their products on top of Google Cloud.
Although Google Cloud remains a small part of the larger company, it does make up a large share of recent revenue growth. Given the high margins of cloud businesses, this growth will start filtering to the bottom line as well.
The POWR Ratings are constructive on Google as well as it has a B rating which translates to a Buy. B-rated stocks have posted an annual performance of 21.1% which compares favorably to the S&P 500’s annual performance of 8.0%. The POWR Ratings also evaluates stocks by different categories including Value, Growth, Momentum, Stability, Sentiment, Quality, and Industry. To see GOOGL’s component grades, please click here.
MSFT is currently the leader in the “Cloud Wars” with $18.3 billion in revenue. In fact, the company has a commanding lead given that second place Amazon and third place Google’s cumulative cloud revenue is $17.3 billion. It’s also the choice of large enterprises given pre-existing relationships with Microsoft.
Of course, MSFT infamously pivoted to the cloud in 2013 upon the selection of Satya Nadella as Microsoft CEO. This decision was pivotal for MSFT as its stock price had been moribund for much of the past decade. However, since then, Microsoft has been the best-performing stock in the S&P 500 and is now the second-most valuable company in the world.
Microsoft essentially turned many of its software products into a subscription which resulted in higher lifetime customer value, higher margins, and more opportunities to upsell. However, the crown jewel of its business is Azure.
MSFT has been layering targeted solutions for its cloud customers in all types of areas. Currently, it counts over 200 specific processes, while there are countless more that have been produced by the developer ecosystem. Some of the most popular include data analytics, AI, machine learning, and visualization.
Of course, MSFT has a lot going for it beyond the Cloud, but it did account for nearly 50% of the company’s revenue growth in the last quarter. The POWR Ratings have a constructive outlook on MSFT as it has a B rating which translates to a Buy. The POWR Ratings are calculated by taking into 118 different factors each with its own weight.
The POWR Ratings also evaluates stocks by different components. In terms of Sentiment, MSFT has an A rating which isn’t surprising given that the consensus price target is $363, implying 26% upside. To see more of MSFT’s component grades including Value, Momentum, Stability, Growth, Quality, and Industry, click here.
WDAY provides enterprise cloud applications with offerings that include financial management applications, cloud spending management solutions, and Workday applications for planning. It is the leading provider of software-based solutions for human resource needs.
WDAY has been one of the best performers of the last decade with a 357% gain since its IPO in 2013. It’s not surprising when considering that companies are increasing spending on their IT systems, software, and cloud systems at a double-digit rate which is forecast to continue over the next decade.
Additionally, WDAY’s products allow companies to save money and become more efficient. Newer companies are able to have smaller HR departments that are able to handle just as much workload and responsibilities as larger ones. We also learned during the pandemic that these software systems are more essential for a company’s operations than office space.
Once companies choose a software or cloud provider, they are unlikely to change given the cost and complexity of changing systems. Further, once companies have people on their platforms, they are able to unlock more opportunities for monetization. This is reflected in WDAY’s high rates of recurring revenue.
The stock has been punished along with other tech and growth stocks, leading to a 27% decline from its all-time high in November 2021. However, WDAY should be bought on the dip due to its strong earnings and business momentum.
In its last quarter, the company had a 21% increase in revenue with 90% of it coming from recurring revenue. It also achieved an important milestone with positive EPS that is expected to grow by 45% next year.
Given these positives, it’s not surprising that WDAY has an overall B rating which equates to a Buy. It’s also quite strong in terms of component scores with an A for Growth and a B for Quality. Click here to see more of WDAY’s POWR Ratings including component scores for Momentum and Value.
Veeva Systems (VEEV)
VEEV is a cloud computing and enterprise software company for the healthcare, pharmaceutical, and life sciences industries. It provides software solutions for the unique needs of companies in these industries, from meeting regulatory standards to conducting clinical trials to managing operations.
VEEV has very favorable economics as the healthcare sector is massive and always expanding, while cloud computing spending is rising. Further, VEEV has high margins and rates of recurring revenue. There are very few competitors in the space given the regulatory barriers and trust issues required for such sophisticated and sensitive work.
For the full year, VEEV is expected to earn $3.69 per share on $1.8 billion in revenue, a 26% and 28% increase, respectively. Next year, this growth is expected to continue as analysts are forecasting 8% earnings growth and 13% sales growth. From the summer of 2021 to February of 2022, the stock has pulled back more than 40%, creating a nice entry point given its long-term prospects.
Thus, it’s not surprising that VEEV has an overall B rating, which translates to a Buy in our POWR Ratings system. It also has an A for Quality as it’s one of the leading stocks in a large total addressable market with only a handful of competitors. VEEV also has a B for growth makes sense given its intersection of two large and growing markets – healthcare and cloud computing. Click here to see more of VEEV’s POWR Ratings including grades for Value, Momentum, and Stability.
SAP is a leading company in the enterprise software space and one of the originators of the entire category. The company operates through three segments: The applications, technology & services segment, and the SAP Business Network. Over time, SAP has branched out from providing enterprise resource planning software to help companies optimize their inventory, supply chains, and production process to all sorts of operations including analytics, CRM, marketing, business processes, etc.
One reason that investors should consider having SAP in their portfolios is that once companies start using their software, they are unlikely to change, especially as employees become comfortable and reliant on it
Switching to a new software system would incur huge costs and disruptions as data would have to be transferred and employees would have to be re-trained. Additionally, since SAP is known as one of the top enterprise software companies, corporate managers are less hesitant to spend money on their products.
SAP is a mature company, but it’s still managing to grow at an impressive rate as analysts forecast 11% earnings growth next year. Further, the company is reasonably valued with a forward P/E of 19, a 2% dividend yield, and 21% profit margins. This makes the stock an intriguing buy the dip candidate following its 25% drawdown during the tech selloff in 2021.
SAP’s POWR Ratings reflect this promising outlook. The stock has an overall A rating, which equates to a Strong Buy in our proprietary rating system. It also has strong component scores including a B for Sentiment. Currently, 4 out of 7 analysts covering the stock have a Buy rating, while none have a Sell. They also have a consensus price target of $152, implying 21% upside. To see more of SAP’s POWR Ratings, click here.
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MSFT shares were trading at $295.97 per share on Friday afternoon, up $1.38 (+0.47%). Year-to-date, MSFT has declined -11.82%, versus a -8.05% rise in the benchmark S&P 500 index during the same period.
About the Author: Jaimini Desai
Jaimini Desai has been a financial writer and reporter for nearly a decade. His goal is to help readers identify risks and opportunities in the markets. He is the Chief Growth Strategist for StockNews.com and the editor of the POWR Growth and POWR Stocks Under $10 newsletters. Learn more about Jaimini’s background, along with links to his most recent articles. More...
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