The world is moving to the cloud. The last decade has seen the emergence of the cloud. All big software names have recognized by now that the best way to survive and compete in the internet age is by putting their software on the cloud. The COVID-19 pandemic was the last straw (or the icing on the cake if you prefer), forcing businesses to move their work to the cloud to facilitate operational flexibility. And so, the remote-working culture that the pandemic induced is probably is here to stay.

The aftermath of the pandemic is expected to make cloud computing a priority for enterprises. Gartner expects global enterprises to spend 14.2% of their IT budgets on shifting to cloud computing by 2024, up from 9.1% in 2020. And the next decade will likely see the emergence of many more cloud stocks.

At present, Amazon (AMZN) and Microsoft Corporation (MSFT) are the leaders in the cloud space. International Business Machines Corporation (IBM) is playing catch up and looking now to unlock its cloud-business potential.

2021: The beginning of the cloud era 

As we move to the next chapter of the technology revolution, 5G will lead the way to the wider adoption of the cloud. Even Warren Buffett admitted the potential the cloud holds. He has invested $735 million in the cloud-data platform Snowflake (SNOW). A wave of enterprise cloud computing is expected to benefit cloud players who know how to surf this wave.

The problem with certain cloud stocks is that they have soared to high valuations. So, if one is looking to buy a cloud stock, one should seek ones that are fundamentally sound and undervalued. When determining which stock is undervalued, one should look at two aspects:

• Quantitative aspects, like the price-to-sales ratio and revenue growth rate, and
• Qualitative aspects, like factors that could drive the company’s growth.

Three cloud stocks — MSFT, IBM, and Workday, Inc. (WDAY) — have the potential to benefit from the cloud wave. The first two companies are now making strategic changes to make the most of the cloud era.

Microsoft Corporation (MSFT)

MSFT CEO Satya Nadella’s decision to transition the company from a Windows operating system to the Azure cloud platform in 2014 unleashed one trillion dollars in value. MSFT was one of the biggest beneficiaries of the remote working culture because many enterprise customers logged into the Azure cloud and subscribed to Office 365 suite.

In the first quarter of fiscal 2021, MSFT’s Azure revenue has surged 48% year-over-year; other cloud services revenue also surged double-digit. Its net income grew 30% and is expected to grow more as MSFT introduces several changes to its enterprise cloud offerings in the coming years.

MSFT plans to drop the perpetual model and shift to a subscription model for the 2021 versions of Exchange Server, SharePoint Server, Skype for Business Server. It will also introduce changes to Power Apps like Office 365 and Dynamics 365 that will charge commercial customers for services that are currently available for free. These changes all suggest more profit for the company from cloud services.

Moreover, MSFT is looking for acquisition opportunities. It did try to acquire the U.S. operations of video-based social media platform TikTok this year but lost out on a deal  to Oracle (ORCL). CCS Insights believes MSFT could consider buying the Finnish firm Nokia (NOK) for its networking business. MSFT might also try to tap the networking equipment opportunity brought by the United States’ ban on China-based Huawei’s networking equipment.

Any of these efforts would likely accelerate MSFT’s revenue growth in 2021. The stock is currently trading at 11 times its sales per share, and analysts expect its revenue to grow 11% in fiscal 2021 and 2022.

How does MSFT stack up for the POWR Ratings?

A for Trade Grade

A for Buy & Hold Grade

B for Industry Rank

A for overall POWR Rating

The stock is also ranked #1 stock in the 98-stock Software – Application industry.

International Business Machines Corporation (IBM) 

The next year is strategically important for IBM as the new CEO Arvind Krishna splits the 110-year-old IT beast by the end of 2021. IBM’s brand name will be retained by the hybrid cloud services, while a New Company, which is still unnamed, will handle its managed infrastructure services.

So why this split? IBM stock has been declining for the last seven years, with its revenue falling for 17 straight quarters. It lost $23 billion in revenue between 2010 and 2019 and is expected to lose another $3 billion this year. In the third quarter, IBM’s overall revenue fell 2.6% year-over-year as 19% growth in cloud revenue was offset by an 11% decline in other segments.

Arvind Krishna noted that slimming down the company would help it better tap the $1 trillion hybrid-cloud opportunity. We think its timing is correct because enterprises are accelerating their move to the cloud. The new IBM could see double-digit revenue growth from recurring subscriptions revenue. The New Company will tap the $500 billion market opportunity in IT infrastructure management.

IBM stock is currently trading at 1.5 times its sales per share, and analysts expect its revenue to grow 1.1% next year. Investors could benefit from the split. Hence, IBM stock is rated “Buy” in our POWR Rating system. It also has an “A” for Trade Grade and a “B” for Industry Rank. In the 30-stock Technology – Hardware industry, it is ranked #13.

Workday, Inc. – (WDAY)

WDAY offers enterprise cloud applications for financial management, human resources, planning, spend management, and analytics. It serves around 45% of the Fortune 500 and 60% of the Fortune 50 companies. The company felt the impact of the pandemic and its revenue growth rate slowed to 18% in the third quarter of fiscal 2021 from 19.6% in the second quarter and 26% in the third quarter of fiscal 2020. Analysts expect its fiscal 2021 revenue growth rate to slow to 18.5% from 28.5% in fiscal 2020.

WDAY stock is currently trading at 13.5 times its sales per share, and analysts expect its revenue to grow 16% next year. As enterprises accelerate their transition to cloud solutions, we think WDAY could see its revenue growth also accelerate.

WDAY is rated a “Strong Buy” in the POWR Ratings. It holds straight “A” in Trade Grade and Buy & Hold Grade and a “B” for Industry Rank. It is also the #4 ranked stock in the Software – Application industry.

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MSFT shares were trading at $223.08 per share on Monday afternoon, up $4.49 (+2.05%). Year-to-date, MSFT has gained 42.96%, versus a 16.02% rise in the benchmark S&P 500 index during the same period.

About the Author: Puja Tayal

Puja is a seasoned writer working with financial publishing companies like Motley Fool Canada and Market Realist. With over 13 years of experience in the field of fundamental research, she brings a blend of comprehensive, well-researched insights into her articles. More...

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