Find Big Opportunities in the Clouds

Cloud computing has quickly gone from “some day” to “now” for both businesses and individuals, and as you would expect, this powerful technology trend is generating some good investing opportunities.

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The cloud has proven to be not only a game-changing innovation but an incredibly fast-growing and profitable one as well. With more and more enterprises moving to the cloud, I expect strong growth to continue.

In fact, research analyst Gartner predicts that cloud computing will become the bulk of new IT spending by next year, and that nearly half of large enterprises will have hybrid cloud deployments by the end of 2017.

According to MarketsandMarkets, the global cloud computing market is expected to more than triple in size from $37.8 billion in 2010 to $121.1 billion in 2015. That’s a strong compound annual growth rate (CAGR) of 26.2%.

Several of my most recent recommendations in GameChangers have been cloud-related plays, and we’ve been making good money along the way. Here are two cloud stocks I continue to like:

Red Hat Inc (NYSE:RHT)

Red Hat Inc (NYSE:RHT) is the world’s leading provider of open-source solutions, providing software to 90% of Fortune 500 companies. Red Hat customers include well-known names like Sprint Corp (NYSE:S), Adobe Systems Incorporated (NASDAQ:ADBE) and Cigna Corporation (NYSE:CI).

RHT management’s goal is to become the undisputed leader of enterprise cloud computing and sees its popular Linux operating system as a way to make this happen. If Red Hat is successful — as I expect it will be — RHT will have a lengthy period of expanded growth as corporations increasingly move to the cloud.

Last year, Red Hat management combined its Linux Platform and cloud offering OpenShift to develop an Infrastructure as a Service (IaaS) product, a take-off from the more familiar Software as a Service (SaaS). IaaS is a public cloud that allows IT departments to quickly create needed tools and get capacity on demand in a pay-as-you-go environment.

Red Hat’s operating results clearly demonstrate that its solutions are gaining greater acceptance in IT departments, with revenues more than doubling in the past five fiscal years from $748 million to $1.53 billion. For the first nine months of the current fiscal year, RHT revenues grew 16% to $1.32 billion.

Looking forward, I expect strong sales growth to continue for RHT. In the last fiscal quarter, Red Hat not only renewed its top 25 deals that were at the end of their contracts, it did so at 120% of the previous value. All of the top 30 new deals during that period were in excess of $1 million for the sixth consecutive quarter, with 12 deals topping $35 million.

As corporations continue to adopt additional cloud technologies in the future, Linux is in position to compete with Windows to be the operating system of choice to run the cloud. Given Red Hat’s already strong presence in enterprise IT departments, I like its chances for success.

It’s these factors and many more that put RHT in a solid position to continue to realize above-average growth, which should drive Red Hat stock higher in the longer term.

Workday Inc (NYSE:WDAY)

I wrote about Workday Inc (NYSE:WDAY) just last week. Workday is well-positioned at the intersection of industry trends as it helps clients manage both time and talent through the cloud, rather than on their own premises.

WDAY just released fourth-quarter results this week, and they were solid. Revenues of $226.3 million were $2 million higher than estimates and up 59% from the prior year. Workday landed a record number of new financial management customers in the quarter as it continues to expand beyond human resources applications. Subscription revenues in the quarter were up 64% to $181.9 million, up to 80.5% of the total.

Looking at the bottom line, WDAY stock’s adjusted loss decreased to 6 cents per share from 13 cents per share, with gross margins up to 69.2% from 64.5% thanks to the gain in subscription revenues. Workday management continues to invest heavily for the future, which is why WDAY lost 6 cents per share, in line with expectations.

For the coming year, WDAY management guided for revenues between $1.14 billion and $1.15 billion, which is slightly better than expectations, with some consideration for currency. This would still represent very impressive growth of 45%, though down from the 68% achieved in 2014. Heavy investment will still keep the company at a loss but lower than the adjusted 33 cents per share achieved last year. Current estimates are for a loss of 20 cents per share.

So, why did investors sell WDAY after a revenue beat and overall strong report? In many ways, Workday is a victim of its own success, and I see the dip as a buying opportunity, just as it was a quarter ago after Workday released results. WDAY stock fell to $80 before running up to $95, and after such a strong move, I think some investors were looking for an even more convincing beat and more upside guidance for the long-term.

WDAY stock is not cheap at 23 times enterprise value/revenues, but Workday is still in the early stages of growth and has plenty of opportunities ahead — even beyond its current human resources offerings to serve other areas of the enterprise. In fact, I wouldn’t be surprised to see the company expand beyond its already dominant position in human resources software into a more complete cloud-based supplier of enterprise software. I expect it to rebound from the post-earnings selling back up toward $100.

Cloud computing remains a strong trend and interesting area within technology. These are two companies worth a look, and there are and will continue to be others as the trend plays out in the coming years.

Hilary Kramer is the editor of GameChangersBreakout Stocks Under $10 and High Octane Trader.

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