Cloud computing currently encompasses a wide array of stocks and a vast tech growth engine. Many of the largest names in tech also happen to be the most popular cloud stocks. However, the cloud business generally remains a no-moat business. Any barriers to entry in cloud stocks largely depend on having as much involvement as possible in all three layers of the cloud. Those layers consist of Infrastructure as a Service (IaaS), Platform as a Service (PaaS) and Software as a Service (SaaS).
Many classify Dropbox Inc (NASDAQ:DBX) as a “hot cloud stock.” However, in a previous article, I speculated DBX would likely become the next AOL due to its lack of control over infrastructure. Like the internet service providers of the 1990s, technological change will eventually force a shakeout for which investors need to prepare.
Still, despite the no-moat status of many cloud stocks, both growth and profits have risen to stratospheric levels for now. Contrary to what many believe, Amazon.com, Inc. (NASDAQ:AMZN) derives the majority of its profits not from retailing, but from its cloud platform, Amazon Web Services (AWS). An early innovator in this area, AWS quickly rose to become the most popular cloud platform. Today, this sector enjoys so much growth that AWS lost market share in the first quarter, despite revenue growth of 49% in the first quarter.
However, with a price-to-earnings (P/E) ratio above 200, its valuation resides closer to the upper reaches of the atmosphere. In fairness, few low-valuation plays exist in this space. Salesforce.com, Inc. (NYSE:CRM) and ServiceNow Inc (NYSE:NOW) also command stratospheric valuations. Still, many cloud stocks provide a more comprehensive cloud offerings and hold valuations that reside closer to ground level, or at least below the clouds.
Reasonably Valued Cloud Stocks: Microsoft (MSFT)
Microsoft Corporation (NASDAQ:MSFT), the long-time king of PC software, found a new lease on life with its cloud platform, Microsoft Azure. Azure has become the second-most-popular cloud platform. With its involvement in all levels of the cloud, MSFT has arguably become the most dynamic company in this industry.
In its most recent report, MSFT claimed a 13% share of the market. This represents a rise from the 10% level seen in the same quarter one year ago. Azure revenues rose by 93% in this same period, while its overall cloud revenue rose by 58%. It also beat Amazon in overall cloud revenues at $6 billion. Of the major cloud players, this stands as the highest level of growth.
MSFT stock has become more expensive than at the height of the “PCs are dead” narrative. Still, at a forward P/E of just above 25, its valuation resembles S&P 500 averages.
Reasonably Valued Cloud Stocks: Alphabet (GOOGL, GOOG)
Alphabet Inc (NASDAQ:GOOGL, NASDAQ:GOOG) has turned its search dominance into a natural play on cloud computing. In reality, most people use the Google Cloud on a daily basis, since Google Search and YouTube utilize the same cloud infrastructure. Paid users remain much fewer in number. However, analysts believe the company increased its cloud market share to 6%, up from 5% one year ago.
Like MSFT, its massive market cap will preclude investors from getting rich. Alphabet does not offer a specific breakdown of cloud-based revenue. However, with the company reporting 26% revenue growth and 75% profit growth, investors should still see impressive profits.
Also, given that Alphabet stands on the cutting edge of tech in many areas, its valuation remains muted compared to other cloud stocks. The forward P/E of GOOGL stock stands at under 25, placing it near S&P 500 averages.
Reasonably Valued Cloud Stocks: IBM (IBM)
IBM Common Stock (NYSE:IBM) has periodically reinvented itself for nearly a century. Its latest reinvention has come in the form of cloud computing. It took its long-time involvement in business computing systems and from that base, launched a cloud platform. Today the cloud generates 21% of IBM’s revenue.
IBM has now become the 3rd largest player among cloud stocks, topped by only Amazon and Microsoft. The company shocked the cloud industry by topping both Amazon and Microsoft regarding cloud revenue in the fourth quarter of last year. While it fell back to third place in the first quarter of 2018, the company still reported quarterly cloud revenues of $4.2 billion.
Regarding valuation, IBM trades at the lowest valuation of all of the major cloud players. Its forward P/E stands at around 10.5 times earnings. Moreover, those who buy IBM stock will enjoy a 4.4% dividend yield, more than double the S&P 500 average. This dividend has been paid every quarter since 1916 and has increased for 22 consecutive years.
Reasonably Valued Cloud Stocks: SAP (SAP)
Walldorf, Germany-based SAP SE (ADR) (NYSE:SAP) began its existence as an enterprise software firm to help businesses manage their operations. Beginning in 2012, the company’s focus switched to the cloud. Although acquisitions focused on software, the company partnered with IBM and Hewlett Packard Enterprise Co (NYSE:HPE) to build the IaaS-related portion of its business. On this platform, it built the SAP HANA platform on which its software runs today. S/4HANA, SAP’s next generation of cloud software, enjoyed a 43% year-over-year growth rate in 1Q 2018.
SAP stock currently trades at about 19 times forward earnings. Compared with other cloud stocks, this P/E ratio comes in lower than most. Although profits stagnated in the middle of the decade, the company has enjoyed double-digit profit growth in 2016.
Reasonably Valued Cloud Stocks: Oracle Corporation (ORCL)
Oracle Corporation (NYSE:ORCL) has been an innovator in cloud technology. The Redwood City, California-based database and enterprise software company provides a comprehensive cloud solution encompassing all levels in the cloud. They also added a classification called Data as a Service (DaaS). ORCL also owns NetSuite, Inc., which many call the “first cloud company.”
Like many cloud stocks, the cloud brought growth to this company which had seen flat growth over the last few years. Now, revenue growth has returned, and Oracle again enjoys double-digit profit increases. ORCL stock also trades at about 14 times forward earnings.
However, Oracle’s proprietary approach may have led to the low valuation among cloud stocks. Our own Dana Blankenhorn describes Oracle as a “proprietary company in an open source world.” I agree with my colleague that a rejection of open source limits Oracle’s potential. I still recommend Oracle based on its cloud assets and its double-digit growth. However, if its cloud market share shows a sustained downward trend, investors need to consider moving out of ORCL stock.
As of this writing, Will Healy did not hold a position in any of the aforementioned stocks. You can follow Will on Twitter at @HealyWriting.
