Cloud computing stocks continue to enjoy an impressive run. Ranging from industry titans like Microsoft (NASDAQ:MSFT) and Amazon (NASDAQ:AMZN), to the smallest, privately-held players, cloud companies have seen massive increases in business. Analysts estimate the market will reach $186.2 billion this year. By 2021, they believe that figure will rise to $302.5 billion.
Under such growth conditions, usually everyone involved in the industry stands to benefit. However, the biggest problem with cloud computing stocks lies in the difficulty in forming a competitive moat. The cloud concept does not have an inherent moat at all. Even those who have built a moat through software only enjoy limited protection from competition.
Also, the eventual, inevitable slowdown will lead to an industry shakeout down the line. When this occurs, it will force weaker players to scale back, or possibly shut down. Many cloud computing stocks will disappear as a result. Others have equipped themselves well enough to survive or even benefit from a shakeout. However, their stock prices might have still risen to levels that do not justify their valuations.
With this in mind, investors need to review their cloud computing holdings. I believe they will find that many companies cannot survive a disruption in the growth. These firms will have to accept buyout offers from the larger players or shut their doors.
Here are 3 cloud computing stocks to take a close look at first:
Dropbox, Inc. (DBX)
Dropbox (NASDAQ:DBX) has long enjoyed a first-mover advantage on cloud data storage. When the company began in 2007, its service of data storage for individuals and business served as a unique offering.
Unfortunately, for holders of DBX stock, the cloud matured since then. Cloud storage has attracted the interest of large companies, such as Apple (NASDAQ:AAPL) and Alphabet (NASDAQ:GOOGL, NASDAQ:GOOG). These mega-cap companies tower over DBX in size. Moreover, each owns an ecosystem that makes file transfers to other platforms and applications more efficient.
Although Dropbox wisely moved most of its storage to its own servers, it lacks that critical ecosystem. Also, individuals make up most of its customer base. Generally, most individual customers only want to use the storage available for free. Apple and Alphabet can mitigate this by deriving revenue from other services. Dropbox lacks that option.
Admittedly, Dropbox has played its poor hand well. DBX’s balance sheet appears healthy, even though the stock trades at more than 16 times book value. Also, it recently began to earn quarterly profits, and its forward P/E stands at 82 times earnings. While that may sound high, this is a lower P/E than many cloud companies.
However, the thin moat should concern investors more than the valuation. All cloud computing stocks need a competitive advantage. For DBX, such market power remains limited. Should either Apple or Google decides to compete more aggressively with Dropbox, that profit margin will likely disappear. For this reason, I recommend that investors stay away.
RingCentral, Inc. (RNG)
RingCentral (NYSE:RNG) also stands out among cloud computing stocks as one that could fall victim to a thin moat. The Belmont, California-based cloud communications company allows users to “bring their own device,” integrating multiple users in different locations who use various devices. Its founding in 1999 offered the company a first-mover advantage. As such, RingCentral gained investor interest from multiple large players and attracted a client base spanning the world.
RNG launched its IPO in 2013, and it has grown into a $7-billion market cap. Unfortunately, this size leaves RingCentral vulnerable to competition from more significant players. Its biggest threat likely comes from Facebook (NASDAQ:FB). Facebook has grown into a large company in need of new revenue sources. One platform which it has not yet monetized to a large extent is WhatsApp. Unfortunately for RNG stock investors, adapting WhatsApp to replicate RingCentral’s function would not be difficult.
Facebook is a $460 billion company with about $42 billion in cash. Competing with FB would be difficult as most do not believe RNG stock will earn an annual profit until 2020.
Moreover, RNG trades at 23.8 times book value. For this reason, its $357 million in long-term debt could prove troublesome since the company only holds about $291 million in stockholders’ equity.
Salesforce.com, Inc. (CRM)
Admittedly, many will see including Salesforce (NYSE:CRM) on this list as a controversial decision. Since Salesforce has become a large player in its own right, the chances of a larger entity pushing them out of business remain low. The company has become so associated with the customer relationship management industry that it put on the map that it chose “CRM” as its stock symbol. To this day, it remains the dominant player in the CRM segment of the software industry.
Despite this dominance, my concerns about CRM stock pertain to its valuation. If the company earns $2.51 per share in this fiscal year as predicted, this takes the forward P/E of CRM stock to 63.5. Wall Street expects net income to increase by only 8.8% next year. They also forecast average annual growth of 30.7% per year over the next five years.
Although that long-term growth rate will keep CRM stock in good stead, I do not believe it justifies the current valuation. Regarding P/E ratios, this places CRM higher than the most significant players in cloud computing other than Amazon.
Unlike many equities involved with the cloud, I believe salesforce will continue to succeed. I also think that CRM stock will earn enough profit to justify its current stock price in a few years. However, for now, the stock has moved ahead of itself. At today’s stock price, I think better opportunities lie in other cloud computing stocks.
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.