Cloud computing truly has revolutionized American business. The ability to deliver top-level performance anywhere — to a customer of nearly any size — has leveled the playing field for small and medium-sized businesses. And growth is only going to rise going forward.
That would seem to create a huge opportunity in cloud computing stocks. But the problem is that the trend isn’t exactly hidden — or new. Investors already are pricing many cloud plays at exceedingly high multiples to earnings — and in the cases of many companies that remain unprofitable, to sales.
But there are still opportunities to play the cloud computing trends with stocks whose valuations still allow for strong upside going forward. These four stocks all will benefit from cloud computing — and all are priced reasonably enough to satisfy investors looking for attractive entry points.
Luke Lango pointed to cloud computing last week in arguing that MU should trade above $70. Stifel analyst Kevin Cassidy made a similar point after earnings this month, and gave Micron stock a $108 price target. JP Morgan (NYSE:JPM) has cited the cloud tailwind, and so has Morgan Stanley (NYSE:MS).
The core argument is rather simple. Micron trades at a seemingly ridiculous valuation (barely 5x forward EPS) because investors are worried that always-cyclical memory pricing eventually will decline. But the memory — particularly on the DRAM side — required for cloud computing should provide years of demand that can help offset any supply expansion. If cloud computing continues to grow, Micron’s pricing should hold — and so should its earnings. And at some point in that scenario, Micron will be trading for a lot more than 5x EPS and its current price of $53.
The story at Adobe (NASDAQ:ADBE) is a faster-growing version of that of Microsoft (NASDAQ:MSFT). In both cases, the shift from “on-premise” software to cloud-based offerings hasn’t just been a case of selling the same product in a different medium. Rather, the move to the cloud has opened up new cross-selling and revenue opportunities … and benefited margins as well.
Indeed, Adobe’s fantastic growth story often seems a bit lost in the shuffle in terms of tech coverage, despite a $120 billion market capitalization and hugely impressive performance. In fiscal Q2, revenue rose 24% and EPS jumped an impressive 77% year-over-year. Adobe once again beat analyst estimates; it hasn’t missed consensus on either revenue or EPS since September 2014.
Valuation is a bit of a concern, as Lango pointed out after the fiscal Q2 report. But a 31x forward EPS multiple isn’t that oppressive in the context of recent growth, and a pullback since earnings has brought the valuation in a bit. Investors are still paying up for ADBE, but at least they’re paying up for quality.
Investors need to tread carefully with Red Hat (NYSE:RHT). RHT stock continues to plunge after disappointing fiscal Q1 earnings last week. The stock now has fallen 24% from all-time highs set just about two weeks ago.
So on one hand, investors are catching a falling knife. On the other, it’s not as if Red Hat stock is suddenly that cheap. RHT still has gained 12% so far this year — and still trades at 33x forward earnings. If growth truly is decelerating, as investors seem to fear coming out of the weak Q1, there is more potential downside here. Near-term, investors might want to wait for a bottom before trying to enter a position.
Still, as ugly as Q1 looked, the long-term story here still looks solid. Red Hat’s dominance in open-source software underpins the business model, and the company should benefit from increasing “private cloud” development going forward. Meanwhile, RHT long has been rumored as a takeover target, with Alphabet (NASDAQ:GOOGL, NASDAQ:GOOG) recently floated as a possible buyer.
RHT stock isn’t cheap but it is cheaper. And there’s a case that after the 24% selloff, it’s back to being too cheap.
But investors looking for yield and cloud exposure can look to data center REITs. And the choice here is CyrusOne (NASDAQ:CONE). Cloud computing efforts require space and datacenter owners like CyrusOne provide that space for a handsome fee.
The industry is still growing — and yet CONE looks reasonably priced. The stock trades at under 18x the midpoint of guidance for full-year normalized FFO (funds from operations). The dividend yield is a solid 3.2%. CONE isn’t going to be a high-flyer like other stocks on this list could be, but it’s an attractive investment with the potential for double-digit annual total return going forward.
As of this writing, Vince Martin has no positions in any securities mentioned.
Legendary Investor Louis Navellier’s Trading Breakthrough
Discovered almost by accident, Louis Navellier’s incredible trading breakthrough has delivered 148 double- and triple-digit winners over the past 5 years — including a stunning 487% win in just 10 months.
Learn to use this formula and you can start turning every $10,000 invested into as much as $58,700.
Click here to review Louis’ urgent presentation.