According to Gartner, the global cloud computing market will continue growing at a 17.5% annual rate over the next decade. Given its current size of $397 billion, this means it will be more than a trillion-dollar industry within the next 5 years.
For investors, this type of growth and scale means there are many different investment opportunities:
- The big companies that are building the cloud infrastructure layer.
- Companies building more targeted, software-based services on top of these platforms and infrastructure.
This type of growth means there are plenty of opportunities for investors in cloud computing. This report will provide a broad overview of the industry, examine some of the most promising niches, and then provide some insight on some of the most intriguing stocks in the sector: Google (GOOGL), Microsoft (MSFT), Salesforce.com (CRM), Adobe (ADBE), and Autodesk (ADSK).
What is Cloud Computing?
At one time, heavy computing power was an expensive and rare asset only available to big corporations and universities. Heavy computing power is a term used to describe all the processing power from servers in data centers that are necessary to operate the cloud. And, technologies of the future like AI, ML, virtual reality will all require even more processing power.
As costs have fallen over the past couple of decades, it’s increasingly become a commodity in that the cost of distribution is more than the cost of production. Now, even distribution costs have also declined while capacity is improving.
Due to these developments, any business can access this heavy computing power and leverage technology to achieve their goals at much less cost. All types of applications requiring computing power are now done through the cloud. Examples include web and application hosting on AWS or Azure, customer relationship management salesforce with Salesforce, or storing photos and videos with Google Drive or Dropbox.
As the costs have dropped, the market has expanded. And, it’s enabled developers to build applications on top of these cloud platforms and applications.
It’s also had notable real-world impacts. For example, the majority of apps and services on smartphones are enabled by cloud computing. The cost of startups has also precipitously declined. Previously, companies would have to invest significant sums in buying or renting servers. Now, companies can access these on a “per-use” basis, turning IT into a flexible cost rather than a fixed cost.
Benefits of Cloud Computing
Cloud computing makes a company’s IT, technology, and operations more powerful, agile, and flexible by enabling the delivery of enterprise-level solutions on demand to increase customer engagement and improve operational efficiency.
Cloud computing encompasses a wide variety of categories. Now, all types of IT services are available on the cloud, from basic infrastructures such as compute and storage, to application development platforms and specific software applications. These services are hosted remotely and accessible through the Internet.
Cloud computing enables companies to scale their IT stack with minimal difficulty. Before, IT services required servers, equipment, and people to operate and manage which was a capital and time-intensive process. For many firms, this constrained growth due to the cost, complexity, and challenge of scaling IT resources.
Now, these services can be scaled according to need in a frictionless manager. As a result, employees can use and operate enterprise-level software on a per-user or per-use basis. Future disruptive technologies are being built on top of and integrated with existing cloud services. Notable examples include autonomous driving and artificial intelligence.
In addition to the attractive economics of cloud computing, cloud systems require less upkeep as maintenance and security needs are handled by cloud computing providers. Therefore, companies have less need for dedicated IT personnel who would spend time on adding new servers and upgrading equipment.
Over time, cloud systems have evolved and the number of use cases has rapidly multiplied. The three major categories of cloud computing are Software as a Service (SaaS), Platform as a Service (PAAS), and Infrastructure as a Service (IaaS).
See the table below for information on each:
|Software as a Service (Saas)||Software Applications over a Network||Slack, email, MS Office|
|Platform as a Service (PaaS)||Developer Environment over a Network||Windows Azure, Google App Engine|
|Infrastructure as a Service (IaaS)||IT resources provided over a network connection||AWS, Google Cloud|
Every cloud computing company falls into one of these three categories. However, PaaS and IaaS are dominated by large companies, while most startups fall into the SaaS category.
This is due to the economies of scale and network effects of these businesses. More users mean more demand for services which leads to more data and iterations to improve the product. This scale leads to lower costs and higher barriers to entry. As a result, these businesses tend to have high rates of recurring revenue and impressive gross margins which have been rewarded by the market over the last decade with high multiples.
Early Stages of Growth
Given the quantitative and qualitative advantages of cloud computing, it’s not surprising that companies are migrating to these platforms, services, and applications. Companies no longer have a choice and must do so to remain competitive.
However, this process remains in its early stages. As of April 2021, 90% of S&P 500 companies had a job posting for a “cloud migration” specialist, indicating that cloud spending remains a priority. Even despite its impressive growth, the average IT environment today, is still majority non-cloud, although it’s expected to shrink in the years ahead.
Further, many types of investments made by companies come with uncertainty in terms of getting a return on investment. Cloud spending is an exception as costs go down but capabilities increase.
Investing in Cloud Computing
In 2022, the cloud computing industry is estimated to be worth just under $400 billion and cross the trillion-dollar threshold by 2026. Investors have many choices when it comes to investing in the sector. One option is to buy a broad cloud computing ETF like the WisdomTree Cloud Computing ETF (WCLD) or the Global X Cloud Computing ETF (CLOU).
Another route is to invest in the cloud infrastructure stocks like GOOGL, Amazon (AMZN), or MSFT. These companies are the leaders in the industry and are unlikely to be disrupted given their scale and early-mover advantage. In less than a decade, their cloud units generated $4.5 billion, $14.2 billion, and $17.7 billion respectively in their last quarter. Despite their size, they are growing at a 46%, 33%, and 32% rate, respectively.
The vast majority of cloud applications are built on top of these platforms, so these companies will benefit from the industry’s overall growth. Another approach is to focus on the PaaS or SaaS companies that are building more targeted solutions for their customers.
Below, we will analyze 5 cloud computing stocks that are a representative sample of the total industry:
GOOGL is the clear leader when it comes to online search with over 80% market share. From this, it derives strong revenue growth and cash flow by selling ads. Using its search proceeds, Google has made investments to grow in new areas. Among these, Google Cloud is one of its most successful bets.
Google Cloud is the third largest cloud provider in the world with a 7% market share trailing only Microsoft’s Azure and Amazon’s AWS. However, it’s the fastest-growing major cloud provider with a 46% growth rate.
In the last quarter, Google generated $4.5 billion for the company. Interestingly, Google Cloud is built on the same infrastructure that it uses for the delivery of its own products and services such as Gmail, YouTube, Google Docs, etc.
Google Cloud counts a large number of premier companies as customers including Shopify (SHOP), Paypal (PYPL), Twitter (TWTR), and Goldman Sachs (GS). It’s also been aggressively making partnerships with telehealth companies with building on top of Google Cloud.
Although Google Cloud remains a small part of the larger company, it does make up a large share of recent revenue growth especially in 2020 when search revenue flat-lined. Given the high margins of cloud businesses, this growth will start filtering to the bottom line as well.
The POWR Ratings are constructive on Google as well as it has an A rating which translates to a Strong Buy. A-rated stocks have posted an annual performance of 30.7% which compares favorably to the S&P 500’s annual performance of 7.3%. The POWR Ratings also evaluates stocks by different categories including Value, Growth, Momentum, Stability, Sentiment, Quality, and Industry. To see GOOGL’s component grades, please click here.
MSFT is currently the leader in the “Cloud Wars” with $17.7 billion in revenue. In fact, the company has a commanding lead given that second place Amazon and third place Google’s cumulative cloud revenue is $17.3 billion.
Of course, MSFT infamously pivoted to the cloud in 2013 upon the selection of Satya Nadella as Microsoft CEO. This decision was pivotal for MSFT as its stock price had been moribund for much of the past decade. However, since then, Microsoft has been the best-performing stock in the S&P 500 and is now the second-most valuable company in the world.
Microsoft essentially turned many of its software products into a subscription which resulted in higher lifetime customer value, higher margins, and more opportunities to upsell. However, the crown jewel of its business is Azure.
MSFT has been layering targeted solutions for its cloud customers in all types of areas. Currently, it counts over 200 specific processes, while there are countless more that have been produced by the developer ecosystem. Some of the most popular include data analytics, AI, machine learning, and visualization.
Of course, MSFT has a lot going for it beyond the Cloud, however, it did account for 65% of the company’s revenue growth in the last quarter. And, this share of growth could increase in coming quarters especially if tech sales slow as the economy reopens.
The POWR Ratings have a constructive outlook on MSFT as it has a B rating which translates to a Buy. B-rated stocks have posted an annual performance of 19.7%. The POWR Ratings are calculated by taking into 118 different factors each with its own weight.
The POWR Ratings also evaluates stocks by different components. In terms of Growth, it has a B rating which isn’t surprising given its exposure to the cloud and history of consistent revenue growth. To see more of MSFT’s component grades including Value, Momentum, Stability, Sentiment, Quality, and Industry, click here.
CRM is currently the largest Customer Relationship Management vendor globally with a 30% market share in the sales force automation space. It’s also one of the first cloud-based companies.
CRM quickly went from something that was a nice feature for companies to something that has become required due to its effectiveness in increasing revenues. Thus, 90% of the Fortune 100 companies use at least one CRM software. CRM is unique as it’s basically invented an entire $130 billion market and remains the dominant leader.
Like many cloud stocks, it has an impressive rate of recurring revenue and has been effective in increasing revenue per user. The company has also been adding more features to its offerings, including customer service, marketing automation, e-commerce, analytics, and artificial intelligence. It’s also been successful in expanding already hefty margins.
The stock has an overall grade of B, which translates into a Buy in the POWR Ratings system. The company has a Growth Grade of B, which isn’t surprising given revenue growth of 22% and earnings growth of 26% in the next quarter.
We also provide grades on CRM based on Quality, Industry, Value, Momentum, Stability, and Sentiment. You can find those here. CRM is ranked #20 in the Software – Business industry out of 125 stocks. You can find other top-ranked stocks in the industry by clicking here.
Like MSFT, ADBE shifted the bulk of its software offerings into subscription-based products which ended up being a major catalyst for its revenues, earnings, and stock price.
ADBE offers a complete suite of software products for content creators. Notable products including Adobe Acrobat, a PDF reader, Photoshop for editing photos, and Adobe After Effects for video editing. It also has branched out into other offerings including electronic document technology and graphic content authoring applications for designers and developers. Another area of growth is its marketing services for digital products.
ADBE also benefited from the surge in remote work and validated its shift to the cloud. Like the top cloud stocks, ADBE has high rates of recurring revenue as once a company starts using its products, switching costs and inconvenience ensure that they stay especially as their products are known for their quality and compatibility.
ADBE is rated a Buy with a grade of B in our POWR Ratings service. The company also has a Quality Grade of A due to its leading position in an expanding market. Further, content creation is increasingly becoming a requirement for companies to discover and engage with customers. To see more of ADBE’s ratings, click here.
ADSK makes software and provides services that are used by architecture, engineering, construction, and manufacturing companies. The company saw a large surge in use during the pandemic due to people working remotely.
Since its peak in mid-January, the stock is down by 15%. This compares favorably to other cloud stocks which have seen much larger declines. Unlike these stocks, ADSK is unlikely to see a decline in revenue since its product is so essential to the functioning of numerous companies. Further, the boom in construction, infrastructure, and housing is another positive catalyst for ADSK.
ADSK is considered one of the higher-quality SaaS stocks due to a lack of major competitors and its importance. It’s quite reasonably valued with a forward PE of 42, 15.6% revenue growth, and 39% earnings growth next year.
ADSK is expected to see revenue growth of 10.5% for the quarter ended April 30th, 2021, and 13.7% in 2022. Its EPS is estimated to grow 22.5% in 2022 and 31% per annum over the next five years. Currently, all 7 Wall Street analysts covering the stock have a Buy rating on it with an average price target of $344, implying a 25% upside from current levels.
ADSK’s strong fundamentals are reflected in its POWR Ratings. The stock has an overall rating of B, which translates to a Buy in our proprietary ratings system. It’s not surprising that ADSK has an A grade for Quality given these positive qualities and exposure to positive trends.
Beyond what we’ve stated above, we also have given ADSK’s grades for Growth, Value, Sentiment, Momentum, and Stability. Get all the ADSK ratings here.
MSFT shares were trading at $245.30 per share on Tuesday afternoon, down $1.88 (-0.76%). Year-to-date, MSFT has gained 10.54%, versus a 10.91% rise in the benchmark S&P 500 index during the same period.
About the Author: Jaimini Desai
Jaimini Desai has been a financial writer and reporter for nearly a decade. His goal is to help readers identify risks and opportunities in the markets. He is the Chief Growth Strategist for StockNews.com and the editor of POWR Growth newsletter. Learn more about Jaimini’s background, along with links to his most recent articles. More…