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All Contents © 2020The Kiplinger Washington Editors
By Ryan Ermey, Associate Editor
| August 11, 2017
You’ve no doubt heard about the awesome and ubiquitous power of the “cloud.” It seems straightforward. You take everything on your computer, upload it to the cloud, and–poof!–you can access your data, photos or programs from anywhere. But what is the cloud? Where is it? It’s all a bit, well, nebulous.
Simply put, the cloud is a metaphor for the internet. Cloud computing means a user can store and access data and programs on the web, rather than on a hard drive. Companies that offer these storage and retrieval services are called cloud providers, and they charge based on usage, much as a utility does.
For an individual, accessing the cloud might mean uploading your digital photos to, say, Amazon Drive, rather than saving them on your computer or accessing an online version of Microsoft Word. For businesses, the shift to the cloud represents a huge cost savings. Companies with a lot of digital information used to have to build their own technology infrastructure, including data centers with rows of high-powered servers and expensive cooling systems. Now companies can access cloud providers’ infrastructure over the internet and pay only for what they use, potentially cutting IT spending by 20% to 60%, says investment research firm Morningstar.
For investors, the cloud represents an enticing opportunity, with worldwide cloud spending expected to reach $383 billion by the end of 2020, up from $247 billion in 2017, according to estimates from tech research firm Gartner. The following five companies range from big-name cloud service providers and companies that supply the service providers to a promising but unproven upstart. It’s not a comprehensive list, but each of the five companies named below is well-positioned, in its own way, to capitalize on the ongoing cloud revolution.
Prices and data are from August 10, 2017. Click on ticker-symbol links in each slide for current prices and more.
Price-earnings ratios are based on estimated year-ahead earnings. Stocks are listed alphabetically.
Share price: $144.92
Market capitalization: $71.5 billion
52-week high/low: $150.40/$97.87
Estimated earnings per share: $3.71
Price-earnings ratio: 39
Adobe is best-known for creating and selling programs, such as Photoshop and InDesign, that consumers and professionals use for graphic design, digital imaging and other creative endeavors. In 2011, the company announced that its flagship suite of programs, traditionally sold as software with a perpetual license, would be available online as a cloud-based subscription service called the Creative Cloud. In 2013, Adobe said it would no longer update the old software, accelerating plans to migrate all users to the cloud-based subscription model. The company took a hit following the shift – total revenues and earnings declined 8% and 66%, respectively, in the fiscal year that ended in November 2013, before flattening out the following year.
But Adobe has since attracted new customers, says Morningstar analyst Rodney Nelson, thanks to the Creative Cloud’s more appealing, a la carte pricing and seamless, automatic upgrades. That has translated into steady earnings and revenue growth since the 2014 plateau, with the new model producing an increasing percentage of more predictable recurring revenues. Shares are priced steeply at 39 times estimated earnings, but analysts at Credit Suisse think the company should benefit from the Creative Cloud’s continued momentum. Companywide, earnings should increase 34% in the fiscal year that ends in November, followed by a 24% increase in fiscal 2018.
Share price: $956.92
Market capitalization: $459.7 billion
52-week high/low: $1,083.31/$710.10
Estimated earnings per share: $4.31
Price-earnings ratio: 222
Amazon.com introduced itself in 1995 as “Earth’s biggest bookstore.” Today, the retail juggernaut is Earth’s biggest cloud provider, raking in more revenue from the cloud than the next five largest players combined. According to the Synergy Research Group, Amazon Web Services commands 33% of the global cloud services market, thanks to its vast network of data centers – huge warehouses full of servers whose computing power Amazon rents to other companies.
AWS is also “the undisputed market leader from an innovation perspective,” say analysts at financial services firm William Blair. That helps draw new users to the platform and retain them once they’ve signed up. AWS upgraded the platform more than 1,000 times in 2016 alone, adding features that address artificial intelligence, cybersecurity and data analytics. Blair expects the stock to outperform the broad market over the next 12 months. Another bull: Sonu Kalra, manager of the tech stock-heavy Fidelity Blue Chip Growth fund. The fund invests 6% of its assets in Amazon stock, making Amazon the third-biggest holding.
Amazon’s cloud business currently accounts for just 10% of total sales, but it supplies an outsize portion of the company’s operating profits. Morningstar analysts believe AWS could post 32% annualized revenue growth through 2021, boosting its contribution to companywide annual revenues to 14% over that period and accounting for more than half of the company’s operating profit.
Share price: $57.43
Market capitalization: $5.2 billion
52-week high/low: $60.55/$38.80
Estimated earnings per share: $3.27
Price-earnings ratio: 18
A dividend-focused real estate investment trust might not sound very cloud-y, but CyrusOne owns and operates data centers – massive stores of servers complete with data backup and recovery capabilities, and intricate cooling systems that serve as the key infrastructure for the cloud. Companies migrating to the cloud rent space in CyrusOne’s centers, so as demand for cloud computing grows, so should demand for CyrusOne’s business.
Unlike traditional REITs, whose profitability is tied to square footage, CyrusOne’s is tied to its computing power. “You can increase the capacity of a data center not by adding space, but by adding extra backup power, cooling capabilities and broadband,” says Eric Marshall, comanager of the Hodges Small-Cap Fund, which owns the stock. That means CyrusOne doesn’t have to go to the expense of developing land or building new centers in order to increase revenues. What’s more, CyrusOne builds its data centers as large, well-equipped shells but then fine-tunes them to meet clients’ specific needs. This makes customers more likely to sign lengthy five- and 10-year leases, says Marshall – a source of steady, predictable cash flow.
The stock went public in 2013 and has increased its dividend every year since. Following an 11% hike in February, the stock currently yields 2.9%.
Share price: $71.41
Market capitalization: $550.0 billion
52-week high/low: $74.42/$55.61
Estimated earnings per share: $3.17
Price-earnings ratio: 23
Since CEO Satya Nadella took over in 2014, Microsoft has been attempting to reposition itself as a “cloud-first, mobile-first” business that relies less on selling its Windows operating system, which analysts expect to flag over the long term, along with demand for desktop PCs. So far, the strategy’s working. Microsoft operates two cloud businesses. In Office 365, Microsoft has made the Office suite available as an automatically updating subscription-based web program, similar to Adobe’s Creative Cloud. With more than 1 billion people using some form of Office worldwide, Morningstar analysts believe that a transition from Office to Office 365 would result in a significant acceleration in revenue growth for Office products, with the segment contributing nearly $45 billion in annual sales by 2026, up from about $25 billion in 2017. (Microsoft reported total revenues of $90 billion for the fiscal year that ended June 30).
Microsoft also operates Azure, which, like Amazon Web Services, provides a web-based cloud platform that it rents to other companies. Azure is the second-largest cloud platform on the market, and although it comes in a distant second to Amazon’s AWS in revenues, it’s growing fast, having posted a 97% year-over-year spike in sales in the fiscal year that ended in June. Analysts at financial services firm Credit Suisse assign the stock an “outperform” rating based on increasing demand for cloud computing that should allow Microsoft to boost earnings in time, starting with a 12% bump in the fiscal year that ends in June 2019. Plus, they say, profit margins overall should improve over the long term as the highly profitable cloud segments occupy a bigger portion of the business.
Share price: $30.28
Market capitalization: $2.7 billion
52-week high/low: $70.96/$22.80
Estimated earnings per share: N/A
Price-earnings ratio: N/A
If you’ve got a high tolerance for risk and a yen to “get in on the ground floor,” consider Twilio, a software development company whose code allows cloud-based companies to offer texting and calling within their apps. Anytime Netflix sends you a text alert, or Uber lets you call or text your driver through the app – that’s made possible by two lines of Twilio’s code. Every time an app user activates that code, Twilio collects a fee.
Shares in the young tech company popped 12% in early August, after Twilio reported sales that beat Wall Street estimates — even though the company has no earnings to speak of, yet. The stock has since receded, and is trading 56% below its September 2016 high, when it was priced at an eye-popping 22 times sales a mere three months after its IPO.
Clearly, investors in this stock should have a speculative streak and are going to have to stomach some serious volatility. Just last May, shares tumbled 30% when the company announced that its top customer, Uber, would be scaling back its relationship with Twilio. But analysts at financial services firm Baird believe the firm is in a dominant position in an industry that is bound to grow as “virtually all communications shift to the cloud over time.” Examples include being automatically alerted by a hospital’s computer system to an appointment that opens up, say, or a cloud-based system that routes customer calls to the appropriate representative. In the meantime, says James Wang, who manages the cloud computing-focused ARK Web x.0 exchange-traded fund, which has 3% of its assets invested in Twilio, the stock gives investors access to “unicorns,” – cloud-based giants, such as Uber, Lyft and Airbnb, who use Twilio’s code but don’t yet trade on public exchanges.