Top 3 Cloud Stocks for 2022
“You know what they say, don’t ya – that data is the new oil mate. Yeah mate, that’s why they invented them Clubcard points, for your data, innit.”
And with great originality, the joke now doing the rounds on Twitter is that oil is the new data.
Hilarious.
While the price of oil is indeed hitting new highs, seemingly every few days, cloud computing stocks have quietly slipped down the pecking order and trade at a notable discount to their former highs.
It would be easy for me just to jump on trend and discuss a handful of well-managed oil and commodity funds, but there are just too many unknown variables which could suddenly turn the oil play on its head.
Most certainly, the momentum is very strong for commodities right now and I’m all one for swimming with the tide. However, on this occasion, I’m inclined to stick with proven consumer and business trends which are consistently growing instead of shorter-term supply concerns and political unrest.
If you’re a trader, then be my guest and explore the various commodity plays at your disposal. But for the longer-term investors amongst us, keep reading…
Now, while the world and his dog might be rushing in to trade a wheat ETF they had never previously heard of before, the cloud computing arena has been quietly compounding growth at a rate of 12% annually. And it’s widely estimated this figure will increase to 15% from now until 2032.
I’ll speed things up a bit and share with you the lightbulb moment which first caught my eye.
In 2021, Amazon’s AWS cloud computing segment accounted for 13.2% of Amazon’s total revenue ($62.20bn). However, the operating income they’ve achieved from that $62.20bn figure came in at $18.53bn. That $18.53bn operating income represents 74% of Amazon’s total operating income.
Yes, you read that correctly – 74% of Amazon’s profit comes from 13.2% of their total overall revenue.
It begs the question, why even bother with all the hoo-har of selling mini food processors when you can generate most of your profit from a virtual cloud?
More importantly, is this an opportunity to add some cloud-led stocks while the other speculators offload them in favour of commodity stocks?
Without further ado, I present to you an investment case for the three largest cloud computing stocks.
Amazon
Any excuse to talk up the prospects of Amazon, because goodness me what an impressive company.
An interesting fact about their new chief, Andy Jassy - it was actually him who was responsible for pitching cloud computing to Jeff Bezos back 2003. 3 years later, they pulled the trigger and launched what is now known as Amazon Web Services (AWS) in 2006.
Andy and Jeff, despite sounding like a delightful kids TV host duo, have created what is now the largest cloud computing entity with a sizeable market lead over their closest rival, Microsoft’s Azure.
Now it’s all well and good dazzling onlookers with ginormous operational profits as highlighted earlier, but Amazon’s share price hasn’t exactly set the world alight in recent years. Largely remaining range bound and drifting sideways.
A very damp squib indeed. For portfolio gains over the last 12 months, you’d have been better off invested with struggling cinema chain turned quasi gold merchant, AMC Entertainment.
So, what gives? Is their valuation too high or is the market mis-pricing Amazon?
Trying to stick Amazon into a box is difficult as their business activities are so far reaching. Should it be bundled in with fellow cloud competitors such as Microsoft or Google whose shares are up 25% and 32% respectively over the last 12 months? Or does Amazon better sit with the likes of online merchants eBay and Alibaba who have lost ground to the tune of 8.8% and 57% in that same period?
As any, suspiciously tanned, ‘self-made’ business guru will tell you, “Turnover is vanity, profit is sanity”. Something to that effect anyway. On that basis, I’d look at where the operating profit is being made, in which case all roads lead to their AWS cloud computing division.
This would surely make Amazon more at home with the Microsofts and Googles of this world, at least on a relative valuation basis. Except, according to the Analyst Forecast data-set on my Mitto Markets trade platform, they’re expected to return $48.92 in earnings per share for 2022. In which case, they trade at a 67X multiple of their earnings at today’s share price.
“Crikey, that’s steep” was my exact internal dialogue when I punched in the numbers and hit the equals button. It’s steep because in comparison, Microsoft trade at 31X their 2022 earnings per share and Google, a bargain basement 23.3X.
Calculating fair valuations doesn’t just start and stop at a basic forward P/E ratio though, there’s a plethora of subjective matters to factor in to try and decipher whether it deserves to trade at such a premium to its peers.
On this occasion, I’m very much of the opinion it’s a fairly awarded premium and for several reasons;
They’ve amassed a dominating lead in the hotly contested cloud space
Their most recent quarter showed their AWS revenue grew by 40% YoY
Sizeable $10bn share buy-back program will support the share price
Amazon Prime subscribers above 200m, almost eclipsing Netflix’s subscriber base
$8.5bn merger with MGM significantly strengthens their Prime Video-on-Demand position
2 nd largest logistics network in North America and on course to become the largest
So yes indeed, they do trade at a hefty premium, but tally up the rest of their business arms and the fact they’re already No.1 in the cloud computing market, it becomes easier to digest.
I haven’t even mentioned their move into grocery shopping with the invention of Amazon Fresh, a cashless and cashierless shop filled with sensors and cameras that’ll detect what you’ve taken and charge you automatically as you walk out. Their acquisition of Whole Foods too will nicely compliment this expansion, too.
The share price movement of late (or lack of) may have been somewhat uninspiring, but that doesn’t mean it has to reflect on future performance.
Having followed Amazon as a company for several years, there’s always been a distinct running theme – whatever they put their hand to, they become the best at.
What started out as a bookseller became the largest global seller of literally everything. Their Fresh stores bring life back to a previously dying Highstreet through innovative technology. A savvy move into e-sports livestreaming through their acquisition of Twitch in 2014 became the market leader of online game-streaming.
With great aplomb, they’re able to seemingly turn their hand to any industry they fancy and just dominate. It’s no surprise then that AWS has become king of the hill.
When they have that much size, money and resource, the barrier to entry becomes just an upturned paving stone. It’s no surprise to see the average price target from US banks suggest they’re worth $4,098 a share.
Before I move onto the bull case for Microsoft, it’s important to note Amazon’s large stake in electric car-maker Rivian. Having such a diversified portfolio of businesses, spearheaded by their cloud division, is wonderful but their $11.3bn Q4 ’21 pre-tax gain from their Rivian holding shouldn’t be ignored.
That’s lovely when the car-maker in question sees its valuation pop to $140bn on its Nasdaq debut.
However, that $140bn figure has since dropped to a lowly $42bn (if you can consider $42bn lowly).
Long-term investing will have ups and downs, and just be wary that Amazon’s stake in Rivian might present a ‘down’ in the next set of quarterly numbers given the significant decline of late. In saying that though, I’d have thought this should be priced well in advance now that Wall Street knows to closely account for fluctuations in Rivian’s valuation.
Microsoft
Not for a moment am I suggesting Microsoft’s 21% share of the cloud market isn’t impressive, but I’m a tad surprised a bookseller has created such a dominating lead.
Computers is kinda their whole shtick. So although 21% of the cloud computing market is great, I can’t help but think that increasing this percentage won’t be anything other than a top priority.
A quick scan on Google (which we’ll get to shortly), and I’m greeted with an encouraging headline to kick off proceedings; “Microsoft Soars After Cloud Forecast Eases Wall Street’s Worries” – thank you Bloomberg Technology.
46% is the magic number I’m after. That’s how much Azure revenue increased in the Q2 ’22 reporting period YoY.
Fantastic, and better than Amazon’s 40% growth.
However, Wall Street analysts weren’t initially impressed as they were wanting Azure’s revenue to grow in the region of 50%. And despite Microsoft beating expectations in all other areas such as bottom-line profit and overall top-line revenue, the shares sold off 5% in response to the Azure segment missing that 50% growth mark.
This should give you an idea of how much emphasis analysts are now placing on cloud revenue. Its profit profile is the envy of corporate America.
BP, for example, is expected to deliver revenues of $223bn for this year, of which $16bn will translate into profit. Microsoft on the other hand is forecasting $200bn, but $71bn in bottom-line profit.
It really is night and day.
Not surprisingly, that 35%+ profit margin is significantly higher than their 24% 5-year CAGR/Avr as their Azure platform becomes a larger segment of Microsoft’s overall revenue each quarter.
Clearly, the fundamentals are outstanding, but the share price is still trending down.
I’m not much of a fan of technical analysis, not when it comes to long-term investing at least anyway. I prefer to think about who’s actually moving the market with $250m+ order tranches – spoiler alert, it won’t be Twitter user: GameStop2daMoon12831 giving their 2 cents on Microsoft crossing through 38-day cup & saucer moving RSI average chart pattern. It’ll be large fund managers such as Warren Buffett and Cathie Wood.
I can say with near certainty, neither Warren Buffett or Cathie Wood will be rushing to the boardroom to discuss downsizing their positions if Microsoft breaks the 20-day moving-average.
However, that’s not to say strong momentum can’t cause unwanted headwinds in the short-term which can be disconcerting for the faint hearted amongst us. But in reality, if the fundamentals remain outstanding while the share price drops, it will be large fund managers hoovering up stock from GameStop2daMoon12831 and his cronies. I know which crowd I’d rather follow.
Now for the valuation, and I’m pleased to report a far more palatable number than what Amazon is offering. Trading at just 32X it’s 2022 full year EPS, it’s offering a tremendous discount on Amazon’s valuation at first glance.
First of all, it’s important to appreciate they’re quite different companies which just so happen to share a key market in cloud computing, so naturally they’ll have different valuation profiles – Amazon has true world domination status given how far reaching their business arms stretch. Then there’s the fact that Microsoft is still playing second fiddle in the cloud contest. The final blow is the profit growth from 2022 to 2023. Microsoft, a noteworthy 15%. Amazon, a dwarfing 49% which should act as the biggest clue as to why there’s a valuation chasm.
That shouldn’t take away from Microsoft’s merit and over the last 5 years, they’ve significantly outperformed the S&P 500 and Amazon for that matter. Additionally, Microsoft offer a small dividend yield of 0.83%.
The average price target for Microsoft is currently $370.89.
Alphabet
Finishing off the list, we’ll end with a very fine business indeed, Alphabet. I must start a serious disclosure, however.
I wholeheartedly admit I suffer a severe case of confirmation bias when it comes to Alphabet, and I didn’t think it would be possible to adore a company which isn’t even aware of my existence – but apparently, I can and do.
You see, I’ve always leaned towards US mega-cap tech for investing ideas over the years. I’ve yet to find another sector which provides such tremendous growth while offering a real sense of safety net by way of cash balance, brand, market dominance and continual innovation.
Now, what makes Alphabet a particularly special case amongst the big tech mainstays is their valuation. It’s entirely possible I’ve consumed too much BBC Bargain Hunt of the years, but when I see a company which has consistently outperformed the S&P 500 trade at just 23.2X their forward earnings… *insert stupid bargain hunt related catchphrase*.
To put that into perspective, I don’t think I’ve ever seen a company’s share price move up so considerably while simultaneously witness their earnings multiple contract.
In other words, despite the rapid share price increase, their earnings growth is still outstripping it comfortably.
So if you’ve watched Google jump from the $1,500 pandemic lows to nearly $3,000 a share and think you’ve missed the boat, you haven’t! Coincidentally, the last time Google traded at just 23X times its earnings was March 2020, their $1,500 pandemic lows. Relatively speaking you have roughly the same entry point today on a forward multiple basis, at least.
This is all well and good, except let’s not get too distracted from the matter in hand and why they’re third in this article.
You came here for cloud related stocks, and Alphabet sits in 3 rd spot with a worthwhile 10% of the market share through their Google Cloud Platform (but tied 2nd with Amazon for imaginative name of the year awards). But if they’re to achieve a higher valuation more in line with their fellow peers, then a concerted effort for that juicy cloud market needs to be seen.
A possible insight as to why Alphabet is trading at a discount to Microsoft and Amazon is their lack of cloud profitability. In their most recent Q4 earnings report, cloud revenue jumped an impressive 45% to $5.5bn, but didn’t offer up any profit. In fact, it was accountable for a $890m operating loss. Better than the comparable Q4 ’20 operating loss of $1.24bn but clearly, they’re running on a different path and still in the heavy investment stage.
Beyond this however, I can’t help but think, $5.5bn doesn’t exactly scratch the surface vs the rest of their $75.3bn quarterly revenue. Nor does it with Amazon either to be fair, but at least it’s incredibly profitable for Andy Jassy. The same can’t be said for Alphabet’s cloud division.
As an investor you’re certainly getting some form of exposure to the sought-after cloud market, but even a proud mother with rose-tinted glasses might be better off seeking solace from their traditional core business activities such as Google Search and YouTube.
Which I can confirm, does not disappoint…
In just 5 quarters, their YouTube segment has gone from clear 2nd place to easily toppling Netflix’s entire business.
The 2006 acquisition of YouTube, which cost (then known) Google $1.65bn, raised many an eyebrow for the high price and concern over its ‘staying power’. At the time, YouTube was cultivating 19m unique monthly users… Impressive for 2006 (and interestingly, the same year Amazon launched AWS).
That number now sits around 1.7bn unique monthly users.
And let’s not forget their biggest weapon in its armoury – Google Search, which generated $43.3bn in revenue (Q4 ’21), quite a bit higher than the expected $41bn.
This is all very impressive when we overlook their cloud credentials, but even then it’s important to understand Alphabet is still very much in spending mode with that division, relentlessly building out data centres, increasing headcount and growing the infrastructure so they can better compete with Azure and AWS. Seeing red on that part of the balance sheet is to be expected. Their hard work there is clearly paying off too, with sales increasing by nearly 50% each Q-on-Q.
What’s most impressive about Alphabet is their overall profit. Given their diminutive earnings multiple, you’d have expected them to also come last too. This couldn’t be further from the truth.
$77,753,000,000 is the projected 2022 net profit. Greater than Microsoft’s $71bn and more than 50 yards higher than Amazon’s $25.4bn.
Indeed it may be trailing in third place for the sought after cloud market, but they more than make up for it in every other division and their cash cow of the group, Google Search, has undeniable moat status.
I’ll leave you with an interesting fact to prove what I mean. Bubble Wrap was originally marketed as a 3D wallpaper. Don’t believe me? Guess you’ll have to…. Ask Jeeves. Not quite the same ring.
And those are the 3 biggest cloud contenders. They all make for a wonderful investing case, be it all a bit different and unique in their own ways. I’d have no qualms in seeing any of these fine companies in my portfolio, but I’ll leave it up to you, the reader, to decide which makes it to your final watchlist!
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