Cloud is Growing 20% Annually: 3 Tech Stocks to Buy for Exposure
Microsoft released its Q2 earnings report last Tuesday, and the results were not great. Microsoft MSFT missed analyst expectations for sales, and narrowly beat on earnings. But the worst part was, following the call MSFT stock saw downgrades, and lowered guidance.
There was a bright spot on the earnings call though, which was Microsoft’s Cloud segment. Although it was noted that growth has been slowing, cloud services still put up 18% YoY growth, and Azure more specifically grew 31% YoY.
While growth rates are down from +60% annually in years past, cloud services are still an extremely valuable, fast-growing segment of the market, and big tech knows this. The ongoing growth potential of cloud computing has ratcheted up the competition between Amazon AMZN, Alphabet GOOGL, and Microsoft. All three are engaged in a long-term arms race to dominate the crucial cloud market.
Cloud computing and cloud services is one of the fastest growing industries in the market today. The global cloud computing market is valued at $369 billion and expected to grow 15% annually to $1.6 trillion by 2030, according to Allied Market Research.
Cloud computing is a remote capable computing option for individuals and institutions. It allows users to minimize the upfront cost of IT infrastructure and enables flexible capacity for storage, computing power, communication, and several other tech related resources.
Accelerated in part by the work from home movement, as well as the expanded computing capabilities enabled by the cloud, enterprises are rapidly adopting the computing paradigm.
There are three primary types of cloud computing services:
Infrastructure as a Service (IaaS) – IaaS is where the provider offers IT services like computing power, storage, and servers. This allows users to scale up or down hardware needs without actually owning the hardware.
Platform as a Service (PaaS) – PaaS is an option where users can utilize a cloud environment to develop, manage and host applications. This comes with tools for testing and support, and the platform supports through security, operating system and backups.
Software as a Service (SaaS) – SaaS is a service where software is accessed remotely through the cloud, instead of needing to install locally.
The competition for cloud dominance is fierce. While we already got an update on MSFT’s most recent cloud services revenues, earnings reports from Amazon and Alphabet this week will provide a more complete picture of how the competitors compare.
According to Synergy Research, in Q3 the cloud services industry made a total of $57 billion, and an increase of 24%, or $11 billion from the year prior. While impressive, this shows a deceleration in revenue, as Q2 YoY growth was 29%. While macro factors may play a role in the deceleration, it is also what happens as industries mature. As the market saturates more of the demand, growth inherently slows.
The current leader, Amazon with AWS, has been slowly losing market share over the last couple of years. Amazon’s 2020 market share was estimated at 41% with it now down to 34%. Q3 revenue for AWS came in at $20.5 billion, below analysts’ estimates of $21.1 billion.
Image Source: Synergy Research
This means Microsoft isn’t alone experiencing slowing cloud growth. In its Q3 earnings report AWS showed 27% YoY growth, which was below analysts' expectations, and down from the prior quarter which saw 29% YoY growth.
There was a standout performance in Q3. Google’s cloud service was the only one to see YoY growth in Q3. Different than the other two, GOOGL is currently running its cloud division at a loss, whereas MSFT and AMZN run their cloud businesses profitably, with wide margins. The reinvestment into sales by GOOGL may be the difference-maker currently.
Alphabet is also the least dominant in the space, so there may be an urge to play catchup against its competitors.
Earnings from GOOGL and AMZN this Thursday February 2 will provide much more clarity on where competition is heading.
If I had to pick one that I think will outperform, I would buy GOOGL stock. As the smallest percent of the industry, and fastest growing of the three I think nimbleness will be an advantage. Also, since they are not yet focused on running the business at a profit as their other business segments generate tremendous cash, it allows them to reinvest more aggressively into growth.
Alphabet is also relatively cheaper than Amazon and Microsoft. With a one year forward P/E of 19.5x it is below Microsoft’s 25x multiple, below its five-year median of 24x, and nearing the low of 16x.
In terms of multiples AMZN is not even in the conversation because it still trades at a 57x forward P/E. Additionally, since Amazon is now so reliant on the Free Cash Flow from AWS, they may be more focused on maintaining that, rather than growing market share, which already contracting.
Image Source: Zacks Investment Research
Although industry growth is slowing it appears cloud services remain resilient in a slowing economy. This is extremely important for the big tech companies as cloud continues to become a more significant addition to their top line. Additionally, across the big three, they are all seeing a deceleration, or outright shrinking of their primary businesses further emphasizing cloud importance.
Cloud infrastructure is an increasingly important contributor to big tech revenues, economic growth, and business productivity. It has already had a massive impact, and though growth is slowing, it is likely to continue to be a leader for many years going forward.
The big three of MSFT, GOOGL, and AMZN are duking it out to see who the leader will be. With the incredible competition between them users will see further competitive pricing, new features, and an expanded use case for the technology.
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