The world is moving on the cloud. The rapid penetration of the internet is generating tons of data every second. All this data is stored in the cloud. Cloud computing technology started developing in the first half of the decade (2010-2015). This gave rise to SaaS (software-as-a-service) companies and IT service companies that support digitization. The COVID-19 pandemic made digitization a necessity rather than an upgrade.
All businesses, educational institutions, and government organizations, big and small, moved to the cloud to keep the work cycle running. Many cloud service companies soared triple-digits. Pandemic or no pandemic, ResearchAndMarkets.com expects the cloud computing market to surge at a CAGR of 17.5% over the next five years. This growth will be driven by the 5G revolution, which will increase the penetration of high-speed internet and fuel edge computing, artificial intelligence, and autonomous driving. 5G will connect billions of devices to the internet, and these devices will create large volumes of data that will be processed on the cloud.
The growth potential of cloud infrastructure
To handle such a massive scale of data, there is a need for that level of cloud infrastructure. The infrastructure includes hardware like storage, Ethernet switches, and servers, and services like Content Delivery Network (CDN), Managed Hosting, and Colocation Services.
The cloud infrastructure provides companies with scalability, lower capital expenditure, and reliability towards their business operations. The cloud infrastructure spending slowed in 2020 because of the pandemic-driven lockdown and fears of an economic downturn. As these concerns ease, the cloud infrastructure market could see significant growth in the coming decade (2021-2030).
Some of the biggest beneficiaries of this cloud infrastructure development would be Microsoft Corporation (MSFT), Alphabet (GOOGL), and Arista Networks, Inc. (ANET). These stocks have surged more than 30% year-to-date and have the potential to grow even further. Wall Street analysts expect the three companies to report double-digit revenue growth next year.
Microsoft Corporation (MSFT)
Any discussion on cloud computing is incomplete without MSFT. MSFT has an 18% market share in the cloud space, according to Synergy Research Group. When Satya Nadella took the helm of MSFT in 2014, he turned around the company from Windows operating system success to cloud. MSFT hit the bull's eye just when cloud computing was picking up. Today, its Azure cloud platform is its fastest-growing segment that generates most of its profits.
MSFT’s cloud offerings include Azure infrastructure services, Office 365 productivity software, and Dynamics enterprise software. Last year, it even beat out Amazon.com (AMZN) and won a $10 billion JEDI, or Joint Enterprise Defense Infrastructure, cloud-computing contract, for a major US Defense Department.
In the first quarter of fiscal 2021, MSFT’s revenue surged 12% year-over-year, driven by 48% growth in Azure. It’s other cloud services revenue also surged double-digit. Nadella drove MSFT’s operating margin from 19% in fiscal 2015 to 34% in fiscal 2019 on the back of its cloud transformation, and the margin is still growing. The margins of MSFT show why small cloud companies are trading at high multiples despite posting losses.
MSFT Should ride the cloud bulls and continue to grow double-digit. Analysts expect MSFT’s revenue and EPS to surge 11% and 17.5% in fiscal 2021. These high earnings have been driving MSFT stock (57% last year and 38% so far this year) and should drive the stock next year as well.
How does MSFT stack up for the POWR Ratings?
A for Trade Grade
B for Buy & Hold Grade
B for Industry Rank
B for Peer Grade
B for overall POWR Rating
The stock is also ranked #13 in the 96-stock Software - Application industry.
While AMZN and MSFT lead the cloud market, GOOGL is catching up with a 9% market share. The internet search giant still earns the majority of its revenue from digital advertising, with cloud business accounting for only 7.5% of its revenue. The company has been struggling with profits, with its operating margin falling from 25.8% in 2015 to 21% in 2019 as it spent significantly on building data centers and cloud business.
To up its cloud game in the corporate market, GOOGL started focusing on security, open-source software, and data analytics. It even acquired a data analytics firm Looker for $2.6 billion in cash last year. It also launched its cloud gaming service Stadia.
GOOGL has now started to see results in its cloud business. In the first three quarters of this year, GOOGL’s cloud revenue rose 52%, 43%, and 45% year-over-year. The company will start reporting its cloud business profitability from the fourth quarter, indicating that it is now riding the cloud bulls.
At present, GOOGL is where MSFT was in 2015. If GOOGL can replicate MSFT’s cloud success, the next few years would drive its margin as well as the stock price. Analysts expect GOOGL’s revenue and EPS to surge by 21% and 18% in 2021. The stock surged 29% last year and 32% so far this year and would surge more next year as cloud earnings pick up.
GOOGL is rated a “Strong Buy” in the POWR Ratings. It holds straight “A”s in Trade Grade, Buy & Hold Grade, Peer Grade, and Industry Rank. It is also the #2 ranked stock in the 58-stock Internet industry.
Arista Networks, Inc. (ANET)
AMZN and MSFT offer the biggest cloud platforms, and ANET provides high-speed networking switches to these cloud titans. Facebook (FB) is another client of ANET. The pandemic saw big cloud companies pause their cloud infrastructure spending over business uncertainty. The reduced spending sent ANET’s second and third-quarter revenue down 11% and 8% year-over-year, respectively. However, it continued to enjoy an operating margin of 38.2% in the third quarter.
ANET is expanding beyond the cloud enterprise campus switching market dominated by Cisco Systems (CSCO). It is also expanding into networking software solutions and services and has made several acquisitions in this space. Its most recent acquisition is of network threat detection startup Awake Security Inc. ANET has developed a software-defined Cognitive Campus network model and is getting increasing contract wins from enterprises and telecom service providers.
As economic activities gain pace, ANET expects to return to growth in the fourth quarter, with revenue expected to surge 13% year-over-year. Analysts expect ANET’s revenue and EPS to surge by 14% and 10%, respectively, in 2021. The stock surged 35% so far this year after falling 3.5% last year due to weak data center demand. It will surge further in 2021 as demand from cloud giants returns.
Hence, ANET is rated a “Strong Buy” in our POWR Ratings system. It also has an “A” for Trade Grade, Buy & Hold Grade, and Peer Grade. In the 53-stock Technology - Communication/Networking industry, it is ranked #1.
Want More Great Investing Ideas?
MSFT shares were trading at $216.40 per share on Monday afternoon, down $0.11 (-0.05%). Year-to-date, MSFT has gained 38.31%, versus a 13.86% rise in the benchmark S&P 500 index during the same period.
About the Author: Puja Tayal
Puja is a seasoned writer working with financial publishing companies like Motley Fool Canada and Market Realist. With over 13 years of experience in the field of fundamental research, she brings a blend of comprehensive, well-researched insights into her articles.3 Cloud Infrastructure Stocks to Buy for 2021 appeared first on StockNews.com