By Contributing EditorMay 2, 2021

3 cloud stocks you should be watching

One of the biggest tech trends in recent years is the growth of the cloud.

The trend accelerated in 2020, as the COVID pandemic forced millions of us to work from home. 

This massive “migration to the cloud” creates demand for a range of related services. That’s why cloud computing will remain an important growth trend for investors, even after the pandemic fades away.

While many cloud stocks saw huge gains last year, we need to be more selective this year.

Today, I’ll explain the cloud and why it’s important… and give you three stocks poised to see big gains this year.

What is the cloud and why is it important?

A few years ago, you had to keep all your software and files on your computer’s hard drive. The cloud makes it possible to keep this stuff on a remote server, allowing you to access everything from any computer with an internet connection.

The cloud creates huge cost savings for businesses. Before the cloud, companies had to maintain a lot of extra infrastructure, which wasn’t cheap. Now, many companies don’t need to pay for their own server centers and IT departments.

The cloud also helps individuals save storage space on their computers. And it allows software companies to provide their products over the internet, instead of requiring users to install their programs from physical discs. Plus, consumers can upgrade their software faster and more frequently.

Why invest in cloud stocks?

Although the cloud has been around for a while, its impact on businesses in all industries is still in the early stages. 

The pandemic accelerated this trend, pushing more companies to migrate their operations to the cloud. 

But even as offices reopen, companies are unlikely to ditch the cloud. It simply offers too many benefits: it provides flexibility for employees… it’s cheaper and more efficient than traditional IT systems… and it provides a platform for technologies such as the Internet of Things (IoT).

In recent years, the cloud has become a pillar of the software industry. It helped create an entirely new business model—software as a service (SaaS)—so that software companies could sell their products to users on a subscription basis. This model makes it easier to gain new users… and it generates consistent revenue for software companies.  

These are all long-term secular growth trends that should benefit cloud companies—and their stocks—for years into the future.

Twilio Inc. (TWLO)

Twilio is a cloud communications platform-as-a-service company (PaaS). It allows software developers to integrate messaging and communications functionality into their own applications. It also helps companies stay connected to their customers. 

Twilio has a gross retention rate of nearly 97%. That means 97% of its customers continue paying for its products year after year… one of the highest retention rates in the software industry. 

Its business model is quite lucrative as it’s based on usage volume. Twilio gets paid based on the number and length of calls, texts, and video sessions. This provides stable, recurring revenue. Plus, if a company’s cloud app takes off, Twilio benefits.

Twilio’s products have benefitted from strong demand from the health care and education industries. Companies in these industries have gone digital faster due to the coronavirus pandemic. And over the past three years, Twilio’s revenue has grown an average of 58.6%. The company reports its latest earnings results next week, so make sure to keep an eye out for them. 

Twilio is in the middle of a major growth phase. It has been adding more employees outside the U.S. to expand its international operations. The company also recently acquired email provider SendGrid. This should strengthen its programmable messaging capabilities—a feature with enormous growth potential.

VMware, Inc. (VMW)

VMware is an industry leader in virtualization—a complex (but important) practice in the tech space. VMware’s products allow its customers to create “virtual machines” to handle specific computing tasks, like running a network or server.

These virtual machines enable cloud providers to serve their users with their existing physical computer hardware. And VMware established a dominant market position in recent years by helping companies virtualize their own private clouds. More than 80% of all virtual machines run on its software. 

While some companies operate their own private clouds, many are moving to public cloud platforms like Amazon Web Services (AMZN) and Microsoft’s Azure (MSFT). But they won’t use a public platform without VMware’s virtualization software, as most prefer it to what AWS and other public clouds have to offer.

Dell (DELL), the majority owner of VMware, recently announced it will spin off its 81% ownership stake soon. The spinoff will give VMware increased control over its operations… plus more financial flexibility to grow the business. Importantly, it will maintain a strong strategic partnership with Dell. 

VMware plans to diversify its product portfolio to help increase its market share. Its Tanzu product, which helps companies simplify their operations, will be a major source of long-term growth for the company. 

Shares of VMware trade at a modest price-to-earnings (P/E) ratio of 24.8. In its most recent quarterly report, earnings per share (EPS) grew 7.8% year over year, while revenue rose 7.2%. For a growing company that dominates the virtual machine market, VMware is a steal at current levels. 

Akamai Technologies, Inc. (AKAM)

Akamai Technologies provides content delivery networks and cloud infrastructure services. Its solutions speed up and improve the delivery of content over the internet. This translates to faster-loading web pages and higher-quality video streaming. It also reduces the impact of traffic congestion. 

Akamai’s solutions help companies improve the performance and security of their applications. With more businesses going digital, there’s a growing market for Akamai’s cybersecurity solutions, which help protect companies from hackers.

The company has a huge, long-term tailwind from the continued growth in internet traffic. This increases demand for cloud security solutions like Akamai’s firewall services. The company grew earnings an average of 43.5% over the past three years, alongside steady sales growth of 7.5%.

Even with all that growth, shares of Akamai trade at just over 20 times forward earnings. That makes it a very affordable cloud stock. 

Akamai’s balance sheet is rock solid. It has a current ratio of 2.5, which means it has more than enough liquidity to handle short-term obligations. Its net profit margin of 17.4% is also attractive. 

Taking action

All the variables are in place to make cloud computing one of the most important industries of this decade. There is massive demand for cloud solutions from almost every single industry. Dozens of companies stand to benefit from the growth in cloud computing.

The three companies I mentioned above all have their niche in the cloud computing industry. Twilio specializes in making communications on the cloud faster and more efficient. VMware provides cloud support for companies, and Akamai offers much-needed cybersecurity cloud solutions. 

As the economy continues its transformation into the digital age, these stocks should soar in the years ahead.

Authors that regularly contribute articles covering topics in their area of expertise.

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