How to pick winning cloud software stocks in 2020
January 15, 2020
Beth Kindig
Lead Tech Analyst
Back in December, I wrote an article on how to pick winning cloud software stocks. I began by pointing out how – on average – cloud software companies have reported 10 to 20 times better revenue growth compared to S&P 500 Index companies, most of which grew at an average rate of 5.2% in the last quarter.
Those are certainly impressive numbers, but investors weren’t interested in growth. What they wanted were companies that posted positive EPS numbers, particularly those that have at least 10% forward growth. This was the market’s response to cloud software stocks with high valuations in 2019, and I believe that it will carry over this year.
I first noticed the trend when investors began leaving cloud software stocks due to a combination of low profitability and high valuations. This was puzzling because cloud shares had beaten most analyst estimates.
A few examples of the trend favoring positive EPS include:
- Microsoft has positive EPS, with acceptable growth and a reasonable enterprise-value-to-sales (EV/sales) ratio of 8.4. The company’s stock price is up 51% this year, more than double that of the cloud ETF.
- Splunk also gained ground recently and is up 19% since Nov. 15, suggesting the stock was undervalued previously, given its positive and growing EPS. Five9 also meets the criteria of positive EPS, with guidance for 11% growth. The stock is up 50% this year.
Examples of the trend penalizing negative EPS include:
- CrowdStrike is an example of negative EPS combined with a high EV/sales valuation. The stock is down 51% from its high of $99 and is down 24% from its opening IPO price of $63.50. The company currently has one of the highest EV/sales of the companies in the table above, and at its peak in August and July, had a whopping EV/sales ratio of 61.
- Yext is a cautionary tale of a company with negative EPS that the market abandoned at the first sign of weakness. The company is trading 35% lower from its high in July.
- PagerDuty has tumbled 60% from a high in June and is down 38% from its IPO opening price of $36.75.
So what happened?
In the article, I explained that start-ups are designed to grow fast; with the average company forecasted to grow 178% in revenue during their first year. The trouble is when these companies need to transition from fast sales growth to stable, consistent profits. Furthermore, SaaS companies, on both private and public markets, use different metrics based on their business model, further complicating the situation.
Investors dealt with these issues by focusing on EPS growth rather than raw revenue numbers. Not only did this strategy allow them to find cloud software companies that deliver steady, consistent growth, it also simplified different variables by rewarding companies that have positive and healthy EPS growth.
Read the full article here.
More To Explore
Newsletter
Nvidia and Google Are Crowding TSMC’s N3 Node - Can Intel Fill the Gap?
Nvidia is moving its next-generation Rubin GPUs from 4nm to 3nm, yet Google’s latest TPUs are already on N3 and are expected to remain there. Meanwhile, a growing number of AI CPUs from Nvidia, Amazon
Intel vs TSMC: How CoWoS Packaging Constraints Could Create an Opportunity for Intel Foundry
Taiwan Semiconductor (TSMC) is the single, most important company to the AI industry. However, to compete with the incumbent, Intel does not need to beat TSMC at leading-edge manufacturing. It only ne
Big Tech’s Free Cash Flow is Turning Negative – Who's Next?
Big Tech’s AI revenue is accelerating, but free cash flow is moving sharply in the opposite direction. Across Google, Microsoft, Meta and Amazon, capex is rising much faster than operating cash flow a
Big Tech Earnings Preview: Is AI Monetization Finally Catching Up to Capex?
The most pronounced difference between 2026’s tech rally compared to rallies in the past is which companies have been left out of it. The names most associated with the AI trade have hardly participat
Nvidia, CXL, and the Battle to Improve AI Inference Economics
This is Part 2 of our two-part series on AI inference economics. In Part 1 — Why Nvidia's Next AI Battle Is About Tokens per Watt, we laid out why tokens per watt has become the defining metric for in
Why Nvidia’s Next AI Battle Is About Tokens per Watt
As hyperscalers move from building AI infrastructure to monetizing it, tokens per watt helps to reflect if revenue is scaling and if profitability is improving. Offload engines can increase tokens per
Micron Is Up 900%. Here’s Why the AI Memory Trade May Still Have Room to Run
Over the past 10 months, memory chip stocks have gone from being solid beneficiaries of the AI boom to capturing a massively outsized piece of the return pie. The inflection in Micron’s performance de
Why the S&P 500 Shrugged Off the Iran War — and What Could Finally Break the Rally
On February 28th, the U.S. went to war with Iran, and the market was handed the kind of shock it hasn't contended with for years. The conflict set off a chain reaction across the region: an ongoing su
Nvidia, CoreWeave, and Nebius: Inside the Circular Financing of the GPU Boom
Neoclouds are one of the more hotly debated AI business models, with CoreWeave and Nebius being the two most widely recognized names. These companies have seen their sales, backlog, and share prices s
AMD, Nvidia, Arm, Intel: Inside the $120 Billion CPU Gold Rush
CPUs have gone from an afterthought to becoming the AI trade’s next great bottleneck – and with AMD, Nvidia, Arm and Intel circling a market that is doubling nearly overnight, the only question left i
