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Sunny Skies for Cloud Computing Stocks

23 August 2013 in Trading Ideas

It can often be a healthy sign for an investing sector when individual companies beating Wall Street profit expectations outweighs their declining profit.

Take cloud computing, for example, which, for some investors, has begun to elicit concerns that it’s now a slower-growing maturing market after spending much of 2010 and 2011 as tech’s Next Big Thing.

On the surface, those concerns seemed to be confirmed by a profit report late last month by Citrix Systems, which saw the company announce that quarterly net income fell 30% from a year earlier, as margins slipped and expenses increased.1

Still, the company’s bottom line ended up beating the company’s – and Wall Street’s consensus — expectations, and since that July 24 earnings report, the stock has gained nearly 9%.

Investors also warmed to cloud computing player VMware, which saw its shares jump 18% one day last month after the company beat Wall Street’s second-quarter profit and revenue forecasts.2 Four weeks later, the stock has continued to hold its pre-earnings report gain.

cloud computingTogether, VMware and Citrix shares make up about 25% of the weighting in the Cloud Computing motif, and their good fortune has contributed to the motif’s 6.9% gain during the last month. Over that same time period, the S&P 500 has lost 1.9%. So far in 2013, the motif has increased 8.4%; the S&P 500 is up 14.8%.

For VMware, the reaction by Wall Street was fairly close to exactly what a shareholder with lingering maturing-market concerns would want to hear. Nomura Equity Research analyst Rick Sherlund boosted his rating and price target on the stock, saying that investors could move beyond worries that the company’s traditional virtualization software is slowing, since customers are lining up for the company’s new products.

Raymond James analyst Michael Turtis was nearly as bullish, but cautioned that a number of customers seemed to be looking for cheaper alternatives to VMware. However, Turtis said this phenomenon merely highlights the dichotomy between an uncertain virtualization market [VMware’s core business] and the “growing cloud opportunity.”

A key for investors will likely be how successful the current cloud players can be in maintaining both demand and pricing power.

1Natalie, Tedhena, “Citrix 2nd-Quarter Profit Down 30%; Results Beat Estimates,” Dow Jones Newswires, July 24, 2013, http://www.4-traders.com/CITRIX-SYSTEMS-INC-4863/news/Citrix-Systems-Inc-Citrix-2nd-Quarter-Profit-Down-30-Results-Beat-Estimates-17124970/, (accessed Aug. 20, 2013).

2Tiernan Ray, “VMware Soars 18%; Two Upgrades, ‘Cloud’ Gathers, Outlook Brightens, barrons.com, July 24, 2013.

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