Many cloud stocks soared last year amid robust demand for their remote software and infrastructure services throughout the pandemic. The unfettered growth of many of these companies throughout the crisis amplified those gains as they became temporary safe-haven stocks.
Unfortunately, many of those stocks generated less impressive gains this year as rising bond yields, inflation fears, and a focus on reopening plays sparked a rotation from growth to value stocks.
That shift could persist throughout the rest of the year, but investors shouldn't blindly sell all their cloud stocks. Gartner still expects global spending on public cloud services to rise 21% to $332.3 billion this year, and jump another 20% to $397.5 billion in 2022. So the market could still offer great opportunities for long-term investors.
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However, investors should still avoid the unprofitable "hypergrowth" cloud stocks that trade at high double-digit price-to-sales ratios for now, since many of those volatile names still have too much growth baked into their prices.
Instead, they should stick with established cloud giants that are firmly profitable and reasonably valued relative to their near-term growth. Here are three stocks that fit that description: Microsoft (MSFT +2.05%), Adobe Systems (ADBE +3.53%), and salesforce.com (CRM +1.44%).
1. Microsoft
Microsoft's commercial cloud revenue rose 33% year over year to $17.7 billion, or 42% of its top line, last quarter. That segment includes Office 365, Dynamics 365, and Azure, the world's second-largest cloud infrastructure platform after Amazon Web Services (AWS).
Microsoft evolved from an aging enterprise software giant into a cloud king under CEO Satya Nadella, who took over in 2014 and prioritized a "mobile first, cloud first" mantra to generate fresh growth again.
Those strategies included the transformation of its Office and Dynamics software into subscription-based services, the expansion of Azure with new services and major partnerships, the development of new mobile apps for iOS and Android, and the launch of Windows 10 as the "last" version of its flagship OS and a firm foundation for its new cloud-based ecosystem.
Analysts expect Microsoft's revenue and earnings to rise 16% and 35%, respectively, this fiscal year (which ends in June). Next year they expect its revenue and earnings to rise another 12% and 7%, respectively, as its cloud business expands, its enterprise software business recovers, and it continues to sell more Xbox and Surface devices.
Microsoft's stock is reasonably valued at 29 times forward earnings. Its low forward yield of 0.9% probably won't attract any income investors, but it's a nice bonus for sticking with this long-term winner.
2. Adobe
Like Microsoft, Adobe has transformed its desktop software into cloud-based services over the past several years. Its flagship software products -- including Photoshop, Illustrator, and After Effects -- are now hosted as subscription services within its Digital Media cloud services.
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Adobe also expanded its enterprise-facing Digital Experience cloud, which provides cloud-based advertising, e-commerce, and analytics services. This smaller segment competes against other cloud-based companies like Salesforce and Shopify.
Both of Adobe's businesses remained resilient during the pandemic since it locked in customers with sticky subscriptions and early cancellation fees. More importantly, Adobe's Digital Media tools still mostly dominate their respective image, video, and document-editing markets as "best in breed" solutions.
Analysts expect Adobe's revenue and earnings to rise 20% and 17%, respectively, this year, as its core cloud services continue to grow and its advertising cloud business -- which suffered a slowdown during the pandemic -- gradually recovers. Next year, they expect its revenue and earnings to both grow about 15%.
Adobe's stock looks a bit pricey at 35 times forward earnings, but the stickiness of its cloud services arguably justifies that slight premium.
3. Salesforce
Salesforce was built from the ground up as a cloud-based CRM (customer relationship management) services provider. It currently controls about a fifth of the global CRM market, according to IDC, while all of its closest competitors hold single-digit percentage shares.
Salesforce also provides cloud-based marketing, e-commerce, and analytics services. Its upcoming takeover of Slack will tie together all those pieces with a unified communications platform.
Salesforce is an evergreen cloud king because it profits from the digitization of businesses, automation of repetitive tasks, and the outsourcing of CRM services to remote workers. Its Einstein AI platform also helps companies optimize their businesses. In short, companies will rely more on Salesforce's services as they cut costs and reduce their overall dependence on human employees.
Analysts expect Salesforce's revenue to rise 21% this year, but for its adjusted earnings to dip 30% as it integrates Slack. But looking further ahead, Salesforce still expects to more than double its annual revenue to $50 billion by fiscal 2026 as its core markets continue to expand.
Salesforce trades at just over 50 times forward earnings. That P/E ratio might seem steep for an enterprise software company, but it's actually fairly low for a pure-play cloud services company.
