Cloud computing services are completely reshaping the IT industry. According to tech researcher Gartner, global spending on cloud will increase some 16% and home in on the $500 billion mark in 2022. Some estimates point to that figure reaching $1 trillion a year within the next five to 10 years.
To facilitate all these new software services, though, new infrastructure needs to be built. That presents a huge opportunity for investors. Three companies that reported a strong conclusion to 2021 and a rosy outlook for 2022 are Arista Networks (ANET +0.02%), Cloudflare (NET +6.25%), and Twilio (TWLO +23.46%). Here's why each is a buy right now.
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1. Arista Networks: Data center and networking hardware needs an upgrade
Gartner predicts that in just a few more years, "95% of all digital workloads will be deployed on cloud-native platforms." In other words, the cloud is the future of all digital operations. But to get there, businesses of all types and sizes need to build out the roads and rails to facilitate this movement from legacy to next-gen technology.
Enter Arista Networks, a company that provides open source network and data center equipment and software management tools. The company suffered a sales slump in 2019 and 2020, first from a general cyclical slowdown in tech infrastructure spending (remember the U.S.-China trade war?) and then heightened by the start of the pandemic. But Arista is putting that dip in the rearview mirror and is hitting record revenue and profitability again.
Specifically, Arista's revenue and free cash flow increased 27% and 32%, respectively, in 2021. Part of this big jump was due to the company lapping depressed results from 2020, but management is forecasting another great year in 2022. Outlook for the first quarter implies year-over-year growth of 27% at the midpoint of expectations. And with customer order lead times extending out into 2023 because of the global chip shortage, there's a good chance Arista will maintain a double-digit percentage rate of growth for some time.
The stock currently trades for 43 times trailing-12-month free cash flow, reflecting the expected rapid increase in profitability. But since it's flush with cash ($3.4 billion in cash and short-term investments), has no debt, and has profits growing at an even faster pace than sales, I'm still optimistic on this company's long-term potential as organizations around the globe build out their data centers and communications infrastructure.
2. Cloudflare: The emerging leader in "edge" computing
As more applications go the way of the cloud, this will drastically alter app behavior and expectations from users. That's where Cloudflare comes into play. The company is an edge computing company -- a push into smaller regional data centers that help move data and software closer to the end user, thereby improving performance and security.
Cloudflare has amassed hundreds of thousands of raving fans over the years with its next-gen internet services, and it's really only just getting started moving up-market to larger paying customers. As a result, the company recorded its fifth straight year of 50% or greater revenue growth (though it's only been a publicly traded stock for less than three years). Full-year 2021 revenue increased 52% to $656 million, including a 54% year-over-year jump in the fourth quarter to $194 million. The company also achieved positive free cash flow of $8.6 million in the fourth quarter.
However, given the massive opportunity it has ahead of it, Cloudflare fully intends to operate close to breakeven for the foreseeable future rather than turn a profit. Long-term, management is targeting a 20% operating profit margin, but as long as the company can stoke this kind of sales growth from its expanding suite of cloud and edge computing services, don't expect that kind of profitability anytime soon.
That means this stock isn't for everyone. Shares will be highly volatile, as is often the case for high-growth but richly valued companies. Cloudflare currently trades for a steep 38 times enterprise value to expected 2022 sales. But with at least 41% sales growth expected this year, there's good reason to pay up to own a little of this business as web and app developers update their toolkits with new services provided by the likes of Cloudflare.
3. Twilio: A new breed of communications infrastructure for the cloud era
Speaking of applications, communication is one of the most fundamental of human interactions -- and communication is also headed for the cloud. Twilio is another high-growth but premium-priced stock in this space. After an early pandemic explosion in stock price, Twilio is now down nearly 60% from its all-time high posted early in 2021. Share price aside, though, this remains an incredibly promising name.
Cloud-based communications services -- everything from web chat and voice to email and video -- was already a growth story in the 2010s. But the pandemic gave organizations a little shove further down that path. Suddenly, staying in touch using a cloud-based tool is the norm. Whether it's a remotely working employee staying in touch with team members or a customer interacting with a business, Twilio has a software solution to pair with the interaction. It launched its own virtual call center product, Flex, a few years ago to help large organizations get more out of their communications. Flex has been a top driver of growth ever since.
Now Twilio is extending the capabilities of its cloud communications platform with data analytics. Twilio management thinks this puts it in a position to disrupt the status quo in the CRM (customer relationship management) software niche. That's because after the acquisition of analytics start-up Segment last year, Twilio's services are unique in offering both tools to build new communications services and data insights in one place. Rather than relying on a third party to help extract useful information from customer data, Twilio can help its users provide a customized experience and relationships in real time.
This could turn Twilio into the leader in cloud communications, which has already been a disruptive force for the global telecom space. Twilio can validate this vision by continuing to provide robust growth figures. 2021 revenue was $2.8 billion, a 61% increase. The outlook for first-quarter 2022 implies year-over-year growth of at least 45%, and management said it expects to reach profitability in 2023 (it's intentionally been operating at a loss as it attempts to maximize expansion). Trading for less than nine times enterprise value to one-year forward expected sales, this stock looks like a real long-term deal right now as the world builds a new form of communications infrastructure.
