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Thursday, December 1, 2022

3 Top Cloud Stocks to Buy in February

According to one source, it is estimated that the global cloud computing market could exceed $900 billion by 2026. Even if this estimate is a bit aggressive, there is no question that the market is vast and growing fast.

Some major players dominate the sector, but there are also niche players. This assortment offers investors a massive opportunity and a plethora of options to play this red-hot market, as these three stocks show.

Image source: Getty Images.

1. Amazon

When most people think of Amazon (NASDAQ:AMZN), they likely think of the incredible e-commerce business and Amazon Prime, but its cloud business is increasingly the key to its success. Instead of seeing Amazon as an e-commerce business with a cloud segment attached, many investors are starting to see that it is actually the other way around. And the recent earnings release illustrates this point. 

Amazon Web Services (AWS) is its cloud computing business, and the segment has grown from $35 billion in net sales in 2019 to over $62 billion in 2021 — a compound annual growth rate (CAGR) of over 33%.

The segment’s growth is also accelerating. Year over year, revenue growth for 2021 was 37%. Even better, the segment is highly profitable. In 2021, AWS produced an operating margin of 30%, as shown below.

Chart of AWS results for 2019-2021

Data source: Amazon. Chart by author.

Amazon’s total sales were $470 billion in 2021, an increase of 22%. So the company still derives most of its revenue from sources other than AWS. However, AWS is much more profitable than the rest of the business. In fact, this segment was responsible for a whopping 74% of operating income in 2021, despite accounting for only 13% of sales. 

AWS is a terrific reason to be bullish on Amazon stock for years to come.

2. Alphabet

Like Amazon, Alphabet (NASDAQ:GOOG)(NASDAQ:GOOGL) is a titan in the cloud services industry. The company recently released its full-year 2021 earnings, and the results were spectacular across the board. Total revenue grew to $258 billion, a 41% increase over 2020. Results for 2020 were dampened by COVID-19’s negative effect on advertising spending, so it is essential to keep this increase in context. Looking back to 2019, the CAGR in sales is still impressive at 26%. Diluted earnings per share in 2021 were equally remarkable at $112.20. 

The Google Cloud segment is growing rapidly. Total cloud sales in 2021 reached $19.2 billion, up from $13.1 billion in 2020 and $8.9 billion in 2019. Unlike AWS, Google Cloud is not yet profitable, posting an operating loss of $3.1 billion in 2021. However, this loss narrowed significantly from 2020, which may indicate that the segment will scale to profitability soon. In the meantime, Alphabet has the advantage of its highly profitable advertising business to power its income.

The stock appears reasonably valued with a price-to-earnings (P/E) ratio of just over 25. As shown below, this is a lower P/E than it has traded for since the stock market’s recovery from the March 2020 crash. 

GOOG PE Ratio Chart

GOOG PE ratio. Data by YCharts.

Alphabet has also announced that the stock will have a 20-for-1 split in July. This is exciting news for investors who may find it challenging to accumulate shares due to their high price. 

A burgeoning cloud segment and high-octane advertising business make it an excellent stock for long-term investors.

3. DigitalOcean

DigitalOcean Holdings (NYSE:DOCN) offers a chance for more adventurous investors to buy shares of a smaller, growing cloud enterprise. In many ways, DigitalOcean is everything that Google and Amazon are not.

Its target market is small to medium-size businesses, whereas Amazon and Google are geared more toward large corporations. Simplicity, straightforward pricing, and excellent customer service are how DigitalOcean seeks to separate itself from the pack. The company estimates that it will have a $116 billion addressable market by 2024 within its target market. 

The company has experienced rapid growth in recent years, going from $203 million in annual revenue in 2018 to an estimated $427 million in fiscal 2021. This is a CAGR of over 28%. Along with this, DigitalOcean reports adjusted earnings before interest, taxes, depreciation and amortization (EBITDA) that went from $39 million to $130 million in the same period. Perhaps most encouraging is that revenue growth is accelerating and is expected to hit 34% in 2021. The chart below shows the company’s revenue, adjusted EBITDA, and revenue growth rate over the past several years.

DigitalOcean selected results 2018-2021

Data source: DigitalOcean. Chart by author.

The stock has been decimated recently along with the general market sentiment away from growth stocks. This might offer long-term investors a compelling entry point. The stock currently trades over 55% down from its 52-week high. A small growth stock like DigitalOcean also carries more risk than megacaps like Amazon and Google, so investors should trade according to their risk tolerance. 

The cloud computing business is booming, and should continue to do so for many years. Investors have several options to take advantage of this, including megacaps with wide-ranging services and niche providers that focus on small and mid-size companies. All three of the above stocks should serve long-term investors well over the next several years.  

This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium advisory service. We’re motley! Questioning an investing thesis — even one of our own — helps us all think critically about investing and make decisions that help us become smarter, happier, and richer.

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