The COVID-19 pandemic accelerated the move to the cloud for enterprises large and small. After all, the public cloud offers more flexibility, access to the latest processors and technologies, and a host of other benefits.
However, recent fears over inflation have caused many leading cloud stocks to decline materially. That's because cloud stocks are fast-growers, with high valuations relative to today's profits, making them susceptible to higher interest rates.
Yet a big marketwide pullback often means opportunity to invest in top companies with leading positions and promising futures. November's swoon has thus makes these three cloud leaders big buys heading into 2022.
Image source: Getty Images.
Amazon
Believe it or not, the stock of Amazon (AMZN -1.11%) has done basically nothing over the past year and half. Yet could this long base lead to an explosive surge in 2022?
Investors soured on Amazon this year because of difficult comparisons to the pandemic-fueled gains of 2020. To some extent, these concerns were valid. Overall growth disappointed last quarter, with online store sales up just 3% and third party seller revenue up just 18% as they lapped difficult comparisons. In addition, supply chain bottlenecks caused shipping and labor costs to rise.
But while Amazon gets the majority of revenue from e-commerce, cloud platform Amazon Web Services (AWS) is its main profit center. Looking underneath the hood, AWS accelerated 39% versus 37% in the prior quarter and 29% in the prior-year period. Operating margins came in over 30%, despite Amazon's heavy investments in growth.
Those investments are also yielding fantastic innovation, with AWS unveiling a slew of new products and services this week at its annual Re: Invent conference. Among some of the most interesting were AWS private 5G networks, which allows companies to set up their own private 5G networks for manufacturing facilities and even corporate campuses as a Wi-Fi replacement. Other innovation included the latest versions of AWS-designed in-house processor Graviton and deep learning chip Trainium. However, there were many, many more.
With e-commerce growth set to bounce back in 2022 on easier comparisons and AWS firing on all cylinders, a big Amazon rebound could be in the offing.
CrowdStrike
One close AWS business partner is cybersecurity leader CrowdStrike (CRWD -1.82%). That's because CrowdStrike is a new-aged cybersecurity company conceived in the cloud. That cloud-first architecture gives CrowdStrike advantages over legacy vendors, as its centralized Threat Graph is able to take data from its entire customer set to continuously train the company's lightweight Falcon agent to prevent the latest cyber-attacks. As CrowdStrike gains more customers, the more intelligent its platform becomes.
CrowdStrike grew that customer count by 75% last quarter, which bodes awfully well for the future. Subscription revenue grew 67%, as did annual recurring revenue (ARR) to $1.51 billion. Adjusted (non-GAAP) gross margin also expanded a percentage point to 79%. While earnings are still negative, CrowdStrike's free cash flow margin was a very hefty 32.4%.
Those are impressive numbers, but CrowdStrike believes it still has lots of room to grow. At the time of its IPO in 2019, CrowdStrike estimated its total addressable market (TAM) at $25 billion; however, it now sees that growing to $67 billion by 2024, thanks to industry cloud migration, innovation in its core endpoint protection products, and a slew of bolt-on acquisitions. And management sees the TAM potentially growing to $116 billion by 2025, given its product roadmap and future initiatives.
At around 30 times annual recurring revenue, CrowdStrike isn't exactly cheap. Yet after a recent 30% sell-off, it may be time to consider this disruptive industry leader with a highly profitable business model and long growth runway.
Splunk
While Amazon invented the concept of cloud computing and CrowdStrike is a cloud-native disruptor, Splunk (SPLK) is a legacy software company that's now transitioning to the cloud. Despite its late move to cloud, Splunk is still a leader in IT observability, data monitoring, and cybersecurity.
Due to the business model change, Splunk trades relatively cheaply. The stock is down around 47% from all-time highs and trades around 6.5 times its annual recurring revenue. Making investors even more nervous, the company recently announced CEO Doug Merritt would be stepping down after six years on the job.
So why would anyone buy Splunk amid all the uncertainty? Mainly because the business transition to the cloud seems to be going quite well. Last quarter, annual recurring revenue surged 37%, but cloud ARR, which still makes up a minority of total ARR, grew an even faster 75%, accelerating over the prior quarter. 68% of Splunk's new software bookings were cloud-based, significantly up from 54% in the prior quarter. And while cloud currently has lower gross margins than overall company margins, Splunk's cloud gross margin did expand by four percentage points over the prior quarter to 64.7%. The company is also on track to generate positive operating cash flow in fiscal 2022 for the first time since fiscal 2019, showing the transition is working.
Basically, for all the nervousness about this transition and the search for Splunk's new CEO, the business appears to be operating at a high level. As cloud growth eventually overtakes the legacy on-premises business, look for overall company growth to remain strong or even accelerate. With such a low valuation relative to other cloud peers, Splunk is looking a value stock, if one could call it that, in an otherwise expensive sector.
