Are Cloud Computing Stocks Overvalued?
“It’s only when the tide goes out that you learn who’s been swimming naked.”
- Warren Buffett, legendary American investor and one of the richest men in the world.
If one were looking for lessons in creating wealth in the stock market, there can be no better teacher than Warren Buffett. In fact, I would venture that he is the guru of value investing, a an investment paradigm that derives from the ideas on investment and speculation that Ben Graham and David Dodd derived while at Columbia Business School. Not surprisingly, Buffett was one of Graham’s students.
Value investing is investing for the long term; as Buffett once said, “My favorite holding period is forever.” Therefore, such a strategy is based on buying stocks at less than their intrinsic value. Do cloud computing stocks qualify as value stocks? That is a question that many are seeking an answer to.
The problem in realizing value of cloud computing stocks is the difficulty in assessing future earnings. Agreed that recent research indicates that spending on cloud computing can only go higher (See: How BIG Is The Cloud Computing Market? and Where Is Cloud Computing Going? Up, Up And Away!), but the very newness of the technology leaves room for doubt. There’s no telling whether security concerns can kill cloud computing or there may be a paradigm shift to a completely different technology.
While many truly believe that cloud computing is here to stay and that stocks of companies investing in this field represent true value for the future, there are others at the opposite end of spectrum who have even compared the recent rise of relevant stocks as symptomatic of, as Alan Greenspan put it, “irrational exuberance.”
If this phrase sounds familiar, there’s a good reason for it. Greenspan first uttered these words when anything related to technology was considered to be gold and tech stocks reached stratospheric heights. Until the bubble burst.
Yes, we are talking about the dotcom bubble of the last decade. If you feel this analogy is a bit far-fetched, consider what Swiss investment bank UBS has to say. In a recent research note, creatively titled Are We In A Cloud Computing Bubble?, UBS makes a comparative analysis between the top 40 expensive tech stocks today and in March 2000 when the dotcom bubble was at its zenith.
Although the top tech companies today are comparatively healthier than their dotcom era counterparts if P/E and market value/sales ratios are taken into account, their rapid ascent as compared to the other tech stocks does give cause for concern, especially since a lot of the top ones are invested in cloud computing – Salesforce.com, Netflix, Akamai, etc.
Now, this data can be interpreted in two ways. The cloud computing proponents would say that is exactly what they expect – that the stocks are rising because their cloud investments are adding value to their shares. The naysayers would protest that it is “irrational exuberance” that is fueling this growth, and that another tech bubble is in the offing.
While it is difficult to determine with absolute certainty who is right, I would bet my money on the former.
There are three reasons for this:
- P/E and market value/sales ratios have been used to determine stock value for a long time. They are reliable indicators and suggest that the recent price increases is not a fluke.
- While the dotcom bubble was born out of overestimating the value of technology that was completely new, cloud computing, in spite of its newness, has a long heritage. Many of the concepts of cloud computing – utility computing, distributed computing – and resources – data centers, Internet – are tried and tested technologies.
- The dotcom bubble came from every second computer engineer trying to become an entrepreneur. The cloud computing revolution, on the other hand, is largely driven by very big IT players like IBM, Amazon, Oracle, etc.
At the same time, I would advise caution if cloud computing stocks continue to rise at an alarming pace. There are still issues to be resolved before it becomes the definitive standard in IT.
By Sourya Biswas