Wall Street has become quite familiar by now with cloud computing.
The model of delivering services over the Web has gained so much momentum that public market investors, who traditionally parked their tech dollars with Microsoft, IBM, Oracle and Cisco, have dozens of new stocks to choose from if they want growth.
But despite the hype surrounding cloud and the rapid influx of capital from money managers, Wall Street is still puzzled when it comes to valuing cloud vendors.
That's because, of the 26 index members to go public most recently, 21 are losing money on a GAAP (generally accepted accounting principles) basis. And not just a little dough. Those unprofitable companies were a combined $388.7 million in the red in the last quarter.
Wall Street doesn't seem to care. Right now, some 28 publicly traded cloud computing companies are worth at least $1 billion, according to the BVP Cloud Computing Index, an index created in 2013 by Bessemer Venture Partners. Of the 42 companies the index tracks, worth a combined $173 billion, 26 have gone public in the past three years. Others like Eloqua and ExactTarget went public before getting acquired.
For that matter, as of Feb. 7, the BVP index was up 146 percent since the beginning of 2011, which is as far back as the data goes, compared with the 63 percent gain in the S&P 500 and 79 percent jump in the Nasdaq.
Which means that, for cloud companies, the trusty price-to-earnings ratio should be tossed out the window. Even Salesforce.com, which went public in 2004, lost almost $40 million in the latest period. Workday, the developer of human resources and financial software, racked up a $59.9 million quarterly deficit.
Investors have grown comfortable with losses, because in the case of cloud companies they rarely reflect the health of the business. In a subscription model, companies pour money into landing customers, particularly when facing off against a big incumbent. Once they get a deal, revenue trickles in by the month, while the bulk of the costs get recognized upfront. Expenses are immediate, but revenue is amortized.
Beyond the financials, investors are betting on a massive paradigm shift in technology. Old packaged and desktop software is being tossed aside as businesses shift to simpler services that run in browsers and on mobile phones while spanning across many machines and performing sophisticated data analysis.
"This is the future of software and a core driver of technology today," said Bessemer partner Byron Deeter, who helped create the BVP index.
The companies that can combine the best user experience and pricing options with efficiency in sales and marketing are in pole position. Software as a service, or SaaS, is the software subscription model that's winning the day.