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Make Room for Rackspace: Pro

Rackspace Hosting Inc. signage is displayed at the front entrance of the company's office in San Francisco, California.
Noah Berger | Bloomberg | Getty Images
Rackspace Hosting Inc. signage is displayed at the front entrance of the company's office in San Francisco, California.

If you’re in business for yourself or you work for a company with an online presence, you know how important it is to have a reliable “host” for your site.

This “host” has to have the powerful servers and applications needed to make your website operate smoothly and reliably. It should provide cloud computing services, be able to manage Web-based IT systems, and have the capacity to do this for businesses of all sizes, including large global enterprises.

The current heavyweight in this vital technology is Rackspace Hosting, based in San Antonio, Texas.

It’s so good at providing a Web hosting service for its clients that its business has been growing at a dizzying pace, with year-over-year quarterly earnings growth reaching 43 percent in the three-month period ending June 30.

Shares of Rackspace have been as hot as its business acumen, hitting a 52-week high of $65.26 on Tuesday, Sept. 11. More about the share price later. Suffice it to say this is one of the hottest tech stocks of 2012, mainly because it’s a company that’s good at what it does.

Earlier this summer, Rackspace was named the 2012 Microsoft Hosting Partner of the Year, an award that recognizes managed, cloud, and hybrid hosting. This marks the fourth time Rackspace has received this coveted honor. It was chosen from among 3,000 global Microsoft partners who applied.

This speaks to its commitment to partner very closely with Microsoft and to grow its services in lockstep with the direction that Web hosting needs to go.

As the “newsroom” on the Rackspace website explains, being selected as Microsoft’s 2012 Hosting Partner of the Year was a very important way for the company to separate itself from its competition.

The news story went on to explain that this achievement was earned “...for demonstrating solution innovations and exemplary commitment to engaging with Microsoft.”

“We have focused on hosted solutions for customers’ business challenges, identified new market opportunities, and along with Microsoft, used technology innovation to address customer needs. In addition, we’ve allowed our partners to leverage our innovation as the partner community becomes a more integral part of Rackspace and its business,” exclaimed its news release. That’s part of the brilliant business model that Rackspace has followed faithfully.

Rackspace has emerged as the worldwide leader in not only offering Web hosting, but also providing dedicated cloud services comprising customer management portal and other management tools for managing the data center, network, hardware devices, and operating system software.

It’s spent a large amount of money building enormous data centers in areas where the land is inexpensive and so is the electricity. It needs affordable energy to power the monster computers that host the tens of thousands of websites and the massive amounts of data that comprises them.

An article on the Oregon Live website states that Rackspace is planning to build a data center in Morrow County, Ore., where industrial power costs around 3.34 center per kilowatt. That’s nearly 75 percent less than what a data center might pay in areas of California, for example.

The point is that Rackspace is cost-conscious and it passes on its savings to its customers, many of whom operate on tight IT budgets and want all the advantages of a great web host at affordable pricing.

Speaking of affordable prices, how do we explain Rackspace shares, which are selling at a current price-to-earnings ratio of nearly 98, and a forward P/E of 59? Looked at from a price-to-earnings-to-growth ratio, Rackspace shares are selling for two-and-a-half times their five-year expected growth rate.

Those kinds of growth rates are achievable for Rackspace, if it can continue to drive earnings much higher, which should equate to a lower PEG ratio.

Who can say what is overpriced, when companies like Salesforce.com, currently trading at $152.71, are trading with negative earnings last quarter and a forward price-to-earnings ratio of almost 77. It’s PEG ratio (five-year expected) is an amazing 3.57!

Now I’m not saying this will happen, but if you’d like to own some shares I’d wait for at least a 10 percent correction in the share price. If you’re a prudent and exceedingly patient investor, you may even see the stock pullback to the Aug. 22 low of $55.30, with a share price of $54.84 being a 15 percent correction from its Sept. 12 closing price of $64.52.

As Jim Cramer likes to say on his “Mad Money” show: “Why not wait to buy it when the entire market has corrected,” which may be sooner than many would like to believe. Stay tuned for Dr. Bernanke’s quarterly report from the Federal Reserve on Thursday and if he disappoints, watch out below.

—By TheStreet.com Contributor Marc Courtenay

Additional News: ‘Cloud’ to Hover Over Asia: Rackspace CEO

Additional Views: Is Chevron Planning to Buy a Rival?: Courtenay

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Disclosure

TheStreet’s editorial policy prohibits staff editors, reporters, and analysts from holding positions in any individual stocks. As of the time of publication, Marc Courtenay held no positions in any of the companies mentioned in this article.

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