Tech earnings boom due to cloud. How to play it

Published Mon, Oct 26 20158:08 AM EDTUpdated Sat, Oct 14 201710:44 AM EDT

Companies with large cloud computing units surged on better-than-expected earnings as the shift to that storage platform accelerates. Amazon shares traded up 6 percent, Microsoft jumped 10 percent, and Alphabet gained 6 percent Friday. "I think (the cloud) just reflects a secular shift. Every business in the world is going to run on (the) cloud eventually, so we view it as an amazing opportunity," Google CEO Sundar Pichai said on Alphabet's earnings call Thursday, according to a FactSet transcript. Amazon Web Services (AWS), the Internet retailer's cloud computing platform, is the biggest example of the trend's amazing growth. AWS sales rose in Amazon's third quarter by 78 percent from the previous year, to $2.1 billion. More impressive is AWS' accelerating operating profit margins at 25 percent of sales versus 21.4 percent a quarter ago and only 8.4 percent last year. AWS is now 52 percent of Amazon's operating profit, even though it constitutes only 8 percent of Amazon's overall sales. Amazon said AWS is growing because it saves their corporate and start-up clients' money. "They like the speed and agility Amazon Web Services offers them," Amazon's CFO Brian Olsavsky said on Amazon's earnings call Thursday, according to a FactSet transcript.. "They like the new features that we launched, many of which also enable them to lower their cost of infrastructure. Amazon Aurora (is) one-tenth the price of other high-end commercial databases." Here is how investors can take advantage of the cloud trend. Friday's gains build upon large year-to-date growth for the cloud computing stocks compared to the legacy technology companies that are losing market share. Amazon is up 93 percent this year, Microsoft has posted a 14 percent gain, Alphabet is 36 percent higher, and Salesforce.com is up 33 percent. Among legacy companies, IBM is down 10 percent, Oracle is off 15 percent, Hewlett-Packard has lost 28 percent. Read More Activists win again with Yum. Which stock is next? "The biggest thing these cloud companies have going for them is that, unlike some of the incumbents, they don't have a legacy business, so the cloud is all upside for them," Jan Dawson of Jackdaw Research wrote in an email. "Amazon and Google in particular have no legacy in premise-based infrastructure, so their cloud growth is all new revenue for them, and even Microsoft is growing its cloud business fast enough that it's mostly a positive trend there too." Investors may want to avoid Hewlett-Packard due to the company's high exposure to legacy hardware. HP is the world's largest manufacturer of high-end corporate servers. Its enterprise group, which includes servers, storage and networking, represented 26 percent of the company sales and 35 percent of profits over the past year. Read More Amazon vs Alphabet: Which could hit $1,000 first? However, given the relatively high valuations of many of the cloud plays like Amazon and Salesforce.com, which trade around 80 times 2016 earnings estimates, it may be prudent to focus on Microsoft as the best opportunity for investors, analysts said. Microsoft, already the number two player in the cloud computing platform market, trades at a more reasonable valuation at 19 times next year's earnings and actually has a faster growing cloud business than Amazon. "While many companies are developing commercial cloud offerings, there are really only two driving enterprise cloud platform innovations at massive scale, Amazon and Microsoft. We push eachother and we each have a unique approach," Microsoft CEO Satya Nadella said on the earnings conference call Thursday, according to a FactSet transcript. Read More 3 investing lessons from Einhorn's candid letter Analysts are enthusiastic about Microsoft's cloud efforts and future growth. "Azure (Microsoft's cloud computing platform) revenue grew 135 percent year-over-year, with revenue and usage both more than doubling," Stifel's Brad Reback wrote in a note to clients Friday. "Commercial cloud (includes Azure and cloud-based software services such as Office 365) is now on an $8.2 billion (annual) run-rate ... and well on its path towards $20 billion in fiscal year 2018." Reback has a buy rating on Microsoft with a price target of $58, representing 9 percent upside from Friday afternoon trading.

Baran Ozdemir | Vetta | Getty Images

Companies with large cloud computing units surged on better-than-expected earnings as the shift to that storage platform accelerates.

Amazon shares traded up 6 percent, Microsoft jumped 10 percent, and Alphabet gained 6 percent Friday.

"I think (the cloud) just reflects a secular shift. Every business in the world is going to run on (the) cloud eventually, so we view it as an amazing opportunity," Google CEO Sundar Pichai said on Alphabet's earnings call Thursday, according to a FactSet transcript.

Amazon Web Services (AWS), the Internet retailer's cloud computing platform, is the biggest example of the trend's amazing growth.

AWS sales rose in Amazon's third quarter by 78 percent from the previous year, to $2.1 billion. More impressive is AWS' accelerating operating profit margins at 25 percent of sales versus 21.4 percent a quarter ago and only 8.4 percent last year.

AWS is now 52 percent of Amazon's operating profit, even though it constitutes only 8 percent of Amazon's overall sales.

Amazon said AWS is growing because it saves their corporate and start-up clients' money.

"They like the speed and agility Amazon Web Services offers them," Amazon's CFO Brian Olsavsky said on Amazon's earnings call Thursday, according to a FactSet transcript.. "They like the new features that we launched, many of which also enable them to lower their cost of infrastructure. Amazon Aurora (is) one-tenth the price of other high-end commercial databases."

Here is how investors can take advantage of the cloud trend.