Will Rackspace Hosting Outperform in 2011?

Each year, we take a look back in order to look ahead. We do this by industry, by trend, and ultimately by stock. Here's a closer look at Rackspace Hosting (NYSE: RAX  ) , Fool style.

Foolish facts

Metric

Rackspace Hosting

CAPS rating (out of 5) ***
Total ratings 508
Percent bulls 92.9%
Percent bears 7.1%
Bullish pitches 70 out of 74
Highest-rated peers Spark Networks, PHOTOCHANNEL NETWORKS, Marchex

Data current as of Dec. 28.

Like many of the fast-growers in our CAPS database, Rackspace gets just three stars from Fools. They like the business, but not the valuation. (Rackspace was trading for roughly 100 times earnings as of this writing.)

Those who are long in spite of the price probably know a triple-digit P/E ratio is historically less scary than it looks. They also sense the company is still early in capitalizing on a corporate shift from owning IT equipment to renting resources over the Web -- a process we've come to call cloud computing.

"Cloud computing on a rampage. It is going to be huge and it is a new cycle of technological innovation that is just starting to be recognized by CEOs," Foolish investor gemick wrote earlier this month.

Looking back to look forward
Rackspace isn't the only company cashing in on the trend. VMware's (NYSE: VMW  ) virtualization technology increases the efficiency of servers, and in the process makes cloud computing possible. Salesforce.com (NYSE: CRM  ) delivers business software from within a browser window.

And yet the rise of webby computing and its attendant impact on the stock was a theme for many of the year's biggest Rackspace stories at Fool.com:

Talk about a nice compliment. Yet, Ousley has good reason to be bullish. He's seen Rackspace's financial performance:

 

Q4 2009

Q1 2010

Q2 2010

Q3 2010

Revenue growth 18.4% 23.2% 23.2% 23.0%
Normalized net income growth 44.6% 42.1% 53.0% 59.1%
Gross margin 68.5% 68.1% 67.2% 67.6%
Return on capital 7.7% 7.9% 8.0% 9.3%

Source: Capital IQ, a division of Standard & Poor's.

And here's what analysts expect from Rackspace Hosting over the next two years, according to data compiled by Capital IQ:

 

2011

2012

Revenue estimate $941.9 million 1,141 million
Normalized profit per share estimate $0.54 $0.84

Source: Capital IQ, a division of Standard & Poor's. Data current as of Dec. 28.

Foolish outlook: bullish
Rackspace isn't cheap, but financially it's delivering exactly what I expected when I first named the stock to our Motley Fool Rule Breakers scorecard. Specifically, an increasing number of low-cost cloud computing accounts is helping Rackspace squeeze more revenue out of each server, leading to progressively higher returns on capital. I'm expecting this trend to continue, and the stock to keep moving higher as a result.

Now it's your turn to weigh in. What do you think of Rackspace Hosting's prospects at current prices? Sound off in the comment box below, and you can also rate Rackspace in Motley Fool CAPS.

Interested in more info on the stocks mentioned in this story? Add Rackspace Hosting, salesforce.com, VMware, Cognizant Technology, Citrix Systems, Equinix, or Savvis to your watchlist.

What will be next year’s best stock? The Motley Fool has created a brand-new free report called The Motley Fool's Top Stock for 2011. In it, we reveal the little company set to profit from the broadband Internet expansion. Get instant access by clicking here – it’s free.

Rackspace Hosting, salesforce.com, and VMware are Motley Fool Rule Breakers recommendations. Try any of our Foolish newsletter services free for 30 days.

Fool contributor Tim Beyers is a member of the Rule Breakers stock-picking team. He didn't own shares in any of the companies mentioned in this article at the time of publication. Check out Tim's portfolio holdings and Foolish writings, or connect with him on Twitter as @milehighfool. You can also get his insights delivered directly to your RSS reader. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool is also on Twitter as @TheMotleyFool. When it comes to stocks, the Fool's disclosure policy is a lookie-loo.


Read/Post Comments (1) | Recommend This Article (10)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On January 20, 2011, at 5:47 PM, busman0232 wrote:

    I'm wondering what about EMC? will that be a big player on cloud computing?

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