2 Top Stocks, and 1 That Could Be Again

Each week, I endeavor to report the results of the Big Idea Portfolio, a collection of five tech stocks that I believe will crush the market over a three-year period. I've done it before; my last tussle with Mr. Market ended with me beating the index's average return by 13.35%.

Real money was on the line then as it is now, which means any one of the five stocks you see below could tip the scales in my favor. This time, Rackspace Hosting (NYSE: RAX  ) , once one of my portfolio's top stocks, plummeted 26% after reporting an earnings miss and subpar guidance.

Revenue grew an impressive 20% year over year to $362 million, but that still came in $5 million below analyst targets. The cloud computing company's Q2 sales target also came in lower than Wall Street was hoping for.

In a post-report interview, Rackspace Director of Finance Bryan McGrath explained that Rackspace failed to pay enough attention to its oldest clients: those who pay for the company to host dedicated types of equipment for specific and complex jobs. These engagements require more time and investment by staff, but they also account for about 75% of revenue.

Most of Rackspace's newer customers have little need to know which equipment hosts their apps. All they want is a secure cloud environment and the promise of high-touch service. As a group, these clients have been slow to move to the more efficient OpenStack platform, McGrath says. Rackspace nevertheless maintained its historically high levels of investment in R&D, infrastructure, and staff in the first quarter, which put pressure on operating margin.

Will Rackspace adjust Q2 spending to reflect the transitional phase it's entered? McGrath says no: "We believe we are playing in a mega market opportunity" that will persist for more than a decade. Investment is required to take advantage, he says. Recent bets include opening new facilities in Sydney, Hong Kong, and Latin America, plus five major data center expansions. McGrath says to also expect more hiring in R&D.

What's the Big Idea this week?
For the week, Rackspace erased noticeable gains by top stocks Google (NASDAQ: GOOGL  ) and salesforce.com (NYSE: CRM  ) in a strong week for Mr. Market, resulting in the Big Idea Portfolio's forfeiture of 290 basis points in our three-year contest to see who can do better for investors. All four indexes gained again.

This time, the small-cap Russell 2000 led the indices with a 2.17% jump, followed by the Nasdaq's 1.72% gain, the S&P 500's 1.19% bump, and the Dow's 0.97% improvement, according to data supplied by The Wall Street Journal. Here's a closer look at where I stood through Friday's close:

Company
Starting Price*
Recent Price
Total Return

Apple

$413.52**

$452.97

9.5%

Google

$650.09

$880.23

35.4%

Rackspace Hosting

$41.65

$40.43

(2.9%)

Riverbed Technology

$25.95

$15.78

(39.2%)

Salesforce

$25.26**

$44.17

74.9%

AVERAGE RETURN

--

--

15.54%

S&P 500 SPDR

$124.39**

$163.41

31.37%

DIFFERENCE

--

--

(15.83%)

Source: Yahoo! Finance.
* Tracking began at market close on Jan. 6, 2012.
** Adjusted for dividends, splits, and other returns of capital.

Notable newsmakers
Among the other tech stocks making news last week:

  • Tesla Motors (NASDAQ: TSLA  ) joined the ranks of the week's top stocks with a 40% rally kicked off when the company reported a surprisingly strong first-quarter profit. Consumer Reports also named the Model S one of the best cars it has ever tested.

  • Apple's iPhone regained some of its lost market share in China. According to researcher Canalys, the iEmpire is now the fifth-ranked supplier in the region, with an 8% share. Samsung still tops the list with a 20% share. Android ranks first among operating systems.

  • YouTube unveiled 54 subscription channels featuring specialized content. We've seen Google experiment and fail with pay-to-watch options in years past. What makes this time different? Some ad-supported channels have already earned substantial audiences.

  • Finally, mark your calendars: Salesforce reports results on Thursday, May 23.

What else caught your eye in the tech world last week? Which are your top stocks right now? Let us know what you think in the comments box below.

Apple has a history of cranking out revolutionary products ... and then creatively destroying them with something better. Read about the future of Apple in the free report, "Apple Will Destroy Its Greatest Product." Can Apple really disrupt its own iPhones and iPads? Find out by clicking here.


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