Are Cloud Stocks Growing too Fast too Soon?

A couple weeks ago, UBS's Art Cashin said that we could be seeing another bubble, and that valuations among cloud and some tech names are reminiscent of what we witnesses during the dotcom era . While Cashin is correct in identifying both price/sales and P/E ratios at ridiculous levels, might there be some companies in the space worth buying?

A buy after a strong quarter?
As we look at cloud, big data, and Internet-based companies, it's important to realize that none are being valued on current fundamentals, but rather future fundamentals. A bubble is then created when large investments are made, and future fundamentals never support the valuation. Given the fact that countless such companies trade with price/sales ratios of 20 plus, there is reason to believe that many will fail. However, some will also succeed.

In the case of Tableau (NYSE: DATA  ) , it is a software company, and part of the enterprise stock group. Tableau shares traded higher by more than 5% after it reported blowout earnings on Tuesday. The company reported revenue of $61.1 million, which was up an impressive 90% year-over-year .

Also, the company added more than 1,500 new customers, and saw its licensing revenue grow 90% year-over-year to $42 million, which is closely watched by investors. However, the most impressive metric might be the company's EPS of $0.08, which is a rare profit in this particular space.

The lesser of two evils
While Tableau's quarter was great, the company already trades with a market cap over $4 billion, more than 20 times sales. Now, in retrospect, Tableau's valuation is not excessive compared to some of its peers, such as Workday (NYSE: WDAY  ) , but still expensive nonetheless.

Workday trades at a whopping 38 times sales, yet Tableau has greater growth. Also, Workday has operating margins of negative 35.42%, while Tableau has been near profitable for much of the last year; this includes a quarterly profit in Tableau's last quarter.

With all things considered, Tableau looks to be a far better value versus Workday. Granted, the two companies do offer different services, as Tableau focuses on data visualization while Workday is a HR/payroll company that offers services through the cloud. Nonetheless, given the excessive valuations that are present throughout the space, it is easy to see why investors are reacting favorably to Tableau's quarter.

A better option
Like I said, there's no doubt that Tableau had a good quarter, but the question is whether or not earnings can ever grow to support the company's valuation. If the NASDAQ trades at 1.8 times sales, then Tableau would need at least $2 billion in eventual revenue to support its current valuation. With current sales under $200 million, investors might now understand why Cashin thinks we are approaching bubble-like levels.

Simply put, expectations are too high and investors are not allowing enough room for error on behalf of these companies. In some ways, it appears investors don't seem worried at all that sales of such companies will ever materialize.

Therefore, a better and safer investment option to capitalize on the growth of this space with a realistic valuation might be MicroStrategy (NASDAQ: MSTR  ) . The company is a worldwide provider of enterprise software platforms, and earlier this month, MicroStrategy unveiled its new Analytics Platform . Essentially, MicroStrategy is entering the data visualization space, which is where Tableau has found its growth.

As a result of this news, MicroStrategy traded higher by 15% following Tableau's big quarterly beat. Investors now have reason to believe that MicroStrategy could see substantial growth in the data  visualization space. Already, the company has annual sales of $589 million, but only has single digit growth. With that said, MicroStrategy trades at just 1.93 times sales, which is comparable to the NASDAQ, making an investment in the company a fairly low risk.

Final Thoughts
Perhaps Cashin is right and these cloud/data stocks have grown too fast too soon. As of now, these companies, including Tableau and Workday, are growing fast. But at what point will these companies begin to see slowed growth, and will these multi-billion dollar valuations then crumble?

With these unknowns, investors must realize that a good offense is a good defense, and if you want to invest in this fast-growing space, then companies that trade with smaller premiums to fundamentals might be more rewarding long-term. In this particular space, MicroStrategy looks to be the safest choice, but one that could still capitalize if growth continues.

More compelling ideas from Motley Fool
The mobile revolution is still in its infancy, but with so many different companies it can be daunting to know how to profit in the space. Fortunately, The Motley Fool has released a free report on mobile named "The Next Trillion-Dollar Revolution" that tells you how. The report describes why this seismic shift will dwarf any other technology revolution seen before it and also names the company at the forefront of the trend. You can access this report today by clicking here -- it's free.


Read/Post Comments (0) | Recommend This Article (0)

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.

Be the first one to comment on this article.

Sponsored Links

Leaked: Apple's Next Smart Device
(Warning, it may shock you)
The secret is out... experts are predicting 458 million of these types of devices will be sold per year. 1 hyper-growth company stands to rake in maximum profit - and it's NOT Apple. Show me Apple's new smart gizmo!

DocumentId: 2706165, ~/Articles/ArticleHandler.aspx, 10/2/2014 2:44:47 AM

Report This Comment

Use this area to report a comment that you believe is in violation of the community guidelines. Our team will review the entry and take any appropriate action.

Sending report...


Advertisement