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3 Best-in-Class Cloud Stocks Down Over 20% in This Correction

By Billy Duberstein - Mar 22, 2021 at 6:45AM

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They could fall further. But they should all be on your shopping list.

One reason to be optimistic even in the recent brutal tech sell-off is that the correction doesn't have anything to do with company fundamentals. Most leading cloud software-as-a-service stocks are reporting torrid growth this earnings season and quickly becoming must-have applications for the new data era. 

The sell-off is rather largely a function of inflation fears and of switching to "reopening" stocks, cyclical stocks, and even bonds, forcing investors to sell some tech winners -- up big over the past year -- to fund purchases even in these new areas.

It's hard to say how long this correction will go on and how much of last year's big gains will be given back. Federal Reserve Chairman Jerome Powell has said that even if inflation spikes a bit this year, the effect may very well be temporary, since interest rates have been low for a decade and inflation has been absent. That could set up a scenario where high-growth tech stocks continue to fall this year but then resume market leadership after the post-pandemic "bump" subsides.

In any case, investors with a long time horizon should closely monitor the best-in-class cloud stocks. These companies are winning the future, so they should be at the top of your shopping list if they continue to fall in 2021.

Two sets of hands hold opposite sides of a fluffy cloud.

Image source: Getty Images.

CrowdStrike

Whether it's last year's SolarWinds hack or the recent SUNBURST attack, cybersecurity is currently on the minds of corporate America and governments worldwide, and the trend isn't likely to ebb anytime soon.

That's why young investors may wish to take a look at CrowdStrike (CRWD 5.62%), an upcoming disruptor in the space. CrowdStrike has a novel cloud- and artificial intelligence-based architecture, consisting of its lightweight Falcon software agents on every endpoint, all of which relay data back to the company's centralized Threat Graph. So with every customer it adds, CrowdStrike's algorithms get smarter in a virtuous network effect. CrowdStrike is taking market share from non-cloud legacy vendors. In fact, SolarWinds switched over to CrowdStrike's solutions following its massive hack last year.  

Last quarter, revenue grew 74% and subscription revenue rocketed 77%, with CrowdStrike exceeding $1 billion in annual recurring revenue for the first time. Subscription gross margin also increased from 80% from 77%. While GAAP profits are still negative, the company impressively logged $292 million in free cash flow in the past 12 months, up from $12.5 million in the prior year.

With a seeming category-killer product in endpoint security, CrowdStrike continues to add new security modules to its arsenal, and recent acquisitions of Humio (log management and observability) and Preempt Security (zero trust access) should further expand CrowdStike's total addressable market.

Despite these analyst-crushing results, CrowdStrike has pulled back over 20% from its recent highs. While the stock is still up massively over the past year, young investors want to keep this best-in-class cloud security operator on their radar if it falls further. 

Young data scientists work in front of a desktop workstation with graphics.

Images source: Getty Images.

Snowflake

Another cloud disruptor is data management company Snowflake (SNOW 1.79%). Snowflake was the first data warehouse to go all-in on the cloud, developing a novel architecture that allows companies to do all sorts of new things with their data at lower cost and higher speed. Snowflake's platform works across all three major clouds and allows companies to consolidate all of their structured and unstructured data into Snowflake's platform to glean insights.

Last quarter, Snowflake posted 117% revenue growth over the prior year, along with gross margin expansion. Although the company still makes hefty operating losses, operating margins are actually improving because revenue is growing so much. Snowflake also eked out a small positive adjusted FCF number of $17.3 million last quarter.

Not only does Snowflake have really slick technology, but its data exchange enables Snowflake customers to share data with each other and combine it with other public and private data loaded to Snowflake. That means Snowflake also has powerful network effects that should tie customers to Snowflake and attract more to its platform.

Of course, the market has been extremely high on Snowflake ever since its September IPO at $120 per share, especially after Warren Buffett's conglomerate, Berkshire Hathaway, surprisingly bought into the IPO. Even though the stock price has nearly been cut in half from its December highs, it's still some 80% above its IPO price as of this writing and still trades at a frothy-looking 82 times sales.

Yet the company still forecasts another year of stellar growth, with an outlook of 81%-84% growth this year with expanding margins. Although the stock still looks expensive, even down as much as it is, with a disruptive technology, powerful network effects, and a long growth runway, it's definitely on my shopping list should the price continue to fall more toward its IPO price.

Businessman seen from neck down working a tablet with foreign currency symbols coming out.

Images source: Getty Images.

DocuSign

Another best-in-class cloud stock that's fallen materially from recent highs is DocuSign (DOCU 5.61%), down more than 30% from highs set back in September, but also 20% from more recent February highs.

DocuSign is a leader in e-signatures, allowing businesses to replace the cumbersome manual processes of document management and physical signatures with digital substitutes. But the company also aims to be much more: Last year, it bought Seal Software, a contract analytics and artificial-intelligence company that automates and streamlines the entire agreements process.

DocuSign's e-signature solutions are expanding from documents to proving identities, click wrap (agreeing to privacy policies), and electronic witnessing. Soon, management expects remote online notary transactions as well. It's all part of DocuSign's Agreement Cloud, which aims to satisfy management's mission to manage all types of business agreements and automate the entire document process, saving customers time and money.

DocuSign's solutions were turbocharged by the pandemic, as people could not meet in person. Revenue grew 57%, and subscription revenue an even higher 59%. Gross margins expanded by one percentage point to 80%. Like the other two aforementioned companies, DocuSign is still making GAAP net losses, but positive free cash flow. DocuSign's next expansion rate was an impressive 123%, which was an all-time record for the company. Usually, it's harder for a net retention rate to go higher or maintain itself as a company gets bigger, so this was quite impressive.

I'd also expect more tuck-in acquisitions like the Seal acquisition going forward. Last quarter, DocuSign sold a $690 million convertible bond, and expanded its credit facility by up to $750 million. Considering DocuSign is generating positive free cash flow, it didn't need the money, so expect more aggressive growth moves in the near future.

Despite its big recent haircut, DocuSign still trades at a pretty high 27 times sales, which is still fairly expensive. However, new customers acquired in the pandemic aren't likely to go back to the old ways of doing things. Should DocuSign's stock continue to fall, it's another high-quality cloud name to put on your buy list.

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Stocks Mentioned

DocuSign Stock Quote
DocuSign
DOCU
$85.34 (5.61%) $4.53
CrowdStrike Holdings, Inc. Stock Quote
CrowdStrike Holdings, Inc.
CRWD
$164.59 (5.62%) $8.76
Snowflake Inc. Stock Quote
Snowflake Inc.
SNOW
$129.07 (1.79%) $2.27
Berkshire Hathaway Inc. Stock Quote
Berkshire Hathaway Inc.
BRK.A
$472,880.23 (0.87%) $4,075.19
Berkshire Hathaway Inc. Stock Quote
Berkshire Hathaway Inc.
BRK.B
$315.17 (0.85%) $2.67
SolarWinds, Inc. Stock Quote
SolarWinds, Inc.
SWI
$12.04 (2.99%) $0.35

*Average returns of all recommendations since inception. Cost basis and return based on previous market day close.

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