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2 Cloud Computing Stocks to Buy After Strong Earnings

By Trevor Jennewine - May 27, 2021 at 7:45AM

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Arista Networks and Cloudflare delivered impressive first-quarter results.

Cloud computing makes it possible to access storage, computing, software, and other services through the internet. This helps enterprises save money and operate with more agility, eliminating the need to buy and maintain costly on-site hardware. 

For most investors, Arista Networks (ANET -1.55%) and Cloudflare (NET -0.75%) probably aren't the first cloud computing companies that come to mind. But both play an important role in the industry, and both look like good long-term investments. Here's why.

Person pressing a cloud computing button within a honeycomb of other options.

Image source: Getty Images.

Arista Networks

Enterprise applications have traditionally been installed on specific servers, meaning most traffic was moving "north-south" (in and out of data centers). But cloud computing changed that model, and applications now run across thousands of servers, meaning more traffic moves "east-west" (between servers).

Put simply, cloud computing created a need for a new type of network, one capable of supporting much greater bandwidth. Arista pioneered software-driven cloud networking to solve this problem.

Compared to hardware-centric solutions, Arista's platform is more programmable and less complex, lowering the total cost of network ownership for clients. Furthering this advantage is Arista's CloudVision, a single platform that allows enterprises to monitor networks in real time across campus and cloud environments. By comparison, Cisco Systems requires its clients to use multiple different products, which increases the burden on IT teams.

Computers physically connected to a cloud.

Image source: Getty Images.

These advantages have helped Arista take the top spot in the 100 Gbps (gigabit per second) ethernet switching market, with 30% market share compared to Cisco's 21%. That competitive edge continued to drive growth in the first quarter of 2021.

During the Q1 earnings call, CEO Jayshree Ullal noted several customers wins, both in the data center and enterprise campus environments. Notably, each of these new clients cited different facets of Arista's software-driven approach as their reason for choosing its networking platform.

In total, revenue hit $668 million in Q1, up 28% from the prior year. And Arista's operating margin expanded 230 basis points, driving earnings of $2.27 per diluted share, up 31%. After a rough 2020, investors should be pleased with this turnaround. But the rest of 2021 looks even brighter.

On the conference call, COO Anshul Sadana said Arista expects the next-gen upgrade cycle for 100 Gbps, 200 Gbps, and 400 Gbps switches to start later this year. As the leader in each of those markets, Arista should benefit from strong top-line growth as this cycle commences.

Beyond that near-term catalyst, computer-intensive technologies like artificial intelligence will place more demand on data centers in the years ahead. That will be magnified by the proliferation of connected Internet of Things (IoT) devices. Those trends should drive demand for high-speed networking solutions, which should help Arista continue to grow its business.

Cloudflare

Cloudflare's edge cloud is similar to central clouds like Amazon Web Services, except its servers are strategically positioned at internet exchange points around the globe. Think of these as intersections of the internet, places where multiple networks come together. As a result, Cloudflare interconnects with over 9,100 other networks, which positions its servers less than 100ms from 95% of the world's connected population.

This strategy lends itself to speed, security, and reliability. Clients turn to Cloudflare to ensure applications and websites load quickly, and to secure corporate networks and resources. In total, management believes the company's addressable market will hit $100 billion by 2024.

Fingers typing on keyboard, overlaid with digital security icons.

Image source: Getty Images.

Cloudflare continued to capitalize on that opportunity during the first quarter of 2021. Revenue reached $138 million, up 51% from the prior year. Gross margin was roughly flat at 76.8%, evidencing its potential profitability, though the company continues to prioritize growth over profits.

To that end, net income was -$40 million, but cash from operations flipped into positive territory, hitting $24 million. This metric adds certain non-cash charges (e.g. depreciation, stock-based compensation) back to net income, making it a better measure of actual cash flow. A positive number is a good sign -- it indicates Cloudflare can continue to operate without issuing debt or diluting shareholders.

However, I think the most impressive metrics were customer growth and retention. Cloudflare ended Q1 with 119,206 paying customers, up 34%. But 945 of those customers now pay over $100,000 each year, a 70% increase from the same period last year.

Cloudflare's dollar-based net retention was 123% in Q1, indicating a 23% uptick in customer spend. That creates a compounding effect -- more customers and more revenue per customer -- which has powered Cloudflare's strong top-line growth. I believe that momentum will carry into future quarters.

Beyond that, cloud computing should continue to gain popularity, as enterprises seek efficiency and agility in an increasingly digital landscape. And I believe Cloudflare will benefit from that trend. That's why investors should consider buying a few shares of this growth stock.

John Mackey, CEO of Whole Foods Market, an Amazon subsidiary, is a member of The Motley Fool's board of directors. Trevor Jennewine owns shares of Amazon and Arista Networks. The Motley Fool owns shares of and recommends Amazon, Arista Networks, and Cloudflare, Inc. The Motley Fool recommends the following options: long January 2022 $1,920 calls on Amazon and short January 2022 $1,940 calls on Amazon. The Motley Fool has a disclosure policy.

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Stocks Mentioned

Arista Networks, Inc. Stock Quote
Arista Networks, Inc.
ANET
$124.71 (-1.55%) $-1.97
Cloudflare, Inc. Stock Quote
Cloudflare, Inc.
NET
$73.68 (-0.75%) $0.56
Amazon.com, Inc. Stock Quote
Amazon.com, Inc.
AMZN
$139.41 (-0.99%) $-1.39
Cisco Systems, Inc. Stock Quote
Cisco Systems, Inc.
CSCO
$45.02 (0.02%) $0.01

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

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