Which Cloud Computing Stock Will Reign Supreme in 2023?

Cloud computing is become the industry standard for the management and distribution of computing resources. Businesses can use the power of the cloud to more effectively run software, store data, and perform powerful analytics. Precedence Research projects the $380 billion cloud computing market (2021 figure) will grow at a 17.4% compound annual growth rate and rise to $1.6 trillion annually by 2030. That suggests a massive investment opportunity is out there for those buying in now.

The three largest cloud computing providers at the moment are Amazon (AMZN -0.59%), Microsoft (MSFT -0.11%), and Alphabet (GOOGL -0.73%) (GOOG -0.81%), although each company's cloud computing segment is just part of a much larger operation. Still, understanding how their cloud offerings stack up against the competitors gives investors insight into what is turning into each company's most significant growth opportunity.

Amazon has the biggest share, but Microsoft isn't far behind

As of the third quarter of 2022, Amazon Web Services (AWS) is the leader in the cloud computing market.

Data source: Synergy Research Group.

While there is a sizable market share gap for AWS over the other two, that may shrink a bit if the current growth rates continue.

Data sources: Amazon, Microsoft, and Alphabet. Note: Microsoft's FY Q1 is the same period as the calendar year Q3.

It's not surprising the smallest competitor is growing the fastest. In this sector, a few new customers can significantly influence results. However, investors will need to watch AWS closely throughout 2023 to see if its revenue growth rate is sustained or slows, as it has trended down throughout 2022. Microsoft is a bit of an outlier, as it holds second place in market share but still managed to grow fast.

Microsoft's quarterly earnings call offered some insight, as CFO Amy Hood said the company saw a "significant volume of large long-term Azure contracts." Because it had a considerable business boost, Azure's growth may have been artificially inflated due to the unpredictability of these contracts.

The fourth quarter of the calendar year will be interesting for this trio, but it should offer some more insight into how the sales cycle is going for cloud computing.

But which stock has the best opportunity for 2023?

Each company is facing challenges in its other segments

As mentioned before, cloud computing isn't the primary focus for any of these companies. However, Microsoft is becoming increasingly more concentrated. While Microsoft doesn't specifically break out its Azure revenue, the Intelligent Cloud division made up 41% of Microsoft's revenue in the first quarter of fiscal 2023, ended Sept. 30. Management projects the Intelligent Cloud division's constant currency revenue growth will slow in the second quarter (calendar year Q4) to 23% growth (it was 20% in Q1). Investors will need to watch whether Azure's revenue growth slows significantly as management indicated it might or if the trend of large contracts continues and surprises everyone.

Most of Amazon's revenue comes from its e-commerce business, which will influence its stock more than AWS. On its Q3 call, management indicated that mid-20% growth for AWS was likely for Q4, but overall revenue growth is expected to come in between 2% and 8%. One thing to note is that AWS is Amazon's only profitable segment, as both the international and North American e-commerce segments are losing money. This is quite the risk, and Amazon is currently going through rounds of layoffs to improve profitability.

Alphabet is in a similar boat to Amazon; most of its revenue (nearly 80%) comes from advertisement sources, not cloud computing. Cloud computing has been the one shining spot for Alphabet, as advertising growth is challenging to come by as the economy slows. However, Alphabet is still extremely profitable, with a 25% operating margin, although this metric has been trending down due to Alphabet's massive hiring spree. With Alphabet, investors need to watch expenses and whether the advertisement spending returns.

Which stock is the better buy for 2023?

All three companies have challenges ahead, but the cloud continues to be a growth engine for all. So which one makes the best 2023 buy?

To me, it's Alphabet.

Alphabet stock trades at 18 times earnings, well below its long-term average of 30.4 and near its all-time low. Microsoft trades at a relative premium valuation of 26 despite the projected slowdown, although it is currently trading below its long-term average of 30.5. The market appears to think there is less upside available to Microsoft right now.  

Amazon is also trading well below its long-term average P/E (78 now versus 214 average), but there are too many questions about Amazon's profitability at the moment. So Alphabet seems like the logical choice to me.

However, I think all three stocks are well positioned for the long-term cloud computing opportunity, and you can't go wrong with any of these stocks if they are held for at least three to five years.