What happened
For good or for bad, the state of the economy has dominated the headlines in recent months and has been the primary market driver thus far in 2023. Market watchers and the Federal Reserve alike have been watching closely for signs of an impending recession, and while talk of a mild downturn has increased in recent weeks, investors have been hopeful for a so-called "soft landing," with the economy sidestepping a recession. However, the quarterly results of a couple of prominent cloud providers gave the clearest indication yet that the expected downturn may yet be avoided.
With that as a backdrop, Cloudflare (NET 3.77%) rose 5.2%, Snowflake (SNOW 2.69%) climbed 8.1%, MongoDB (MDB 7.69%) jumped 11.2%, and Datadog (DDOG 3.58%) rallied 14% as of 11:10 a.m. ET on Wednesday.
A check of all the usual sources -- regulatory filings, earnings results, and changes to analysts' targets -- turned up nothing in the way of company-specific news driving these cloud stocks higher today. This seems to support the conclusion that investors are reacting to the possibility that the economy might actually be headed for better days and the worst of the bear market could be in the rearview mirror.
Image source: Getty Images.
So what
Minutes from the April meeting of the central bank's Federal Open Market Committee, released earlier this month, revealed that Fed officials believe the economy will likely experience a brief recession later this year. The potential for a recession, however brief, led to fears that businesses would further rein in spending, which would weigh on growth in cloud computing.
However, quarterly results released by cloud infrastructure leaders Microsoft and Alphabet were more robust than expected, which seemed to dispel those concerns -- at least for now -- giving investors a much-needed dose of confidence, and sending a number of stocks in the cloud sector higher.
After the market close on Tuesday, Microsoft reported the results for its fiscal 2023 third quarter (which ended March 31). The tech giant delivered revenue of $52.9 billion, up 7% year over year. The growth was even better when excluding the impact of foreign currency exchange rates, growing 10% in constant currency. That strength continued to the bottom line: Earnings per share (EPS) of $2.45 rose 10%, or 14% in constant currency. For context, analysts' consensus estimates were calling for revenue of $51 billion and EPS of $2.24, so Microsoft surpassed expectations with ease.
Alphabet's results were also better than anticipated. For the first quarter, the Google parent generated revenue of $69.8 billion, up 3% year over year, or 6% in constant currency. Alphabet's EPS of $1.17 slipped 5%, but the company cited a one-time charge of $2.6 billion related to job cuts as the culprit. Market watchers were expecting revenue of $68.9 billion and EPS of $1.31, so it was a mixed bag.
Still, the results were better than many expected, helping to buoy many companies in the cloud sector and helping push the tech-centric Nasdaq Composite into positive territory on Wednesday morning.
Data by YCharts
Now what
It's important to note that while investor sentiment is rosy today, the market is only one negative report away from further declines, as the final chapter on this economic story has yet to be written and stocks will likely remain volatile for the foreseeable future.
Veteran investors know full well that calling a bottom is hard, if not impossible. There's good news, however. As illustrated in the above chart, each of these companies has continued to grow revenue over the past year, even as their stock prices have trended lower. Once the economy stabilizes, which it no doubt will, Wall Street will reward companies that have proven their mettle during uncertain times -- and this quartet of stocks clearly meets that criteria.
There is, of course, the matter of valuation to consider. While none of these stocks is necessarily cheap, they are trading at a significant discount to their recent highs. Snowflake, Cloudflare, MongoDB, and Datadog are currently selling for 12 times, 11 times, 9 times, and 9 times next year's sales, respectively, when a reasonable price-to-sales ratio is generally between 1 and 2. That said, valuation shouldn't be viewed in a vacuum and investors frequently award a higher valuation to companies with continued strong revenue growth -- particularly in the face of economic headwinds.
For investors expecting to hold their shares for at least three to five years, these stocks represent an intriguing opportunity, and could generate impressive gains over time.
