2022's bear market sent cloud computing stocks into a downward spiral, and bad news has kept coming in 2023. The Fed indicates interest rates will stay higher for longer (remember, higher rates lower the present value of a business), and many companies put a pause on spending on new software-based projects to conserve cash.
The result has been another lackluster year for many cloud stocks, especially those in the mid-cap and small-cap universe. But that could be a big win for investors with a long-term mindset.
How bad is the bad news exactly?
Reinforcing the belief that 2023 has been another terrible year for software technology is the fact that many company executives point out time and again on earnings calls that "customer spending has slowed." With fears of recession flaring up multiple times throughout 2023, cash conservation is the norm, and giving the red light to new software projects (or at least delaying the green light until 2024) is a top way to do so.
But how bad off is the cloud computing industry exactly? As it turns out, not so bad after all -- at least according to tech researcher IDC. In a recent report, IDC upgraded its outlook for cloud infrastructure spending in 2023, bumping the growth rate to over 10% (versus an outlook for over 7% growth before). If true, global cloud infrastructure spending would top $100 billion this year, offsetting a decline in non-cloud enterprise computing infrastructure (expected to decline about 8% to under $60 billion).
In fact, IDC expects various cloud infrastructure projects to continue to gobble up market share of new IT deployments, reaching an expected share of 70% by 2027, compared to about 63% this year.
What are all those chips for?
What exactly is "infrastructure" in this context of the cloud? It's in reference to big powerful computing machines called servers installed in data centers, and accessed via an internet or private network connection.
IDC says another big pivot to cloud infrastructure is underway as many organizations around the world start putting artificial intelligence (AI) to work -- especially with servers powered by Nvidia's heavy-duty chips. Many organizations don't have the financial firepower to build their own data centers for advanced AI workloads, so tapping a cloud provider (think Amazon's (AMZN 3.43%) AWS, Microsoft (MSFT 1.82%) Azure, Alphabet's (GOOGL 10.22%) (GOOG 9.96%) Google Cloud, or Oracle (ORCL 2.02%) Cloud) makes more sense.
In a separate related report, IDC estimates global spending on cloud services (the software that runs on all those AI chips and servers) will expand at a blistering average 19.9% rate every year through 2027, at which point global cloud service spending will be worth $1.35 trillion a year.
Time to cash in on the cloud's "bad year"
If you believe IDC is even remotely in the right ballpark for cloud growth expectations in the next five years, 2023's "bad" performance for cloud companies spells opportunity for investors looking for a place to park cash for the long term. As a result of the bear market of 2022 and only limited recovery in 2023, many stocks in this sector trade for a long-term value right now.
Where is a good place to start? The aforementioned big four cloud infrastructure and software service providers -- Amazon, Microsoft, Google, and Oracle -- are rock solid and sport reasonable valuations.
Data by YCharts.
A lot of semiconductor companies are delving into this arena too. I already mentioned Nvidia, but that's a valuation battleground right now. As an alternative, investors should take a look at Broadcom as it finalizes its acquisition of cloud giant VMware. Once complete, the addition of VMware will transform Broadcom into a unique chip-and-software hybrid business, and its valuation is also reasonable right now.
And if you're a new investor just getting started, getting a broad-based index of many software stocks might be a better route. I've owned Vanguard Information Technology ETF (VGT 1.72%) for many years. It currently includes over 300 individual stocks -- meaning it yields access to a lot of mid- and small-cap stock names in addition to the big companies listed above -- and has obliterated market returns over the long term.
The news may have not been so great for the world of software this past year, but that's a win for investors looking to deploy cash. Now could be a great time to go shopping.
