Will Rackspace Hosting Outperform in 2011?

Each year, we take a look back in order to look ahead. We do this by industry, by trend, and ultimately by stock. Here's a closer look at Rackspace Hosting (NYSE: RAX), Fool style.

Foolish facts

Data current as of Dec. 28.

Like many of the fast-growers in our CAPS database, Rackspace gets just three stars from Fools. They like the business, but not the valuation. (Rackspace was trading for roughly 100 times earnings as of this writing.)

Those who are long in spite of the price probably know a triple-digit P/E ratio is historically less scary than it looks. They also sense the company is still early in capitalizing on a corporate shift from owning IT equipment to renting resources over the Web -- a process we've come to call cloud computing.

"Cloud computing on a rampage. It is going to be huge and it is a new cycle of technological innovation that is just starting to be recognized by CEOs," Foolish investor gemick wrote earlier this month.

Looking back to look forward
Rackspace isn't the only company cashing in on the trend. VMware's (NYSE: VMW) virtualization technology increases the efficiency of servers, and in the process makes cloud computing possible. Salesforce.com (NYSE: CRM) delivers business software from within a browser window.

And yet the rise of webby computing and its attendant impact on the stock was a theme for many of the year's biggest Rackspace stories at Fool.com:

• In February, Rackspace reported fourth-quarter results that included -- get this -- a 93.2% increase in revenue from cloud computing accounts. More than 10,000 new customers signed up for its services during the period.
• In July, Rackspace teamed with NASA to transform the agency's Nebula code base for cloud computing into an open source platform. More than 25 companies backed the effort, including Dell and Citrix Systems (Nasdaq: CTXS).
• In August, Cognizant Technology Solutions (Nasdaq: CTSH) borrowed from Rackspace when management referred to a commitment to outstanding service in explaining big quarterly revenue and earnings gains. Meanwhile, Rackspace's own Q2 report -- also given in August -- revealed an additional 78% improvement in cloud computing revenue.
• Two months later, shares of Rackspace suffered a double-digit loss when data center operator Equinix (Nasdaq: EQIX) reduced third-quarter and full-year guidance because of unexpected churn and discounting. Traders mistakenly assumed Rackspace would be forced to follow suit. Whoops.
• Last month, I took a closer look at how small cloud-computing customers affect Rackspace and found that these turnkey accounts now comprise 13.4% of the company's revenue. Revenue per server is up dramatically as a result.
• Rackspace CEO Lanham Napier joined us for a live chat the week before the Thanksgiving holiday to discuss cloud computing, competitors, and the company's growth plans and prospects.
• You'd expect Napier to be bullish about Rackspace's prospects, and he was. But so are his peers. This month, Savvis (Nasdaq: SVVS) chief executive Jim Ousley called Rackspace an "attractive company in an attractive space."

Talk about a nice compliment. Yet, Ousley has good reason to be bullish. He's seen Rackspace's financial performance:

Source: Capital IQ, a division of Standard & Poor's.

And here's what analysts expect from Rackspace Hosting over the next two years, according to data compiled by Capital IQ:

Source: Capital IQ, a division of Standard & Poor's. Data current as of Dec. 28.

Foolish outlook: bullish
Rackspace isn't cheap, but financially it's delivering exactly what I expected when I first named the stock to our Motley Fool Rule Breakers scorecard. Specifically, an increasing number of low-cost cloud computing accounts is helping Rackspace squeeze more revenue out of each server, leading to progressively higher returns on capital. I'm expecting this trend to continue, and the stock to keep moving higher as a result.

Now it's your turn to weigh in. What do you think of Rackspace Hosting's prospects at current prices? Sound off in the comment box below, and you can also rate Rackspace in Motley Fool CAPS.

Interested in more info on the stocks mentioned in this story? Add Rackspace Hosting, salesforce.com, VMware, Cognizant Technology, Citrix Systems, Equinix, or Savvis to your watchlist.

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