Due to the strong demand for cheap software, cloud computing companies are enjoying great market momentum. This has attracted hundreds of competitors, from start-ups to traditional tech giants. At least 13 new players have gone public in the last 18 months, with most of them surpassing the $1 billion market cap milestone in a few months. But only cloud companies that innovate their product portfolio constantly, and build economic moats, will be able to survive the competitive landscape.
Computer Associates Technologies (NASDAQ:CA), Amazon.com (NASDAQ:AMZN), and NetSuite (NYSE:N) are the best-performing stocks year to date in the cloud computing index. What makes each of these three companies special? How did they manage to build strong economic moats in a fierce landscape? More importantly, after experiencing more than a 40% increase in stock price, can they still be considered attractive investment opportunities?
Computer Associates and its 800 patents
Up an amazing 50% since January 2013, Computer Associates, also known as CA, started as an antivirus company and now is one of the largest cloud based software developers. Specialized in the business-to-business segment, CA has taken charge of several cloud projects, from developing a project management system for Siemens, to implementing a client automation system for Bank of Finland.
To improve its competitive advantage, CA invests $600 million per year in research and development, or R&D, and employs highly skilled cloud engineers, who have obtained more than 800 patents so far. Furthermore, the company's new management has shown great interest in allocating less resources to legacy products, and focusing instead on high-growth areas, such as advanced authentication systems and data mining solutions, which could improve CA's top line in the medium run.
Amazon.com: From an e-commerce website to a server farm
Although Amazon isn't a pure cloud company, the company's cloud services unit is the second largest storage provider in the industry, making more than $3 billion in annual revenue. This is still less than 10% of Amazon's total revenues. However, it is also one of the fastest-growing business units in Amazon's portfolio.
The company managed to create a successful cloud server farm by focusing on developing a simple, reliable, and cheap service. To promote its cloud solutions, Amazon decided to give one-year free trials. The company also gave free, one-day events in 12 major cities around the world, offering customer presentations on cloud computing, and tech sessions by its most respected engineers. This strategy helped Amazon to establish its solutions package as a standard in the industry quite quickly, despite not being an early mover in the cloud arena.
NetSuite's efforts to create a global platform are paying off
NetSuite has been another terrific performer this year. In the second quarter, the company's top line increased 31% to $101 million, beating the consensus. Its OneWorld solution is said to be the world's most deployed cloud enterprise resource planning solution.
To get as many clients as possible, NetSuite aims to create a truly global platform. Therefore, it has localized its software to more than 15 languages, included support for more than 170 currencies, and added support for several accounting standards.
However, although NetSuite has plenty of growth potential, investors should note the company's current market valuation isn't cheap. Trading at 22 times trailing sales, the company is selling at more than twice the price of Salesforce.com. It is almost twice as expensive as Workday on a price-to-book basis.
Final Foolish takeaway
The fast-growing demand for cloud solutions brings several new investment opportunities to the table. Investors should focus on companies with a great product, and a relatively cheap valuation. To identify the next outperformers, a great starting point is screening companies that are investing heavily on R&D, developing localized software or creating strong communities of developers.