Best of the Week
Most Popular
1. The Trump Stock Market Trap May Be Triggered - Barry_M_Ferguson
2.Why are Central Banks Buying Gold and Dumping Dollars? - Richard_Mills
3.US China War - Thucydides Trap and gold - Richard_Mills
4.Gold Price Trend Forcast to End September 2019 - Nadeem_Walayat
5.Money Saving Kids Gardening Growing Giant Sunflowers Summer Fun - Anika_Walayat
6.US Dollar Breakdown Begins, Gold Price to Bolt Higher - Jim_Willie_CB
7.INTEL (INTC) Stock Investing to Profit From AI Machine Learning Boom - Nadeem_Walayat
8.Will Google AI Kill Us? Man vs Machine Intelligence - N_Walayat
9.US Prepares for Currency War with China - Richard_Mills
10.Gold Price Epochal Breakout Will Not Be Negated by a Correction - Clive Maund
Last 7 days
The Best “Pick-and-Shovel” Play for the Online Grocery Boom - 18th July 19
Is the Stock Market Rally Floating on Thin Air? - 18th July 19
Biotech Stocks With Near Term Catalysts - 18th July 19
SPX Consolidating, GBP and CAD Could be in Focus - 18th July 19
UK House Building and Population Growth Analysis - 17th July 19
Financial Crisis Stocks Bear Market Is Scary Close - 17th July 19
Want to See What's Next for the US Economy? Try This. - 17th July 19
What to do if You Blow the Trading Account - 17th July 19
Bitcoin Is Far Too Risky for Most Investors - 17th July 19
Core Inflation Rises but Fed Is Going to Cut Rates. Will Gold Gain? - 17th July 19
Boost your Trading Results - FREE eBook - 17th July 19
This Needs To Happen Before Silver Really Takes Off - 17th July 19
NASDAQ Should Reach 8031 Before Topping - 17th July 19
US Housing Market Real Terms BUY / SELL Indicator - 16th July 19
Could Trump Really Win the 2020 US Presidential Election? - 16th July 19
Gold Stocks Forming Bullish Consolidation - 16th July 19
Will Fed Easing Turn Out Like 1995 or 2007? - 16th July 19
Red Rock Entertainment Investments: Around the world in a day with Supreme Jets - 16th July 19
Silver Has Already Gone from Weak to Strong Hands - 15th July 19
Top Equity Mutual Funds That Offer Best Returns - 15th July 19
Gold’s Breakout And The US Dollar - 15th July 19
Financial Markets, Iran, U.S. Global Hegemony - 15th July 19
U.S Bond Yields Point to a 40% Rise in SPX - 15th July 19
Corporate Earnings may Surprise the Stock Market – Watch Out! - 15th July 19
Stock Market Interest Rate Cut Prevails - 15th July 19
Dow Stock Market Trend Forecast Current State July 2019 Video - 15th July 19
Why Summer is the Best Time to be in the Entertainment Industry - 15th July 19
Mid-August Is A Critical Turning Point For US Stocks - 14th July 19
Fed’s Recessionary Indicators and Gold - 14th July 19
The Problem with Keynesian Economics - 14th July 19
Stocks Market Investors Worried About the Fed? Don't Be -- Here's Why - 13th July 19
Could Gold Launch Into A Parabolic Upside Rally? - 13th July 19
Stock Market SPX and Dow in BREAKOUT but this is the worrying part - 13th July 19
Key Stage 2 SATS Tests Results Grades and Scores GDS, EXS, WTS Explained - 13th July 19
INTEL Stock Investing in Qubits and AI Neural Network Processors - Video - 12th July 19
Gold Price Selloff Risk High - 12th July 19
State of the US Economy as Laffer Gets Laughable - 12th July 19
Dow Stock Market Trend Forecast Current State - 12th July 19
Stock Market Major Index Top In 3 to 5 Weeks? - 11th July 19
Platinum Price vs Gold Price - 11th July 19
What This Centi-Billionaire Fashion Magnate Can Teach You About Investing - 11th July 19
Stock Market Fundamentals are Weakening: 3000 on SPX Means Nothing - 11th July 19
This Tobacco Stock Is a Big Winner from E-Cigarette Bans - 11th July 19
Investing in Life Extending Pharma Stocks - 11th July 19
How to Pay for It All: An Option the Presidential Candidates Missed - 11th July 19
Mining Stocks Flash Powerful Signal for Gold and Silver Markets - 11th July 19
5 Surefire Ways to Get More Viewers for Your Video Series - 11th July 19

Market Oracle FREE Newsletter

Top AI Stocks Investing to Profit from the Machine Intelligence Mega-trend

Your Best Stock Investment in the "Cloud" Is Right Here

Companies / Microsoft May 01, 2015 - 12:13 PM GMT

By: Money_Morning

Companies

Michael E. Lewitt writes: Last week, investors drove up the market valuations of both Amazon.com Inc. (Nasdaq: AMZN) and Microsoft Corp. (Nasdaq: MSFT) by tens of billions of dollars based on excitement over the companies' "cloud computing" hosting businesses.

For both companies, cloud revenues and growth were the catalyst of the big moves.


Indeed, both featured screaming improvements in what are critical segments in their business models….

Amazon Stock Is Rewarded for the Wrong Reasons

But that's where the similarities end. Savvy investors looking for the best long-term investment would be wise to dig deeper into the both company's quarterly results.

Once we do that, the decision on which stock to buy is an easy one.

Amazon's stock price rise came after it disclosed the first financial details about its cloud service Amazon Web Services (AWS), which offers hosting services to Internet startups, video streaming companies like Netflix Inc. (Nasdaq: NFLX), and the Central Intelligence Agency.

AWS's revenues for the first quarter of 2015 were $1.57 billion and its operating income was $265 million, which immediately placed this business segment among the e-commerce giant's most promising businesses from a profitability standpoint.

How do we know that?

Because once again the rest of the company lost money! In fact, Amazon reported a net loss of $57 million for the quarter on $22.7 billion of revenue.

AWS is a wonderful enabler for entrepreneurs that are able to start new businesses and pay very little for hosting services. Fifteen years ago, the system was not designed to handle the voracious appetite for bandwidth that video streaming and the thousands of new Internet-based businesses consume.

In fact, fifteen years ago the cloud did not exist. But today entrepreneurs can capitalize on low-cost storage of their data to build multibillion dollar businesses.

According to John Dinsdale, chief analyst and research director at Synergy Research Group, there are six companies that have annual cloud revenue run rates in excess of $5 billion: Amazon, International Business Machines Corp. (NYSE: IBM), Microsoft, Hewlett-Packard Co. (NYSE: HPQ), Cisco Systems Inc. (Nasdaq: CSCO), and Salesforce.com Inc. (NYSE: CRM).

Each of these can claim leadership in a different part of the cloud, although AWS is the current leader in cloud infrastructure services. With the market growing by almost 50% a year, there is enormous potential for all of these companies to grow their revenues.

The big question, however, is whether they can earn enough of a profit to move the needle on their stock prices in a business where price competition is intense and margins will come under enormous pressure.

The answer for Amazon stock is still very much up in the air.

AWS's results showed that Amazon earned an operating margin of 19.6%, far lower than the 70% to 90% margins that some technology aficionados were touting before the actual results were released.

Furthermore, this operating margin is actually overstated because it excludes stock-based compensation and likely other charges that are buried in Amazon's financials. Rackspace Hosting Inc. (NYSE: RAX), which is a pure cloud hosting company, generates operating margins in the low teens, so Amazon is doing roughly the same.

But if Amazon's history is any indication, profitability is not its endgame. If Amazon has proved anything, it is willing to pay any price to gain dominance in any business. And that price usually spells the destruction of profit margins for competitors and the obliteration of traditional business models.

There is little reason why Amazon should change its spots – it has been rewarded by the stock market with a huge valuation, and the more money it spends and loses, the more investors seem to clamor for its stock. Year to date, Amazon is up an astounding 39% – but two-thirds of that move came before the disclosure of AWS's results.

The Cloud Pays Dividends for Microsoft Shareholders

Microsoft's growing cloud business is running at about $6.3 billion in annual revenues and contributed to the company's 6% year-on-year revenue growth. Most Wall Street analysts were unimpressed with the company's first-quarter earnings despite the impressive performance of its cloud business and Goldman Sachs even reiterated its "sell" rating on the stock.

However, this did not deter investors, who bid up the software giant's stock after the AWS news by 10%, adding $37 billion in market capitalization. Microsoft is twice as large as Amazon – $400 billion market cap vs. $200 billion market cap – so it should take a much larger cloud business at Microsoft to move the needle than at Amazon.

Yet both stocks moved by roughly the same amount in terms of market cap after AWS's results were disclosed. Clearly investors are using something other than logic to guide their actions…

At both companies, it takes enormous leaps of faith (or leaps of something) to justify such large stock moves based on what we learned about AWS.

First, investors had to extrapolate AWS's first-quarter numbers to a full year ($6 billion in revenue and $1 billion in operating profit before stock option and other expenses); second, they had to extrapolate that growth out several years in a business that is already featuring vicious price competition and epitomizes creative destruction.

This is the kind of exponential thinking that got investors in trouble during the dot-com crash 15 years ago.

There is already intense price competition occurring in the cloud computer space. Amazon has been cutting prices like mad and will likely continue doing so. Having already destroyed margins in the retail business, there is no reason to think it will act any differently in this business.

If history is any guide, Amazon can be expected to sacrifice profits to expand its cloud business. Its goal is to be the no. 1 provider of cloud infrastructure services, not to be the most profitable provider of those services. Such a goal would be consistent with its approach to every other business it has entered.

Amazon is like a Rorschach test for investors – some see a business that will someday be able to turn on the profits spigot and earn billions. Others (like me) see a business that requires enormous capital investments without generating significant profits on any reasonable time frame.

Still others could argue that Amazon is creating a wholly new business model for our digital age in which value is measured not based on profits but on other metrics.

Before getting any further carried away, investors should stop and catch their breath. At infinity-times earnings and without a dividend, Amazon stock is grossly overvalued and should be avoided.

Microsoft stock, however, is trading at mid-teens multiple (net of cash) and pays a 3% dividend and is more reasonably priced. The company will continue to grow its cloud business as well as the rest of its very profitable operations that generate enormous amounts of cash.

Source :http://moneymorning.com/2015/05/01/your-best-investment-in-the-cloud-is-right-here/

Money Morning/The Money Map Report

©2015 Monument Street Publishing. All Rights Reserved. Protected by copyright laws of the United States and international treaties. Any reproduction, copying, or redistribution (electronic or otherwise, including on the world wide web), of content from this website, in whole or in part, is strictly prohibited without the express written permission of Monument Street Publishing. 105 West Monument Street, Baltimore MD 21201, Email: customerservice@moneymorning.com

Disclaimer: Nothing published by Money Morning should be considered personalized investment advice. Although our employees may answer your general customer service questions, they are not licensed under securities laws to address your particular investment situation. No communication by our employees to you should be deemed as personalized investent advice. We expressly forbid our writers from having a financial interest in any security recommended to our readers. All of our employees and agents must wait 24 hours after on-line publication, or after the mailing of printed-only publication prior to following an initial recommendation. Any investments recommended by Money Morning should be made only after consulting with your investment advisor and only after reviewing the prospectus or financial statements of the company.

Money Morning Archive

© 2005-2019 http://www.MarketOracle.co.uk - The Market Oracle is a FREE Daily Financial Markets Analysis & Forecasting online publication.


Post Comment

Only logged in users are allowed to post comments. Register/ Log in

6 Critical Money Making Rules