January 14, 2011 / 2:05 PM / 7 years ago

Analysis: Investors look to cloud for tech stock picks

BOSTON (Reuters) - Jeffrey Saut simply looks up to remind himself which tech stocks will be hot in 2011.

Saut, chief investment strategist for brokerage Raymond James, says he is betting on companies that are leaders in cloud computing -- using Internet technology to move computers and information away from desktops and into remote data centers.

Despite the surge in cloud computing stock prices last year, investors are expecting an encore in 2011 as the revenue growth for these companies rises faster than the broader technology landscape.

Will Danoff, who manages the $72 billion Fidelity Contrafund, is among the most closely watched investors who has embraced the cloud. He says that the cloud is one of his investing strategies for 2011 because he expects companies that sell into the sector to outperform the broader market.

IT research firm Gartner estimates that companies that sell software as a cloud-based service will see revenue growth accelerate this year, climbing 16.2 percent. Last year sales grew an estimated 15.7 percent.

The sector is drawing attention because its sales are revving up just as growth in overall technology spending is on the decline. Gartner sees worldwide tech spending growth slowing to 5.1 percent this year, down from 5.4 percent in 2010.

Buyout speculation on cloud computing leaders sent valuations in the sector to nosebleed levels last year. Cloud pioneer Salesforce.com Inc trades at 122 times next year’s average forecast for earnings per share, compared to a ratio of 13 times for tech blue-chip IBM.

Oracle Corp Chief Executive Larry Ellison last year told Reuters that he looked at buying Salesforce, but that its CEO, Marc Benioff, wanted too much money for the software maker.

Reuters also learned on Wednesday Ultimate Software Group Inc could be the next to go on the block. Ultimate said it has “no present intention” to sell itself.

MOMENTUM PLAY

Some investors are nervous about the high valuations commanded by cloud computing companies, whose volatile trading has led to precipitous declines on some days last year.

But there is simply too much momentum behind the sector to falter this year. “It will probably still emerge as a leader,” said Steve Goldman, market strategist at Weeden & Co in Greenwich, Connecticut.

The optimism on the sector is underpinned by the belief that companies behind them are fundamentally reshaping the way businesses use technology, investors and analysts said.

Cloud leaders like Salesforce.com sell their software through web browsers, saving customers the expense and time of buying and maintaining expensive computer servers.

When Benioff founded Salesforce more than a decade ago, his goal was to make running software for managing corporations as easy as using Amazon or Ebay.com Inc to buy goods. Industry analysts say that to a great extent he has succeeded.

Besides ease of use, cloud computing saves money by providing huge economies of scale. It offers businesses centralized software, storage and computing services that are less expensive to procure. That model is somewhat similar to the one that online retailers like Amazon use to provide discounted goods to consumers.

Raymond James is betting on that the model will work.

Saut says his company estimates that embracing the cloud will shave some 30 percent off his company’s annual IT budget, which runs at about $170 million per year.

TOP PERFORMERS

The big names in cloud computing also rank among last year’s top-performing stocks: VMware Inc, which sells software to build clouds, saw its shares more than double in 2011. Salesforce.com, which sells software that workers access over the Internet from web browsers, soared 80 percent.

NetApp Inc and EMC Corp, which both sell equipment for storing data in the cloud, were also top gainers in 2010.

Wall Street analysts say they are constantly peppered with questions from portfolio managers eager to profit from the surge in popularity of cloud stocks.

Industry analysts say that cloud computing projects tend to generate quick returns on investments, which means that companies are able to quickly recoup the money they spend on the projects and see tangible benefits to their businesses.

That resonates with Fidelity’s Danoff, who holds cloud players including Google Inc, Amazon, Salesforce, NetApp and Citrix Systems Inc.

Quick and demonstrable returns on investment mean that it is easier to get chief financial officers and chief executives to approve budgets for projects, Danoff said.

“CFOs and CEOs will say ‘Yes Mr. CTO, this is a good thing. We’re going to save money by spending money,'” Danoff said.

Additional reporting by Ross Kerber and Noel Randewich, editing by Dave Zimmerman

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