9 months ago • 8:39 mins
The cloud offers a solution to a huge number of things. Not only does it provide cheaper, better, and more scalable infrastructure and data storage than anything available prior, but it allows the huge amounts of stored data to be analyzed and used collaboratively to deliver insight and drive innovation. And the market for cloud computing is expected to grow extremely quickly: at a 19% compound annual growth rate (CAGR) over the next seven years. That’s something you can profit from by investing across the two key layers of the cloud value chain.
Cloud enablers are companies that make the hardware components to build and power cloud platforms and their supporting infrastructure. It follows that rising cloud demand will mean increased demand for these components, which should benefit companies in the following five submarkets.
Central processing units (CPUs)
CPUs are the engines that power all the calculations and data processing done on the cloud. The market for CPUs is expected to grow at a 7.8% CAGR between 2021 and 2028, which should benefit key players like Intel and Advanced Micro Devices (AMD).
Graphics processing units (GPUs)
GPUs are capable of “parallel processing” which results in much greater speeds – fast enough to power cloud-based artificial intelligence and machine learning applications. One of the fastest-growing areas within cloud computing, the market for GPUs is expected to grow at a 33.4% CAGR between 2020 and 2027 – which should benefit key players like Intel, AMD, and Nvidia.
Memory storage was one of the earliest cloud applications (think Dropbox). The cloud offers a source of cheaper, better, and more scalable data storage, after all – something that’s becoming even more important as the amount of data created globally grows every year. The market for memory is expected to grow at a 7.0% CAGR between 2020 and 2026, which should benefit key players like Samsung and Micron.
A microcontroller is essentially a scaled-down computer on a single chip. And the rise in the cloud-connected Internet of Things is increasing demand for these chips. In fact, the market for microcontrollers is expected to grow at a 10.6% CAGR between 2020 and 2027, which should benefit key players like STMicroelectronics and ON Semiconductor.
Don’t let all this cloud talk make you think the physical hardware is actually located in the sky: it’s down here on the ground, at large data centers. And the market for these centers is expected to grow at a 9.9% CAGR between 2020 and 2025, which should benefit key players like Equinix and Digital Realty.
The other key layer of the cloud value chain is the solution providers, which are split into two groups: infrastructure providers and software providers.
Cloud infrastructure providers include well-known names like Amazon Web Services, which has 33% of the market, Microsoft Azure with a 20% market share, and Google Cloud Platform coming in with 9%. From an investor’s perspective, an industry dominated by a few big players is more attractive than one with many small players competing against each other. And while the pandemic has accelerated the shift to the cloud, there’s still a long runway of stable growth ahead for the dominant companies – as you can see in the image below. Notice the strong 33% CAGR forecast in China: that should specifically benefit key Chinese cloud infrastructure providers like Alibaba and Tencent.
Software providers are the complete opposite to infrastructure providers when it comes to industry structure: there are over 20,000 software-as-a-service (SaaS) companies around the world, but less than 1% of those are valued at more than $1 billion, according to Capital Group.
This fragmented nature of the market means it’s even more important to conduct in-depth research when trying to identify investment opportunities. A good place to start is by looking at SaaS companies specializing in a particular segment like Salesforce (customer relationship management), Zscaler (security), Adobe (creativity), Paylocity and Workday (human resources), Shopify (ecommerce), Splunk and Palantir (big data), and Zendesk (customer support).
SaaS companies are attractive from an investment point of view: they tend to have high profit margins, generate strong free cash flow, and benefit from good returns on capital invested. That’s because SaaS companies use cloud infrastructure providers to offer their software, so they don’t have to invest in or maintain expensive physical infrastructure. Better still, each additional subscriber to a SaaS business comes with high marginal revenue and low marginal cost, meaning SaaS companies see their profit margins expand as they scale and grow. You can see this with Salesforce’s data in the chart below.
Breaking down the cloud value chain into enablers and solution providers can help you accurately assess investment opportunities and form a portfolio of stocks set to benefit from the fast-growing industry.
One approach you could take is to build a “core-satellite” portfolio of cloud stocks. The core portion can include the companies that make hardware components to enable the cloud, as well as the big tech companies that provide the cloud infrastructure. The satellite portion can include single SaaS stocks of your choosing, based on your in-depth research. Here’s an example of how this could look.
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