2 oversold cloud stocks to buy in the Nasdaq bear market
Jthere is no nice way to dress it. It’s been a lousy year for tech investors.
The technology managers Nasdaq Compound has fallen 29% since hitting an all-time high last November. Even those of us who have invested long enough to remember the dot-com crash at the turn of the century continue to rub our eyes in disbelief.
This time around, shares of already profitable companies in the booming cloud services sector have been hit hard, even though they are in a high-growth sector. Technological research specialist Gartner estimated global spending on cloud services at $411 billion last year and expects that figure to reach $600 billion in 2023.
Last year, when trading at high valuations, these cloud stocks looked like smart buys as their business grew at a blistering pace. They continue to grow, and now that their stock prices are down 40% or more from their previous highs, they look like screaming buys.
Most Americans think Amazon (NASDAQ: AMZN) as an e-commerce business, but that’s not how it makes the most money these days. In the first quarter of 2022, service revenues actually exceeded product sales. Profit margins for cloud services are typically much larger than margins in the e-commerce space.
In 2020 and 2021, Amazon has invested heavily to effectively double the size of its distribution network. Now that most of us can shop in person again, that vast network of warehouses resulted in a net loss of $3.8 billion in the first quarter, which would have been much worse had Amazon Web Services not had not contributed to an operating profit of $6.5 billion.
Amazon’s e-commerce business has suffered minor losses due to its rapid expansion in the past, and I think it’s only a matter of time before it becomes very profitable again. At recent prices, the stock is trading at just 2.4 times sales, compared to more than four times sales at its peak last year. With higher-margin revenue coming from its cloud services business, earnings could soar in 2023 and take the stock to new highs.
While Amazon remains the go-to cloud service provider for established businesses, these services aren’t always accessible to individual developers, data scientists, or hobbyists. DigitalOcean (NYSE: DOCN) lets anyone with a credit card start building their own apps for $0 a month.
By enabling access to powerful tools for almost nothing, DigitalOcean cultivates a large audience of developers. The company’s customers may start out small, but many have grown with the amount of revenue they contribute. First-quarter sales increased 36% year over year to $127 million. With around 84% of customers spending less than $50 per month, it’s clear that most small developers stay small.
DigitalOcean is a great stock to buy now and hold for the long term, as individual customers running serious app-centric businesses are highly unlikely to switch vendors. We can see this playing out in recent results. In the first quarter, the company reported a net dollar retention rate of 118% for customers who spend more than $50 per month.
In the first quarter, average revenue per user jumped 28% year over year to $68.90 per year. It may not seem like much, but it’s already enough to generate strong profit margins. In 2022, the company expects free cash flow to reach approximately 9% of revenue.
With an army of individual developers building apps, this company’s cash flow could skyrocket in the years to come. At the moment, you can buy shares of DigitalOcean for only nine times the sales. This is a very attractive price for a company with a demonstrably profitable business model that is growing its revenue by around 35% per year.
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John Mackey, CEO of Whole Foods Market, an Amazon subsidiary, is a board member of The Motley Fool. Cory Renauer holds positions at DigitalOcean Holdings, Inc. The Motley Fool holds positions and endorses Amazon, DigitalOcean Holdings, Inc., and Unity Software Inc. The Motley Fool has a Disclosure Policy.
The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.