Cloud stocks are in correction mode — but here's why the pain may only be temporary - The Average Joe

    Cloud stocks are in correction mode — but here’s why the pain may only be temporary

    Victor Lei — Head of Research

    December 16, 2021

    cloud stocks

    December 16, 2021

    Cloud stocks get knocked down again and again — but they keep getting back up. If you’ve been feeling bruised from their beatings — it might only be temporary. Cloud companies fell hard this past month, but we’ve been here before — 6 times in the past 7 years to be precise.

    Why investors love cloud software companies

    Software companies (i.e. Salesforce, Shopify, Asana) — those creating applications accessible over the internet — are one of the biggest and fastest-growing trends of the past decade.

    Beyond their fast growth and massive market sizes, investors love software companies for their:

    • Recurring revenue — Software companies charge on a monthly/annual subscription model — allowing for predictable sales.
    • Scalability — Costs are largely fixed with companies incurring small costs per additional customer i.e. business becomes more efficient with size.

    The cloud industry grew 10x in the past 8 years — with many ups and downs along the way.

    The next down: In the past month, fears of rising interest rates led to many falling 30-50% plus from peaks — overvalued cloud stocks falling the hardest.

    Corrections are common in the cloud industry

    JPMorgan added to the pain by downgrading several cloud companies — including Zscaler, Datadog, Cloudflare and Adobe — for a challenging 2022 ahead.

    The Global X Cloud Computing ETF (NASDAQ:CLOUD) is down 17% from its peak — with most sectors impacted (i.e. e-commerce, cybersecurity and cloud infrastructure).

    Per venture capitalist, Tomasz Tunguz, there’s been 6 corrections in the software industry since 2014 — with one a year between 2018-2021 for various reasons:

    • 2018 — US-China trade war, rising interest rates and slowing global growth.
    • 2019 — US-China trade war and Brexit.
    • 2020 — COVID, rising treasury yields in early-2021 and again in 2021 on rising interest rate expectations.

    During each correction, valuations fell between 30-60% before the market reached new highs within 6-12 months.

    Investors: Nothing is certain

    Last month, top-tier venture firm, Battery Ventures released their 2021 cloud report — viewing cloud’s market size exceeding forecasts and their growth accelerating. They expect:

    • The cloud market to grow to $848B by 2025 — 2.7x its current size, which would still only be 16% of global IT spend.
    • Microsoft (NASDAQ:MSFT), Amazon (NASDAQ:AMZN) and Alphabet (NASDAQ:GOOGL) to control 35% of the market.

    For now, cloud stocks have proven to be unbreakable — but as we’ve seen with all technology — nothing is truly undisruptable.

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