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3 Overvalued Cloud Stocks to Avoid in February

With mounting pressure to achieve greater business agility to meet changing customer needs, businesses increasingly see cloud computing as core to their operations. While the trend should help cloud service providers thrive, the skyrocketing rally of some cloud stocks since the onset of the COVID-19 pandemic has led to the current overvaluation of many names. With little certainty of further upside, we think stocks such as Twilio (TWLO), Datadog (DDOG), and Fastly (FSLY) could be due for a pullback and as such it is wise to avoid these stocks for now.

Cloud computing usage has accelerated amid a fast-paced digital transformation triggered by the COVID-19 pandemic. In addition to adopting a remote working model, many enterprises have increased the online presence of their products and solutions to serve customers remotely. The trend has helped the shares of cloud solutions providers race skywards , as is evidenced by First Trust Cloud Computing ETF’s (SKYY) 62.4% returns over the past year. Because most cloud stocks are trading at premium valuations currently, uncertainty is now creeping into whether there is further upside  in some of these stocks. Moreover, headline data breaches and cyber-attacks in recent months has led to an increase in  legal actions and financial penalties for many cloud companies.

Twilio Inc. (TWLO), Datadog, Inc. (DDOG), and Fastly, Inc. (FSLY) are three cloud computing solutions providers that are trading at premium valuations, but we think their  current and expected financials do not support their valuations.  Consequently, we expect these stocks  to see limited to no gain  in the upcoming months.

Twilio Inc. (TWLO)

TWLO is an international cloud-communications Platform-as-a-Service (PaaS) company. Its services include  its Programmable Communications Cloud, Super Network, and Business Model for Innovators, which enable developers to build, scale and operate communications within software applications.

In late September, TWLO announced the launch of Microvisor, an IoT connectivity and device management platform that offers embedded developers a place to build connected devices and manage them. Earlier, in November, TWLO acquired Segment, a market-leading customer data platform, for $3.20 billion in  TWLO class A stock.

Despite these developments, however, TWLO’s loss from operations has increased 18.6% year-over-year to $112.27 million in the third quarter ended September 30. Its net loss increased 33.3% from its ear-ago value to $116.91 million, resulting in a loss per share of $0.79, a  23.4% increase over the period.

Analysts expect TWLO’s EPS to decrease 300% year-over-year to a negative $0.08 in the about-to-be reported quarter (ended December 31, 2020).

The stock has gained 214.6% over the past year. In terms of forward its non-GAAP p/e, the stock is currently trading at 3236.2x, which is significantly higher than the industry average of 26.98x.

TWLO’s POWR Ratings are consistent with this bleak outlook. The POWR Ratings are calculated by considering 118 different factors with each factor weighted to an optimal degree.

The stock has an overall rating of D, which equates to Sell in our proprietary rating system. TWLO has a grade of D for Stability, Value, and Quality. It is currently ranked #11 in the D-rated, 13-stock Software - SAAS industry.

In total, we rate TWLO on eight different levels. Beyond what we stated above, we also have given TWLO grades for Momentum, Sentiment, and Growth. Get all TWLO’s ratings here.

Datadog, Inc. (DDOG)

DDOG develops and markets analytics and monitoring platforms for developers, IT teams, and business users. The  platform integrates and automates functions such as log management, application performance monitoring, and infrastructure management.

Despite a 61.3% increase in revenues  to $154.68 million in the third quarter ended September 30, 2020, DDOG reported an operating loss of $9.27 million. Its net loss increased 264.1% from its  year-ago value to $15.15 million. Its loss per share was  $0.05. Analysts expect DDOG’s EPS to decrease 33.3% year-over-year to a $0.02 in the about-to-be reported quarter (ended December 31, 2020).

The stock has gained 151.3% over the past year. In terms of trailing-12-month non-GAAP p/e, the stock is currently trading at 604.74x, which is significantly higher than the industry average of 27.31x. But the stock's valuation does not seem any more attractive based on its earnings outlook. Many experts argue that DDOG might not be able to sustain its frothy valuation for the long term because the stock  poses more risk than reward.

DDOG’s poor prospects are apparent in its POWR Ratings. The stock has an overall rating of D, which equates to Sell in our proprietary rating system. DDOG has a grade of D for Growth, Stability, and Value. In the 60-stock Software - Business industry, the stock is ranked #47.

Click here to see the additional POWR Ratings for DDOG (Momentum, Quality, and Sentiment).

The POWR Ratings are calculated by considering 118 different factors with each factor weighted to an optimal degree.

 

Fastly, Inc. (FSLY)

FSLY is a real-time content delivery network (CDN) company. The company provides delivery, security, streaming media, e-commerce, and private CDN services. With FSLY, users can manage traffic spikes and mitigate security threats. It operates an edge cloud platform for its primary business services and works with Alphabet’s (GOOG) Google Cloud Platform to extend infrastructure and application logic to its users.

FSLY witnessed accelerated growth in enterprise customers during the third quarter ended September 30, 2020. Its total number of customers increased 4.9% year-over-year to 2,047 over the period. However, lower-than-expected usage by its largest customer, TikTok owner ByteDance, was a  headwind during the quarter. Though the company believes that there is a possibility that some of ByteDance lost usage could return, it would be unwise for  investors to count on that. FSLY went public in May 2019, and the stock returned nearly 437% over the past year. However, the company is still unprofitable and its loss per share has widened in each of the trailing four quarters. The consensus loss per share estimate of $0.09 for the current quarter ending March 31, 2020 represents  a 50% increase year-over-year.

In terms of price/sales, the stock is currently trading at 43.37x, which is significantly higher than the industry average of 9.16x.

FSLY’s POWR Ratings are consistent with this dour outlook. The stock has an overall rating of F, which equates to Strong Sell in our proprietary rating system. FSLY has a grade of F for Value Grade, and D for Stability and Sentiment. It is currently ranked #76 in the C-rated, 1-stock Technology - Services .

We also have given FSLY grades for Growth, Quality and Momentum. Get all FSLY’s ratings here.

The POWR Ratings are calculated by considering 118 different factors with each factor weighted to an optimal degree.

 

 

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TWLO shares were trading at $400.75 per share on Monday morning, up $0.69 (+0.17%). Year-to-date, TWLO has gained 18.39%, versus a 4.19% rise in the benchmark S&P 500 index during the same period.



About the Author: Rishab Dugar

Rishab is a financial journalist and investment analyst. His investment approach is to focus on quality stocks, trading at low prices, with business models that he readily understands.

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