These 7 cloud stock look like good bets in the sector now.
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CNBC’s Jim Cramer gave investors a “quick and dirty” trick that he said can be used to narrow down the best enterprise software stocks on the market.
Cramer talked about “the rule of 40” where a company’s revenue growth and profit margin should add up to 40% or more. Wall Street experts use this rule to determine the tradeoff in growth and profitability, and any stock that doesn’t meet that 40% threshold is a red flag.
After their mini-meltdown last week, Cramer said that now is the time to be “more selective” with cloud stocks and this trick can help investors find winners.
Cramer said that when investors are making decisions about what to buy, “you need to be ruthlessly logical, not emotional… We’re in triage mode, and that means we need to be as objective as possible.” And anything that passes the filter, the host gives his blessing to buy.
“I like this rule of 40 because it recognizes that there are two ways to win,” Cramer said. “The healthiest cloud stocks are either growing very rapidly and losing money or their growth is slowing, but they’ve got increasingly strong earnings.”
When using EBITDA for profit margin, Cramer said that all seven of the stocks in his so-called “Cloud Kings” basket fit the bill. That basket includes Adobe (NASDAQ: ADBE), Salesforce.com (NYSE: CRM), ServiceNow (NYSE: NOW), Twilio (NYSE: TWLO), VMware (NYSE: VMW), Splunk (NASDAQ: SPLK), and Workday (NASDAQ: WDAY).
The group was led by Adobe and Twilio with scores of 68% and 82%, respectively.
On Twilio, Cramer said earlier this year, “You might think that this stock has run up too far too fast, that it’s too hot to handle, but I think it’s the kind of incredible growth story where you rarely get any kind of significant dip, and when you do… you have to pounce.”
And hit a significant dip, this stock has. Twilio was up as much as 72% from the start of the year through July 29. Since then the stock is down -23%, giving investors an attractive entry point.
Morgan Stanley analyst Meta Marshall upgraded TWLO shares Thursday, rating the stock an Overweight and boosting his price target to $130 – 13% higher than the current price.
Marshall noted that Twilio’s “depth of platform and (overall market share) position should help [it] outgrow this marketing,” and added that the company has “a meaningful runway for growth that is being missed in recent pullback.”
As for Adobe, shares took a bit of a hit on Tuesday after soft guidance offset a solid Q3 earnings beat. Much like Twilio, Adobe saw big gains early in the year—shares were up 42% until the end of July—and have since fallen -10%.
In its Q3, Adobe said adjusted non-GAAP earnings came in at $2.05 per share, up 18.5% year-over-year and well ahead of analysts’ expectation of $1.97 per share. Revenue from the company’s Digital Media business, which includes its Creative Cloud and Document Cloud, came in at $1.96 billion, an increase of 22% from a year ago.
“Customers across every industry continue to rely on Adobe to run their businesses, transform how they work, and bring their creative ideas to life as reflected in our record Q3 results,” said CEO Shantanu Narayen in a press release. “We’re excited for the opportunities in front of us and confident in our ability to drive strong top-line and bottom-line growth.”