What is Cloud Computing?

Despite fears to the contrary (or perhaps because of them), 2010 has so far been a pretty good year for investors—especially the last few months. Stocks in a lot of sectors—retail, automobiles, banks—recovered from their recessionary lows, creating plenty of profits for smart investors. But there were also new stocks that rose to new highs, thanks to growing companies and new ideas. Some of the most impressive performers in this category were (and are) the cloud computing stocks. And as the stocks rose and made investors money, cloud computing became a familiar term on Wall Street. In fact, it gained a special cachet, lending some magic to any company it was attached to—not unlike the effect of the words dot.com in the 1990s.

But, like dot.com—and like web 2.0, synergy, and any number of buzzwords before them—many of the people championing cloud computing companies couldn’t actually give you a concise explanation of what it means. You’ll hear a lot about moving things to or doing things in “the cloud” … which conjures up a nice fluffy image, but doesn’t tell you much.

A lot of explanations only make things cloudier, if you’ll forgive the pun. IBM’s cloud computing site has nice pictures of bright fluffy clouds but says, “Cloud computing provides enterprise IT delivery flexibility for hybrid environments including development and testing of applications.” Oy vey.

It’s unfortunate that there are so many bad explanations of cloud computing out there—because it’s really not that complicated. I think a lot of the confusion comes from the name, cloud computing. It sounds pretty cool, and it gets people to invest a lot of money, but it doesn’t really tell you anything. A much clearer, but more boring, name would be Internet-based computing. Because that’s all it is.

The cloud is basically a new word for the Internet. (I don’t know why we needed a new nature-based metaphor, when “web” was working just fine.) In fact, the Wikipedia entry on cloud computing begins: “Cloud computing is Internet-based computing.” It continues:

“Cloud computing is Internet-based computing, whereby shared servers provide resources, software, and information to computers and other devices on demand, as with the electricity grid.”

The main difference between cloud computing and the alternative is that things that would otherwise be stored or processed on your local computer are instead stored or processed on someone else’s. And that other computer is a server (a computer specialized to serve other computers, like yours) and it’s somewhere that is not your office—possibly it’s not even in your state.

Cloud computing can refer simply to storing data off-site, on servers in the cloud. You probably store most of your data (photos, documents, lists of contacts) on your own computer, and sometimes it gets full, and you need to delete some stuff—or get a bigger computer. Up until recently, the same was true for most companies—they stored all their own customer data and all their own documents on their own servers. When they were full, they had to buy more, and if one failed, they lost data.

The other major reason companies needed their own servers was for hosting their websites or other content online. For web-based companies, buying, powering and cooling all those servers could cost a mint.

Then two things changed. First, the Internet got faster, making it feasible to store your data or host your services farther away from your office or your customers without creating a bunch of headaches. Second, virtualization was developed.

Virtualization is a broad term for creating a virtual, rather than physical, version of something. It can be used to create multiple small “virtual servers” on one large physical server. It can also be used to make multiple servers act in concert, as one really powerful virtual server.

What virtualization combined with the faster Internet meant was that companies no longer needed to own rooms full of servers. They could rent a virtual server in some remote location and store their data and host their website there. The beauty of it is that a virtual server can expand and shrink as necessary—when there’s high traffic on your website, your virtual server might be using the processing power of multiple physical servers. When things are quiet, your data can share space and processing power with other virtual servers on a single physical server. And you’ll never notice a difference. (Plus, all your data is backed up in multiple physical places, so if one server fails, you won’t lose anything.)

There are several companies that rent virtual server space; but Rackspace (RAX) and Amazon.com (AMZN) are the major public ones. Rackspace and Amazon have both been recommended by multiple newsletters, and in the Dick Davis Investment Digest, recently. Both stocks are in strong uptrends, and could be bought here. They’re popular (especially Amazon.com) and thus not without risk, but both may still have plenty of upside.

So far we’ve discussed two uses for cloud-connected virtual servers: storage and hosting websites. But as cloud-based storage and hosting became more popular, some visionaries realized the cloud could be used for a lot more than server space. And along came cloud-based applications.

Companies offering cloud-based applications have generated a lot of the profits in the cloud computing sector this year. The most well known is probably Google (GOOG), although no one describes it as a cloud computing company. But think about it: If you use Gmail, Google Calendar, Google Reader or Google Docs, you’re using a Google application. But none of them are software running on your computer. There’s no Gmail icon to click on. They run on Google’s servers, and your emails, appointments or documents are stored on Google’s servers, and you access them from your computer. That’s cloud computing.

One of the other well-known cloud-based application companies is Salesforce.com (CRM), which offers cloud-based Customer Resource Management (thus the ticker symbol) applications. I don’t have any firsthand experience with CRM software, but a lot of companies use it, and they’re not going back to the old model of computing.

Salesforce.com’s CRM applications were the first to show what cloud computing could offer. Other cloud computing applications are just now getting off the ground. Microsoft (MSFT) has thrown itself into the space, launching its own cloud computing platform, Windows Azure, and docs.com, an online version of its office suite. SuccessFactors (SFSF) provides cloud-based Business Execution Software that helps corporations improve productivity by tracking lots of data.

And all four stocks look pretty good. SuccessFactors has not yet been recommended in the Digest, but I have seen it in other newsletters. It was recommended in the Cabot Top Ten Weekly on December 6, when Editor Michael Cintolo wrote:

“The firm delivers its software through the cloud (so it’s easily updated and customizable), and also sells it on a subscription basis, so the earnings numbers … are misleading—while earnings were about breakeven in the third quarter, cash flow from operations was about 17 cents per share. More important, bookings last quarter hit a whopping $65.9 million (about one-third of trailing 12 months sales), and management sounded an optimistic tone on the conference call. We can’t say it’s unique or revolutionary, but SuccessFactors has carved out a great and growing niche. SFSF came public in late 2007 and tanked with everything else during the bear market … and also rallied with everything else for much of 2009 and early 2010. Then came a sound, sideways consolidation; even as the general market corrected 15% to 20% during the spring and early summer, SFSF refused to give up much ground. And since the market got going in September, shares have been moving steadily higher—the stock, in fact, is up 15 of the past 16 weeks, a sign of steady accumulation. We think any pullback of a point or so is buyable, with a stop around 26.”

Microsoft was recommended in the Dick Davis Dividend Digest back in June; it’s only gone up a little since then, but it has made two dividend payments and currently yields about 2.30%. If steady growth and even steadier income sound good to you, Microsoft is the way to go.

Then there’s Salesforce.com. CRM was featured as the Spotlight Stock in the Investment Digest back in September, 2009. Back then it was trading at 51.10. The recommendation, from Cabot Stock of the Month Editor Timothy Lutts, said:

“Salesforce.com won’t be the hottest stock; the company is just too big. But Salesforce.com is very well managed, and in our mind its leadership in cloud computing gives it a fundamental advantage that should translate into growing market share gains and steady revenue flows for years to come. Recommendation: BUY.”

Well, it may not have been the hottest stock, but it has gone up 157% since then.  And it was recommended in the Digest again on October 6 of this year, this time by Louis Navellier, ditor of The Blue Chip Growth Letter. And it’s gone up 20% since then. Last week, Navellier wrote in a follow-up:

“Salesforce.com hosted the Dreamforce Cloud Computing conference in San Francisco this week. Over 30,000 people attended. At the conference, the company announced several big projects in the works. The company announced a new partnership with BCM Software. The two will work together to produce a new cloud-based IT service management and support system, known as RemedyForce. This marks the first time Salesforce.com will be working with another company to launch a new product line and its first attempt at IT organization. Another significant move for the company is its acquisition of Heroku, an open source, Ruby-based application development platform. Heroku is considered by many as the leading cloud platform in the Ruby market. The acquisition of Heroku supports Salesforce.com’s new initiatives to become a stronger platform company. Also at the conference, Salesforce.com announced that they would be expanding its social media network, Chatter, by offering a free public branch of the site. The company has also launched a new stand-alone website, Database.com, that offers a more democratized developing application effort. Salesforce.com’s many innovations all fall into its wider plan of enhancing its social media applications department. The company is trying, and making great efforts, in keeping big-name companies like Microsoft and Oracle out of the cloud computing market. With so many exciting efforts in the works, I believe Salesforce.com will show some great movement in coming months. The stock has already gained 27% since I first recommended it in the October Issue!”

So, is CRM a good buy here? Probably not. Investors Intelligence recorded a bearish point-and-figure chart signal for the stock on December 14, and Cabot Stock of the Month sold it in October (for a 113% gain.) I think it’s time to look for the next Salesforce.com. You could try SuccessFactors if you’re game.

Finally, there’s Google, the 800-pound gorilla in every discussion of tech stocks. A lot of investors shy away from GOOG because of its $600 price tag. But they shouldn’t. Nathan Slaughter’s MarketAdvisor newsletter currently holds four shares of GOOG (compared to his 50-100 share positions in most other stocks) and has made a 104% return on those four shares in the last two years.

So, is GOOG a good buy at $600?

Nathan still gives the shares a “catalyst rating” of 5, his highest, and they’re still almost $100 away from his price target.

One value investing letter recommends holding GOOG until it hits a minimum sell price of $887!

Another analyst recently wrote “In the big picture, Google’s shares aren’t the bargain they were when I recommended them in July, but the stock remains a great one for the long term.”

And Investors Intelligence recorded a bullish point-and-figure chart signal for the stock on December 13.

Those are all very good signs. If you decide to buy GOOG, just focus on the amount of dollars you’re investing, not the number of shares you’re buying.

Wishing you success in your investing and beyond,

Chloe Lutts

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