Cloud Hosting

First Trust Cloud Computing ETF (NASDAQ:SKYY) is the first and only ETF to provide exposure to the fast-growing cloud computing industry. This market segment is growing by leaps and bounds and should do so for several years to come. For example, Amazon (NASDAQ:AMZN) Web Services recently announced that its operating income increased from $580 million in the year-ago quarter to $926 million in the fourth quarter of 2016. Meanwhile, Microsoft (NASDAQ:MSFT) announced that Azure revenue surged 93% year-over-year.

According to research firm IDC:

Between now and 2020, worldwide spending on public cloud services is expected to soar to more than $195 billion. This is double the revenue the industry is expected to generate by the end of 2016.

The share price of SKYY should be in the clouds, right?

Well, no. Despite the great promise for cloud computing, the ETF has not really performed much better than the S&P 500.

In fact, you could get almost the same performance holding the SPDR S&P 500 Trust ETF (NYSEARCA:SPY) with a lot less volatility.

The reason for the mediocre return is because there is a limited number of public companies that are focused specifically on cloud technology. Besides small pure play cloud computing companies, SKYY necessarily holds larger firms involved in the cloud computing space, but they derive much of their revenues from other operations. This minimizes or eliminates any advantage that the themed ETF may have over a broad index. I had a similar problem with Global X Internet of Things Thematic ETF (NASDAQ:SNSR) as was described in this article. Fortunately, being a small investor, I can pick and choose from the holdings of SKYY instead of buying the entire ETF.

One nice thing about ETFs is that the fund provider must, by law, publish the stock holding daily, and this makes the job very easy using Portfolio123, my investment tool of choice.

Using Portfolio123, I devised an investment strategy that significantly outperforms the S&P 500. The model portfolio periodically chooses 5 stocks from the 30 stocks held by SKYY.

The model ranks the stocks based on two criteria: highest 5-year compound annual sales growth and lowest Beta. The model has been live since July 28, 2016 and has outperformed SKYY by a wide margin.

Investors can get access to this model by paying a small monthly subscription fee. Unfortunately, I cannot reveal the 5 picks in this article, but instead, I am going one better, and that is to reveal the one stock from the 5 current holdings that I believe is shooting for the clouds (literally).

The stock is Open Text Corporation (NASDAQ:OTEX).

Why I Like OTEX

OTEX is one of the 5 picks from my cloud computing stock portfolio, which means that the stock has good compound sales growth and relatively low Beta compared to most of the SKYY holdings.

The stock price has risen from under $22 to $33 in the last year, and is now near a 52-week high, while sitting at a support level. The stock appears to be ready for take-off.

OTEX has a trailing twelve month (TTM) Return on Equity (ROE) of 41.7%, third highest of the cloud computing stock universe, higher than Apple Inc. (NASDAQ:AAPL).

Intuit Inc. (NASDAQ:INTU) and International Business Machines Corporation (NYSE:IBM) both have higher ROE than OTEX, but have lower 5-year compound sales growth. In the case of IBM, the 5-year sales growth is negative.

Open Text announced that it would acquire the Enterprise Content Management division of Dell back in September. Since that point in time analysts have been warming up to OTEX, with the average recommendation improving from 2.1 to 1.7 now. Note: 1 is a strong buy.

Likewise, the short interest percent of float has been dropping. It was approximately 3.4% in September and now it is 2.3%. This means that fewer traders are taking a short position in the stock, which is generally considered to be positive.

Based on the above observations, I believe that buying and holding OTEX alone is better than buying SKYY.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Read more from the original source:
Skip The Cloud Computing ETF And Buy This Stock Instead - Seeking Alpha