How to Trade the Move to Cloud Computing

01/21/2011 7:07 am EST

Focus: STOCKS

Cloud computing has been all the rage over the past two years, with more doubles and triples, and more home runs than Josh Hamilton hit in the home run derby. Cloud technology has reduced barriers to entry for small businesses by reducing overhead and increased cost efficiency for bigger companies through economies of scale and automation. The growth prospects for cloud infrastructure networking companies are bright despite lofty valuations.

The problem for retail investors has been that, without specialized knowledge of the industry, it is difficult to identify the individual companies best positioned to take advantage of the cloud revolution. Given the often-reactionary nature of analyst recommendations, those are hard to trust, too. Cloud stocks trading at high multiples also carry significant risk. An earnings miss or negative guidance revision can trigger a harsh selloff, as we saw with cloud stocks last fall when Equinix (EQIX) trimmed their earnings outlook.

With tech stocks continuing to lead the market, and cloud-centric stocks the strongest among them, it would be worth considering a vehicle for exposure to the sector. An interesting play to consider is the PowerShares Dynamic Networking Portfolio (PXQ). The fund tracks the Dynamic Networking Intellidex Index. The stocks in the index represent companies that are a part of a technology upgrade cycle that is transforming life and business, including chipmakers, software companies, and cybersecurity protectors.



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The fund, which has 29 holdings overall, is comprised of 50% hardware, 24% telecommunication, 23% software, and 3% industrial materials. The holdings have an average P/E ratio of around 30 and a price-to-book of more than 3.0, both of which are high but not unexpected for a high-growth sector ETF. The top ten holdings of the fund, which comprise slightly less than 50% of the portfolio, are as follows:

  1. VMWare Inc. (VMW): 5.27% of total fund holdings

  2. Juniper Networks, Inc. (JNPR): 4.91%

  3. QUALCOMM Inc. (QCOM): 4.91%

  4. Symantec Corp. (SYMC): 4.74%

  5. F5 Networks Inc. (FFIV): 4.64%

  6. Amphenol Corp. (APH): 4.61%

  7. QLogic Corp. (QLGC): 4.44%

  8. Citrix Systems Inc. (CTXS): 4.36%

  9. Finisar Corp. (FNSR): 4.06%

  10. Acme Packet Inc. (APKT): 3.19%

(Other notable holdings include Riverbed Technologies, Inc. (RVBD), the number-one stock on the IBD 50.)

If you are looking for a balanced vehicle to play the technology upgrade cycle, cloud computing, and networking stocks, consider PXQ. The fund continues to make all-time highs, so the more cautious technical investor may consider waiting for a pullback before buying. With earnings season in full swing, though, that pullback may never come, or it may be harsher than you can stomach.

You may also consider investing in the infrastructure, hosting, and data storage side of cloud, which has been subject to consolidation and takeover chatter over the past year. Among my favorites in that group are EMC Corporation (EMC) (also a majority shareholder in VMWare) and Rackspace Hosting, Inc. (RAX).

By John Darsie of T3Live.com

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