Small-Cap Cloud Software Stocks Trounce the Market
Earnings season is always an exciting time in the market. And during the Q3 2017 season, I’ve been continuing my close watch of cloud software stocks. The growth in many of these companies is just too enticing to ignore, and while several are growing into mid caps (and out of my coverage range), there is also a wave of smaller cloud software stocks and recent IPOs that are migrating in.
The bottom line is that if you’re a growth investor and a small-cap investor, you almost have to be invested in at least a few small-cap cloud software stocks. You can’t afford to miss a bull market, and if you haven’t had any exposure to this group, you’ve missed out on some big gains over the years.
The average annual gain for Software-as-a-Service (SaaS) stocks from 2010 to 2016 was just shy of 30%, versus 11% for the S&P 500! While there’s certainly no guarantee that market-beating performance will continue, the fact that small-cap cloud software stocks are up by around 26% thus far in 2017 means it’s worth paying attention to the trend.
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Here are three that jumped out at me, and are up in value after reporting earnings.
3 Cloud Software Stocks Rallying after Earnings
Cloud Software Stock Winner #1: Apptio (APTI)
As companies around the world use more technology to run their operations, adapt to digital disruptions and integrate technology services (i.e., cloud-based, rather than on-premise, software), the needs of Information Technology (IT) departments are evolving. Like Human Resources and Finance Departments, IT departments need dedicated platforms to run their business. That’s where Apptio, which has a market cap of just under $1 billion, comes in. The company has developed a cloud-based software platform that helps Chief Information Officers (CIOs) manage technology investments, benchmark financial and operational performance against peers, and achieve transparency through the planning and decision-making process.
Management says it’s attacking a $6 billion market. And it appears to be doing a good job. It has roughly 360 customers paying around $400,000 a year for its software.
The company reported a better-than-expected Q3 2017 result last week, which showed revenue growing 15.7% (to $47 million) and EPS improving to -$0.02 (from -$0.16). That result puts Apptio on pace to grow revenue by around 16% this year, quite a bit slower than the 24% rate of revenue growth in 2016. But that anticipated top-line growth rate didn’t stop shares from surging 27% the day after reporting!
The bottom line is that Apptio crushed earnings expectations by $0.08 as gross margins hit an all-time high. Management sees more headroom to grow margins, which means cash flow will keep going up, and the company will likely become more profitable, sooner, than analysts had previously estimated. Last week’s jump means the stock has just broken into a new trading range.
Cloud Software Stock Winner #2: Hortonworks (HDP)
We’re all aware of the growth in digital devices, and how that’s driving a lot more data creation, collection and analysis than ever before. Hortonworks (market cap of $1.2 billion) is on a mission to manage all this data for its customers. It’s differentiated in the big data market by being the only pure open-source provider. Open-source means the software’s computer code becomes available to the client, which Hortonworks believes drives a lot more collaboration and software innovation in its Hortonworks DataPlane Service (DPS) above and beyond what it could achieve on its own.
Given that the company was just founded in 2011 and went public in late-2014, it’s a little too early to tell how big the opportunity is. But Hortonworks is certainly making progress selling DPS. The platform manages, secures, and governs data assets, including data that’s moving, data that’s at rest, and data that resides in multiple environments (i.e., a company with data both in the cloud and on-premise).
Shares surged 8% on Friday after the company beat Q3 2017 expectations by a wide margin. Revenue was up 45% to $69 million (beating by $6 million) while EPS of -$0.24 beat by $0.16. The key takeaways from the quarter were that subscription revenues accelerated by 64% (versus 48% in Q2 2017), gross margins expanded, and first positive cash flow is still expected in the next quarter.
I haven’t yet seen any analyst upgrades, but several analysts have mentioned increasing confidence in the company’s market position and growth potential. That confidence will likely turn into higher prices and higher price targets heading into 2018, provided that Hortonworks delivers on expectations when full-year results come out in a few months.
Cloud Software Stock Winner #3: Callidus Software (CALD)
Callidus popped 12% on Friday after reporting Q3 2017 results that came in ahead of expectations. The company, which specializes in cloud-based sales, marketing, customer experience and enterprise incentive management software, grew revenue by 22.3% (to $64.2 million). EPS of -$0.06 beat by $0.04. Preliminary 2018 guidance was also above analyst expectations, as were Q3 cash flows and profit margins (notice the patterns with the three stocks I’m discussing today!). Callidus has a market cap of $1.9 billion.
One of the interesting projects Callidus has been working on is its just-released artificial intelligence (AI) and machine learning platform, Thunderbridge Augmented Intelligence. This platform takes sales and learning processes and then uses machine learning algorithms to help design actions to maximize profits and sales effectiveness. The company has also formed alliances with the biggest names in software, including Salesforce.com (CRM), Workday (WDAY), Automatic Data Processing (ADP), SAP (SAP) and Microsoft (MSFT).
The company is well-liked by the analyst community, and widely viewed as a best-of-breed software provider for sales execution and sales performance management.
The Best Small-Cap Cloud Software Stock Today
I cover a number of small-cap cloud software stocks in Cabot Small-Cap Confidential.
Each of our stocks must get over several critical hurdles before I’ll include it in our portfolio.
First, the stock has to be a pure-play small-cap cloud software stock benefiting from a long-term growth trend.
Second, it needs to have a great business model.
Third, it must have excellent software products now, and show evidence that more excellent products are coming in the future.
And fourth, it needs to have solid fundamentals, including revenue and earnings growth. I don’t care if it’s profitable right now or not, but there must be a clear path to profitability and positive cash flow.
One of our biggest potential winners will report Q3 2017 results this coming Monday. I’m not predicting that it will rally after earnings, but I do think the long-term potential is massive, especially given that it plays in a huge market and it has a market cap of just $140 million! Plus, revenue is growing by more than 40% a year.
You can find out more, and grab a subscription to Cabot Small-Cap Confidential, here.
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