The Safest Way to Invest in “the Cloud” and Earn 5% Yields

The Safest Way to Invest in "the Cloud" and Earn 5% YieldsThere is a big difference between a great company and a great stock. And nowhere is it more apparent than in the high-growth cloud-computing sector. Companies that specialize in cloud services and infrastructure have seen big gains in sales and earnings in the past few years as the trend of outsourcing technology resources accelerates.

But in spite of their impressive gains, cloud stocks are trading with nose-bleed valuations and priced for perfection, making them extremely vulnerable to bad news or weakness in the market. Take Acme Packet, Inc. (NASDAQ:APKT) for example. The leader in cloud-based IP-communications networks has seen sales more than double since 2009, but the company is still unprofitable. Analysts even expect a loss of 10 cents a share this year and 2 cents a share in 2013. This makes the company’s share price of $17 off-the-charts expensive.

The story is much the same for salesforce.com, inc. (NYSE:CRM). There’s no doubt Salesforce is a great company, an undisputed leader in cloud-based CRM (customer relationship management) technology. But analysts are calling for a loss of 9 cents a share this year and a marginal gain of just 18 cents a share in 2013, so the stock trading above $145 a share looks insanelyovervalued.

And that’s just a glimpse of the trend in cloud stocks. Other leading companies are growing sales at an impressive pace, but overvalued share prices makes it difficult to invest with confidence.

That is why I’m such a huge fan of Digital Realty Trust, Inc. (NYSE:DLR), a real estate investment trust (REIT) with a market cap of $7.5 billion that offers investors direct exposure to the growth trend in cloud computing. The company specializes in technology-related real estate, owning and managing facilities that its customers lease to house large data centers, server farms and other technology infrastructure. With a portfolio of 110 properties and more than 21 million rentable square feet, Digital Realty is a leader in cloud services.

Digital Realty traded strong with the market in the first half of 2012, hitting an all-time high in mid July above $80 a share. But shares have since taken a nose dive, falling more than 35% in the past five months. Some of that weakness has been related to general market conditions, but shares have also been affected by some industry headwinds. Digital Realty has lowered its lease commencement guidance for 2012 two times this year as its corporate customers scale back on cyclical information technology spending. Take a look at the drop in the chart below.

The Safest Way to Invest in "the Cloud" and Earn 5% Yields

Although news of slightly slower growth had a big effect on investor sentiment, sending shares sharply lower, it barely registered on earnings. In fact, analysts recently revised earnings expectations for Digital Realty higher, with the current-year estimate climbing three cents to $4.41 per share. The next-year estimate also looks solid, with analysts calling for full-year earnings of $4.98 per share in 2013, a healthy 13% growth projection.

The big dip in shares while earnings and other key financial metrics held steady has created a rare value opportunity in the cloud-computing space. Digital Realty’s forward price-to earnings (P/E) ratio of 14, for example, is a solid discount to its seven-year average of 16. For comparison, cloud peers such as Level 3 Communications, Inc. (NYSE:LVLT), trade at 55 times projected 2013 earnings and Rackspace Hosting, Inc. (NYSE:RAX), trade with a forward P/E of 85.

The recent dip also sweetened Digital Realty’s dividend yield. One of the key features of REITs is that the companies required to pay out 90% of their earnings to their limited partners (shareholders) in order to avoid paying federal taxes. Those earnings are paid out in the form of dividends. Digital Realty also offers a solid stream of income with its outsized 5% dividend yield. The company also has a great track record of boosting its dividend, climbing more than 300% from its inception at 16 cents a share in 2005.

Beyond value and a great dividend, Digital Realty is also a leveraged play in cloud-computing and specialized commercial real estate. The company already boasts a powerful portfolio, but Digital Realty continues to aggressively expand.

On the international front, Digital Realty recently announced it had closed on the acquisition of a three-property portfolio adding 733,000 square feet in the highly lucrative London market. With a hefty price tag of $1.1 billion, the company used a secondary equity offering and credit facility to finance the deal.

Digital Realty has also been active on the domestic front, adding a 286,000 square foot data center and office complex located in Aurora, Colorado for $91 million.

Longer term, Digital Realty management intends to continue to pursuit its growth strategy, currently scouting further global acquisitions in excess of $600 million.

Risks to Consider: Capital spending on IT resources is cyclical by nature. Although that has weighed on Digital Realty in the short run, the long-term trend of growing demand for cloud-related real estate is still well in play.

Action to Take –> Most cloud stocks are priced for perfection, making them highly vulnerable to any bad news or a weak market. That makes Digital Realty incredibly unique in the space, offering a compelling combination of growth, value and income.

This article was originally written by Michael Vodicka, and posted on StreetAuthority.

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