Inside the Epic Collapse That Crushed My Portfolio: Rackspace Hosting, Inc. (RAX)

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Each week, I report the results of the Big Idea Portfolio, a collection of five tech stocks that I believe will crush the market over a three-year period. I’ve done it before; my last tussle with Mr. Market ended with me beating the index’s average return by 13.35%.

Real money was on the line then as it is now, which means any one of the five stocks you see below could cause me a lot of public embarrassment. This time, Rackspace Hosting, Inc. (NYSE:RAX) inflicted the most pain. Shares of the hosting provider are off more than 21% since reporting earnings last week.

Rackspace Hosting, Inc. (NYSE:RAX)Rackspace fell short on both the top and bottom lines. Revenue grew 25% to $353 million while profit improved 17% to $0.21 a share. Analysts were looking for $355.4 million and $0.22 a share, respectively. Stifel Nicolaus downgraded the stock following the report.

Is the sell-off deserved? I’m not so sure. Gross margin has improved six quarters in a row and now stands at 73%. Returns on invested capital came in 16.9% in Q4, up sharply from 15% in Q1 and within spitting distance of the 17.2% in last year’s artificially inflated result.

OpenStack is an open-source toolkit for managing networked computing resources more efficiently. It’s important stuff, and not just for avoiding the sorts of miscues that have seen, Inc. (NASDAQ:AMZN) suffer multiple outages in recent months. OpenStack has allowed Rackspace to introduce a variety of new cloud computing products.

Meanwhile, Rackspace is early in the process of taking advantage of another open-source movement called the Open Compute Project. Facebook Inc (NASDAQ:FB) is a vocal proponent of the movement, which seeks to redefine the way we think of data center hardware in order to make deploying computing power cleaner and more efficient.

At Rackspace, what OpenStack is to software, Open Compute is to hardware. Both efforts promise to help the company boost margins and returns on capital. Investors should love that. Instead, they’re selling to due to a minor miss.  Bad move.

Rackspace’s free fall comes on the heels of a similar sell-off at Riverbed Technology, Inc. (NASDAQ:RVBD). Between them, these two stocks have given back — wait for it — more than 62 percentage points in gains over the past three trading weeks. Any edge I had on Mr. Market is now gone.

Indexes didn’t move much. Only the small cap Russell 2000 improved meaningfully, closing the week ahead 1.04%. The S&P 500 also inched higher, up 0.12%, while the Nasdaq fell 0.06% and the Dow declined 0.08%, according to data supplied by The Wall Street Journal. Here’s a closer look at where I stood through last Friday’s close:

Company Starting Price* Recent Price Total Return
Apple (NASDAQ:AAPL) $416.26** $460.16 10.5%
Google (NASDAQ:GOOG) $650.09 $792.89 21.9%
Rackspace Hosting $41.65 $59.00 41.7%
Riverbed Technology $25.95 $15.84 (38.9%) (NYSE:CRM) $100.93 $175.03 73.4%
S&P 500 SPDR $124.94** $152.11 21.75%

Source: Yahoo! Finance. *Tracking began at market close on Jan. 6, 2012. **Adjusted for dividends and other returns of capital.

Among the other tech stocks making news last week:

1). Intel Corporation (NASDAQ:INTC) announced plans to enter the set-top box business, challenging not only Roku but also Apple TV, the Xbox 360, and Google’s various on-demand TV partners. For its part, the chip maker says it will brings thousands of developers to the effort. Or to put it another way: The revolution won’t be televised. It’ll be streamed.

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