Software stocks are among the most repudiated names in the tech space this year. Not surprisingly, that trend is weighing on cloud computing equities and the related exchange traded funds.
On the other hand, this year’s retrenchment by cloud stocks could bring opportunity with ETFs such as the WisdomTree Cloud Computing Fund (WCLD). Indeed, WCLD, which tracks the BVP Nasdaq Emerging Cloud Index, is enduring its share of weakness this year.
However, if other corners of an investor’s portfolio are holding up relatively well, it can pay to add some risk with assets that recently struggled. WCLD could be a prime example.
“Sometimes, there can be big downdrafts within a particular market segment. It may be easier to add risk in these areas because other parts of your overall asset allocation may be doing well and taking some of the pressure off making a decision,” according to WisdomTree research. “Software-focused cloud computing companies in March 2022 could be one such market segment.”
While cloud stocks have been criticized for being richly valued — arguably a primary drag on the group this year — a case can also be made that punishment of the group on the basis of valuation is too severe. For example, at one point last month, about 56% of WCLD’s components were trading at prices lower than where they were in the months leading up to the coronavirus pandemic.
“More than a quarter of the portfolio weight is in companies that only went public in 2021, meaning they did not have any price history in 2020. All of those companies but one, that is, 24.7% of the portfolio weight, had their closing level on the first day of trading above their closing level on March 18, 2022,” adds WisdomTree.
To be sure, there are cloud stocks that were trading at triple-digit earnings multiples, and this isn’t the market environment for valuations that rich, regardless of industry. In other words, the valuation pullback many investors were waiting for is here, and that could spell opportunity with WCLD.
“It is now much harder to find companies trading at enterprise value to sales ratios above 100 times. While it is impossible to know if the current valuations properly reflect all known risks today, an investor facing cloud computing today likely faces less risk of overvaluation than they did in November 2021,” concludes WisdomTree.
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The opinions and forecasts expressed herein are solely those of Tom Lydon, and may not actually come to pass. Information on this site should not be used or construed as an offer to sell, a solicitation of an offer to buy, or a recommendation for any product.
