When earnings season comes into full bloom, it gets investors’ juices up as they wait and watch with bated breath for which companies are going to outperform analyst forecasts to propel their stocks higher.
Earnings season typically kicks off the second week of January, April, July and October, with a few early bird reports from some notable tech companies that are leaders in the software sector. There currently are some embedded tea leaves in the software space, namely the pace of information technology (IT) business spending by medium-to-large corporations set to reach the highest levels in five years.
Wall Street analysts carefully track business spending on refreshing and upgrading software that are needed to maintain competitive advantages and reduce long-term costs of running the business. But as the old saying goes, “You’ve got to spend money to make money.” And when the economy is muddling along at a gross domestic product (GDP) growth rate of less than 2.0% of, companies put off spending and will do without until their forward budgets determine the expense for more IT is justified by order backlog.
This economic cycle is no different this time around, with the exception of some major technological advances. The advent of cloud computing has mushroomed into a trillion-dollar global industry and 74% of technology chief financial officers (CFOs) say cloud computing will have the most measurable impact on their business in 2017.
Cloud platforms are enabling new, complex business models and orchestrating more globally-based integration networks in 2017 than many analyst and advisory firms predicted. Combined with cloud services adoption increasing in the mid-tier and small & medium businesses, leading researchers including Forrester are adjusting their forecasts upward.
The best check of any forecast is revenue. Amazon’s first-quarter results show Amazon Web Services (AWS) attained 43% year-over-year growth, contributing 10% of consolidated revenue and 89% of consolidated operating income. Some recent data compiled by Forbes magazine looked at the cloud computing industry for 2017 and further out and forecast a massive multi-year investment theme.
Wikibon is predicting enterprise cloud spending to grow at a 16% compound annual growth rate (CAGR) between 2016 and 2026. Cloud computing spending has been growing at 4.5 times the rate of IT spending since 2009 and is expected to grow at better than 6 times the rate of IT spending from 2015 through 2020. According to the International Data Corporation (IDC), worldwide spending on public cloud computing will increase from $67 billion in 2015 to $162 billiob in 2020, attaining a 19% CAGR.
Gartner predicts the worldwide public cloud services market will grow 18% in 2017 to $246.8 billion, up from $209.2 billion in 2016. Infrastructure as a Service (IaaS) is projected to grow 36.8% in 2017 and reach $34.6 billion.
Software as a Service (SaaS) is expected to increase 20.1% to reach $46.3 billion in 2017. By the end of 2018, spending on IT as a Service (ITaaS) for data centers, software and services is projected to hit $547 billion.
Deloitte Global predicts that procurement of IT technologies will accelerate in the next 2.5 years from $361 billion to $547 billion. At this pace, IT-as-a-Service will represent more than half of IT spending by the 2021/2022 timeframe.
Total spending on IT infrastructure products (server, enterprise storage and Ethernet switches) for deployment in cloud environments will increase 15.3% year over year in 2017 to $41.7 billion. IDC predicts that public cloud data centers will account for the majority of this spending (60.5%), while off-premises private cloud environments will represent 14.9% of spending. On-premises private clouds will account for 62.3% of spending on private cloud IT infrastructure and will grow 13.1% year over year in 2017.
Heading into the teeth of the second quarter 2017 earnings reporting season, already there is strong evidence of profit growth supporting the larger data points noted above. Early results from Oracle Corporation (ORCL) and Red Hat (RHT) handily beat analysts’ estimates that not only corroborate the industry research findings, but also provide investors and traders valid reasons to get in front of other software companies’ earnings reports. Shares of both Oracle and Red Hat spiked 10% on the earnings headlines and I expect similar moves on the parts of other key software stocks that deliver cloud solutions and services based on what is called the ”subscription model,” the other transformation catalyst for the software industry.
Instead of purchasing the latest software upgrade in the form of a floppy disk, companies can simply establish an active account where advanced versions and upgrades can be easily applied to current computer systems and also can be maintained remotely. The subscription model is doing away with the legacy practice of having to own and replace huge on-site clean rooms of servers and hardware that had to be maintained by a large staff of IT technicians.
Knowing full well how volatile tech stocks can be when traded in and around earnings season, it argues well to sell out-of-the-money covered calls on software stocks that spike on bullish earnings news. It is possible to capture 10% in call option premium for a call option contract that expires in 30-45 days. In doing so, a high-performance software stock can deliver 20%, 30% or more per year just in option premium income alone, before capital gains potential is considered.
Assuming there are two to five stocks that fit this profile, anyone with the most basic knowledge of options trading can put together one hot basket of software stocks and sell covered calls against them. Two good things then take place. First, selling calls generates immediate income. Secondly, selling calls lowers one’s cost basis.
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In case you missed it, I encourage you to read my e-letter from last week about the investing picture so far this year.