Cloud computing is expected to undergo the next boom, with forecasted market size of $1.2 trillion over the next six years, which is a CAGR of around 20%. Today’s FA Alpha will look at a relatively unknown but critical player in the industry, NetApp (NTAP), to see its potential for growth and profitability.
Over the next six years, the cloud computing industry is expected to reach a massive $1.2 trillion market size, which is a CAGR of over 19%.
This huge market opportunity means investors are looking to get in now to ride this massive tailwind, especially when technology names like Meta (FB) and Netflix (NFLX) have been letting down investors.
When most people think about the cloud, they are focused on the three largest cloud vendors—Amazon’s AWS services (AMZN), Microsoft’s Azure platform (MSFT), and the Google Cloud (GOOGL). While these names directly interface with cloud customers, their other businesses make them an awkward investment for purely cloud exposure.
Furthermore, while one or more of these names may win or take market share over the next decade in the battle for customers, all of them will need to invest in the hardware and software which actually powers the cloud.
This is why names like NetApp (NTAP), which creates both the hardware and software to store and manage all of this cloud data, are so interesting.
NetApp started off as a simple data storage company, but has experienced a stock run over the past five years as it has transitioned into providing both the hardware and the software necessary to run cloud computing.
However, it’s no wonder investors looking at getting into the cloud have consistently looked past NetApp. Over the last five years, NetApp has had an as-reported return on assets (ROA) of between 4% and 8%, barely above the cost-of-capital for the business.
Investors looking at NetApp see nothing but a hardware business which has struggled to make itself relevant in an industry dominated by software names.
However, this thesis of the company is totally incorrect, propped up only by the distorting nature of as-reported accounting. After we remove these distortions and examine the company under Uniform Accounting, a completely different picture of the business emerges.
Over the last five years, NetApp has seen returns climb from these cost-of-capital levels to highs of 23% thanks to investment into both the hardware and software markets of the cloud. This huge inflection in profitability is completely missed using the GAAP numbers.
Thanks to Uniform Accounting, investors can get context into why NetApp has been a consistent winner over the last five years, and see the power of a software transformation in the technology industry.
Investors relying on GAAP metrics to make financial decisions like this are constantly missing out on the true performance of companies across the market, making theme based investing impossible. To learn more about how to gain access to the real numbers for almost 25,000 companies around the world, click here to read about our Uniform Accounting database.
SUMMARY and NetApp, Inc. Tearsheet
As the Uniform Accounting tearsheet for NetApp, Inc. (NTAP:USA) highlights, the Uniform P/E trades at 18.8x, which is below the global corporate average of 24.0x, but around its own historical P/E of 19.4x.
Low P/Es require low EPS growth to sustain them. In the case of NetApp, the company has recently shown a 22% decline in Uniform EPS.
Wall Street analysts provide stock and valuation recommendations that in general provide very poor guidance or insight. However, Wall Street analysts’ near-term earnings forecasts tend to have relevant information.
We take Wall Street forecasts for GAAP earnings and convert them to Uniform earnings forecasts. When we do this, NetApp’s Wall Street analyst-driven forecast is a 39% and 10% EPS growth in 2022 and 2023, respectively.
Based on the current stock market valuations, we can use earnings growth valuation metrics to back into the required growth rate to justify NetApp’s $76 stock price. These are often referred to as market embedded expectations.
The company is currently being valued as if Uniform earnings were to grow by 7% annually over the next three years. What Wall Street analysts expect for NetApp’s earnings growth is above what the current stock market valuation requires through 2023.
Furthermore, the company’s earning power in 2021 is 2x the long-run corporate average. Also, cash flows and cash on hand are about 3x its total obligations—including debt maturities, capex maintenance, and dividends. All in all, this signals low credit and dividend risk.
Lastly, NetApp’s Uniform earnings growth is above its peer averages, and the company is also trading above its average peer valuations.
Joel Litman & Rob Spivey
Chief Investment Strategist &
Director of Research
at Valens Research
The Uniform Accounting insights in today’s issue are the same ones that power some of our best stock picks and macro research, which can be found in our FA Alpha Daily newsletters.