Clouds May Soon Part For This Cloud Computing ETF

Cloud computing stocks, particularly those with direct Software-as-a-Service (SaaS) exposure, were hot until investors started recently cooling on frothy valuations in the group.

The SaaS slump has plagued software exchange traded funds, including the Global X Cloud Computing ETF CLOU. CLOU, which debuted in April, resides nearly 11% below its previous high.

However, data suggest the fund has plenty of supporters. With nearly $470 million in assets under management, as of Oct. 11, CLOU is easily one of this year's most successful new ETFs. Additionally, CLOU has been trading modestly higher this month, indicating SaaS stocks could be ready to rebound. The ETF holds 36 stocks, over 58% of which are application software providers.

Why It's Important

Trade tensions with China appear to be cooling and that's important for the trade-sensitive technology sector, but an underappreciated SaaS trait is the group's domestic focus and ongoing growth, the latter of which explains the often high multiples assigned to these stocks, including some CLOU components.

“Largely insulated from trade tensions thus far, SaaS companies continue to achieve high top-line revenue growth in an economic environment where growth is increasingly scarce,” according to Global X research.

CLOU also devotes almost 27% of its combined weight to systems software and internet services companies, giving the fund some added diversity relative to the competing legacy fund in this category.

“Many cloud companies boast high net dollar revenue retention rates, a metric that is now a key performance indicator (KPI) in the broader 'as-a-service' industry as analysts place a premium on recurring cash flows,” according to Global X.

What's Next

Vital to the long-term CLOU thesis are the subscription models many SaaS companies operate and the high switching costs associated with cloud computing offerings. Put simply, the specter of downtime and higher costs associated with switching cloud systems are unappealing to corporate IT departments. That keeps them loyal to SaaS providers they're already working with and that revenue “stickiness” partially explains the high valuations of some CLOU components.

“Calculated as the beginning of period revenue of a cohort of customers + upgrades – downgrades – churn, divided by beginning of period revenue, this metric reflects how attractive and sticky business models tend to be in SaaS,” according to Global X.

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