CAN SLIM Winner!!!

Mohamed is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

One of my favorite investment books that really taught me the basics of how the stock market operates when I was just starting to invest is "How to make money in Stocks" by William J. O Neal.

William J. O' Neal's method of investing focuses on finding the highest quality game-changing companies in the stock market, usually trading at very lofty valuations and investing in them at the right moment when they meet certain fundamental characteristics.

He called this approach the CAN SLIM method of investing

The Criteria  

Current earnings:  At least 25% Quarter on Quarter growth and preferably earnings growth acceleration

Annual earnings: At least 25% Year on Year growth and at least 17% ROE

New: New products, New Business Model, New management, New conditions, & preferably New 52 Week High

Supply and Demand: Higher Volume on price gains, The less shares the better, under 200 million shares ideal, higher priced stocks favored

Leader or Laggard: Industry performance leader (Qualitative) and Stock price Performance Leader (Quantitative)

Institutional Ownership: Accumulation by Institutions such as Mutual funds & hedge funds, decent amount of Institutional Ownership.

Market direction: Bull or Bear market sentiment at time of investing.

One Stock that meets all the above criteria is Rackspace Hosting (NYSE: RAX).  The company operates in the exciting field of cloud computing. 

 

Current and Annual Earnings Growth

<img src="/media/images/user_13029/rax-earnings-growth_large.gif" />

RackSpace's earnings has grown like clockwork for the past few years. Its half year results in 2012 is equal to the entire year of 2010, how about that for growth!!! Current growth for the past two quarters were 36% for Q2 2012 and 54% for Q1 2012 over the same respective quarters last year. Annual Earnings Growth had been 59% for 2011 and 48% for 2010 over the previous year. Those are some pretty impressive numbers.

ROE stands at 15% slightly below the 17% that O'Neal looks for, but 15% isn't too shabby considering that the company is growing at a rapid pace and another Cloud Company, Salesforce (NYSE: CRM) is trading at a higher P/S multiple and which happens to have a much larger market cap is producing a negative return on Equity as it is not profitable.

The New Factor 

There are currently three ways that businesses can fulfill their IT requirements:

1. “Do it Yourself,” or DIY. This is the legacy approach to managing IT services, in which a business retains complete ownership and responsibility for ongoing maintenance and management of servers, software, networking equipment,
IT staff, etc. 

2. Outsourcing, where businesses transfer full responsibility for their IT systems, operations, and employees to a third party.

3. Cloud Computing, which is the delivery of IT services on demand, usually over the Internet. Computing power becomes more of a utility such as electricity

Currently there is a strong push from "Do It Your Self" IT and Outsourcing to Cloud Computing due to:

  • Lack of In-House IT Expertise and Equipment
  • Strategic Resource Utilization 
  • Market Acceptance
  • Accelerated Business Creation
Cloud Computing is especially beneficial to the millions of small and medium enterprises (SMEs) who simply couldn't afford the previous two options.

Some believe that the advent of cloud computing will be the 3rd IT revolution, with the arrival of personal computing being the first and the internet being the second.  If that's true then cloud computing companies such as Rackspace will deliver some serious returns over the next few decades such as the companies that were involved in the first revolution, example: Microsoft (NASDAQ: MSFT) and DELL and companies that were involved in the 2nd revolution, example: Amazon (NASDAQ: AMZN), eBay, and Google (NASDAQ: GOOG)

Some of these companies that had previous successes with other technology are also in large part turning to "the Cloud" to continue fueling their long term growth. Amazon has helped in kick-starting the cloud computing industry with Amazon Web Services launched in 2002. Amazon Web Services is one of the fastest growing segments of Amazon and may be one of the reasons among others that the company is trading at an uber lofty 300 P/E ratio while being a $110 Billion Titan-Cap at the same time.

Google has been gaining a lot of traction in the cloud computing sphere ever since Gmail was beta launched in 2004. Google's free Google docs is one of the most recognizable and widely used cloud applications today. Google's web-based premier Business Applications or Google Apps have reportedly saved businesses and other users a ton of money and have clearly intruded on Microsoft's playground which responded by launching the Business Productivity Online Suite in 2010. 

Microsoft whose traditional business model is being threatened by the advancement of the cloud computing industry as we speak is fighting back with Windows Azure, its very own cloud computing platform, and has beenencouraging companies to move existing IT resources off their existing grounded infrastructure and into the cloud. 

Perhaps the poster child for the current popularity and future potential of the cloud computing industry is Salesforce the provider of customer relationship management software over the cloud. The company's stock has been soaring through clouds of its own in the past couple of years reaching a market cap of $21 Billion even though the company is still in the red.

Other than this new and exciting industry which Rackspace is involved in, the company has recently re-branded itself as the open cloud company due to its open-source cloud platform OpenStack.

As for the icing on the cake, Rackspace is trading at a 52-Week and an all-time high portraying the high level of investor confidence in the company.

 Supply and Demand

Rack Space has a low number of shares, 138 million to be exact. The lower the number of shares the less buying it takes to move the stock significantly to the upside.  Interestingly enough, RackSpace has about the same number of shares that Salesforce has.

The Stock has been moving significantly to the upside on steadily rising volume. The stock formed a base bottom at around $45 in July in which trading range was tight and volume thin. Then the stock started moving significantly to the upside, broke out of its trading base, and shot past its previous high of $60.55 on 70% above average daily volume on September the 4th 2012 closing that day at $62. 16

Weekly Stock Chart 

<img src="/media/images/user_13029/graph_large.png" />

Leader or Laggard

Rackspace may not be the biggest company on the block when it comes to cloud computing as it competes with large diversified players such as GoogleAmazon, and Microsoft, but that doesn't mean it isn't an industry leader. 

Rackspace creates a sustainable competitive advantage for itself over larger competitors in four key areas.

  • Fanatical support of customers
  • Singular Focus on providing cloud computing services
  • Portfolio approach to services
  • Commitment to Open technology standard
Delighting customers is a way of life at Rackspace Hosting. The company had 130,000 customers at the end of 2010 that number grew into 172,000 and is currently over 190,000 as this article is being written and the company's churn rates have been negative for the past three years. None of those customers accounted for more than 2% of Rackspace's revenues.
 
Rackspace specializes exclusively in providing computing power over the Internet using dedicated and pooled technologies in contrast to other diversified companies. This specialist focus has allowed us to build a productized set of services that are repeatable,efficient, high-quality and valuable to customers in an ever-changing complex IT environment. 
 
Unlike other companies that merely rent out computer hardware and software to their customers, Rackspace specializes in offering a set of support and managed services on top of raw computing services. This approach positions Rackspace as a mission-critical extension of its business customers' IT departments. Rackspace also happens to be a pioneer in an emerging category, Hybrid Hosting, which combines the benefits of hosted computing on dedicated hardware and on pools of shared resources.
 
Rackspace has helped in achieving market acceptance for cloud computing through its OpenStack open-source cloud computing platform to quell business fears of vendor lock-in and rising prices.

The company's share performance has reflected the qualitative aspects of Rackspace business quite well. Take a look at a 5 year comparison between Rackspace and other companies involved in cloud computing.

 

<img src="http://media.ycharts.com/charts/c592a9abd0186d0f37712e1fd8f8ae5a.png" />

RAX data by YCharts

Institutional Sponsorship

There are 328 Institutional Investors who together own 77% of Rackspace Hosting's shares according to the NASDAQ. That 77% increases to 91% when we include only free float shares. Solid institutional ownership shows the faith of  the so-called "smart money" in the company and should provide the stock with strong support as it reaches new highs.

In addition to the Institutional Ownership, 19% of Shares are owned by Insiders. It's always a good thing when management owns a significant part of the company.

Market direction

Well, we're definitely not in a bear market; however the fiscal cliff may be the one thing on the horizon that can cause a significant correction in the short term.

Foolish Bottom Line:

Rackspace is a CAN SLIM market leader that should be part of any long term portfolio.  


Eliteinvesting has no positions in the stocks mentioned above. The Motley Fool owns shares of Amazon.com, Google, and Microsoft and has the following options: short JAN 2013 $150.00 calls on Salesforce.com and long JAN 2013 $150.00 puts on Salesforce.com. Motley Fool newsletter services recommend Amazon.com, eBay, Google, Rackspace Hosting, and Salesforce.com. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.If you have questions about this post or the Fool’s blog network, click here for information.

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