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Is the much-hyped trend toward cloud computing an investor's ticket to cloud nine?

I'm as leery as anyone else about following an investment crowd, particularly one in technology. And the cloud has drawn a crowd. But it would be a mistake to dismiss this trend as a bubble or a fad.

The cloud offers so many benefits to consumers and businesses that there's still a decade's worth of huge spending as companies try to catch this trend. This should help drive up the stocks of the key companies involved, including Salesforce.com (CRM, news), Apple (AAPL, news), Google (GOOG, news), Microsoft (MSFT, news), Amazon.com (AMZN, news), EMC (EMC, news), VMware (VMW, news), IBM (IBM, news) and Accenture (ACN, news). (Microsoft is the publisher or MSN Money.)

Before we get to the best stocks to buy to invest in the cloud, let's ask simply: What's the cloud?

A mainframe in the air

If you ask 10 experts, you'll get 11 answers, quips Jimmy Lin, an associate professor at the University of Maryland who was recently part of a Google-IBM effort to get universities to better train computer-science students to work in the cloud. After talking with at least 10 experts in the space, I can tell you he's got a point. But it boils down to this:

  • In the early days of computing, people had dumb desktop devices that tapped into mainframes. The big boxes handled the heavy lifting of running software and storing data.
  • Later, computing power shifted to the desktop in the PC revolution -- which made a lot of investors very rich.
  • In a way, with the cloud, we're going back again. Software and storage are moving to a central location, away from your desktop. Thanks to the Internet, this place may now be far away -- on a server farm in another state or country, not down the hall on a business or university mainframe.

One benefit is that you can reach your stuff from anywhere, using a variety of devices. You don't even need to plug in. Another advantage, says David Rudow a tech stock analyst at Thrivent Asset Management, is that pooling resources like massive server farms shared by many companies mean lower computing costs.

Image: Michael Brush

Michael Brush

There's been buzz around cloud computing since 2008, but the trend is still young. There are many ways to slice the market, but by one measure, annual spending by companies on cloud computing will grow to $227 billion by 2020, from around an estimated $18.6 billion last year, according to Forrester Research. A lot of that spending will happen over the next three to five years. Bank of America Merrill Lynch estimates companies will spend $117 billion on cloud computing during that time.

"Over the next three years, most small and medium-size companies will move a lot of their operations into the cloud," predicts Eric Openshaw, a cloud expert and vice chairman at Deloitte. And big companies will keep setting up there, too. "The cloud is one of the most important shifts in technology to happen in a very long time," says Shan Sinha, the group product manager of Google Apps for Business, which offers services that help businesses move to the cloud.

Based on a recent survey of corporate tech managers, Morgan Stanley predicts the workload handled by the cloud will grow 50% a year for the next three years, or twice as much as most investors currently estimate. In other words, investors recognize this is big -- but they underestimate how big.

Most of the money will be spent behind the scenes by businesses using the cloud. But let's start with the segment of the cloud that's most visible to consumers.

The personal cloud

Back in the old days, you had a computer at work and maybe one at home. Music was on CDs. Family photos were in albums on the shelf. Home videos were on tape.

How quaint.

These days, many of us have three or four devices -- a PC, a notebook or laptop, a tablet, a smartphone and perhaps something else. Last year, 124 million adults in the U.S. regularly used at least two devices connected to the Internet, and that will grow to 184 million of us by 2016, according to Forrester Research.

Forrester says this trend has turned the Internet into the 'Splinternet.' Each of your devices probably holds a different collection of music, photos and personal contacts. Wouldn't it be nice to have all that in one place?

Various companies are working on this as they help consumers grab their piece of the cloud.

Apple tried to get an edge earlier this month when it announced the iCloud, which lets users access digital content from any Apple device. Analysts think iCloud will be popular, and it will increase loyalty to Apple devices -- its revenue bread and butter. "Apple is bringing the integration of its platform to a new level," says Goldman Sachs analyst Bill Shope, who has a "buy" rating and 12-month price target of $470 on the stock, from about $320 now.

The business cloud

By now, lots of businesses have begun using the cloud to run key software and store data. "It has really become a part of the DNA of a business," says Phil Garland, a partner at PricewaterhouseCoopers who advises companies on how to use the cloud. The following advantages will drive a continued ramp up in business spending on the cloud over the next several years:

  • Lower capital spending. Before the cloud, companies had to fork over a lot of money for servers and software before they even knew if the equipment would do what they hoped. "Now you can rent computing from Amazon," says Lin. For entrepreneurs, this can dramatically cut a big capital expense. The cloud does this for startup divisions within big companies, too.
  • More agility. When companies rent software and storage space in the cloud, they can quickly add capacity. Openshaw cites the example of Animoto, the online photo album company, which quickly expanded its server base -- to thousands from a few dozen -- after it took off. "That type of elasticity is not available in any (traditional) data center I know of on the planet," says Openshaw.
  • Better data mining. The cloud gives companies "massive computational resources" that would otherwise be tougher and more expensive to get, says Lin. This computing power might help fund managers run complex simulations on options-investing strategies or help pharmaceutical companies crunch drug-study data.
  • Support for the 'digital native.' Increasingly, a lot of jobs are performed "in the cloud." We store work there. We go there to collaborate with co-workers in other cities, when we work from the road or from home, or when companies hire employees who work from remote locations. Forrester calls this the new kind of worker the "digital native."

How do you invest in a cloud?

As with any big tech trend, the cloud can put you knee deep in jargon pretty quickly. Let's sum things up by saying cloud companies typically offer software services (the biggest growth area in the space), platforms where other companies can run their own software, and infrastructure such as massive server farms. Then there are the "enablers" that help companies understand how to use the cloud.

The big players in the space -- tech giants -- do most of the above. Google, for example, is betting that a lot of businesses will want keep things simple by renting their apps. It also has massive server farms to give companies a place to do that.

"The cloud gives companies an easier way to manage all their technology," says Sinha, of Google Apps for Business. "It moves all the hard, boring parts into the sky and makes it invisible." Companies seem to like this. Sinha says Google Apps for Business sales have tripled over the past year. The company doesn't break out numbers, though, so it's hard to know how big an impact it is having on overall revenue growth.

Still, Google's cloud efforts are part of what makes it a buy right now, say analysts. Trading at about $490, down from above $640 earlier this year, Google looks cheap, says Michael Scanlon, a stock analyst at John Hancock Asset Management. Down here, the stock trades for less than 10 times expected earnings, if you take out its $36 billion in cash. Scanlon believes the contributions to growth from cloud computing and mobile search are being overlooked by investors. "Anything that can get people into their ecosystem benefits the wider franchise," he says.

Of course, by attempting to move business computing to the cloud -- and away from the PC -- Google and other cloud providers pose a direct threat to Microsoft, which makes a lot of its money by selling desktop operating systems and business software deployed inside companies.

But don't count Microsoft out, because it has cloud offerings of its own, known as Azure and Dynamics. "Its public cloud offerings polled the strongest of any vendor in our survey," says a recent report on the sector by Morgan Stanley. "Microsoft is likely to gain the most from a broader adoption of public cloud environment."

Besides, as useful and popular as the cloud is, it's not clear the PC is going away. "The cloud won't replace conventional computing, because it is still convenient to have your data and applications on one machine," says Michael Cusumano, a professor at Massachusetts Institute of Technology's Sloan School of Management and author of "Staying Power: Six Enduring Principles for Managing Strategy and Innovation in an Uncertain World." "And remote access doesn't always work well. It may be at least 10 years before we have such ubiquitous broadband wireless connectivity that people will want to give up their desktops or laptops. It may never happen."

Amazon, through offerings called the Elastic Compute Cloud and Simple Storage Solutions, is another major player that provides a combination of software services, and the platforms and infrastructure to run it all.

Getting pure

Unlike these giants, which are involved in a lot of different businesses, several smaller companies represent more-focused ways to invest in the cloud.

Salesforce.com serves as a nearly pure play. It offers software that helps corporate sales teams track leads and sales as well as share developments inside their companies, all from the cloud.

This is a stock that traders love to short, or bet against, mainly because of a rich price of 74 times earnings. But the company has defied such investors. "They own their market. They are taking share," says Rudow, at Thrivent.

On the infrastructure side, VMware plays a big role by selling software that helps cloud providers subdivide servers for private use by customers. "It's like two kids sharing a room, and not knowing it," says Scanlon.

And of course, EMC is a major cloud play because it sells storage devices and the virtualization and security software that make them run. "They have a lot of the key technology. When you are setting up cloud servers, it is hard not to buy something from EMC," says Abhi Gami, senior analyst for the Invesco Van Kampen American Franchise Fund (VAFAX), which has beaten the Standard & Poor's 500 Index ($INX) over the past year.

Among the "enablers," Accenture and IBM stand out as public companies that should continue to get meaningful business by helping companies set up in the cloud.

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Of course, among the big risks here are concerns about the safety and privacy of data in the cloud. Openshaw, at Deloitte, says such fears are overblown. "Security is good, and probably better than what most individual organizations can muster on their own."

Besides, having all your data up in the cloud and not on your laptop can be a blessing, says Google's Sinha. "Your data can't just get up and walk out the door with the device."

At the time of publication, Michael Brush did not own shares of any company or fund mentioned in this column. Brush is the editor of Brush Up on Stocks, an investment newsletter.

Michael Brush is the editor of Brush Up on Stocks, an investment newsletter. Click here to find Brush's most recent articles and blog posts.