WCLD: Small Cloud Companies Tread Water Amid Sector Rotation (NASDAQ:WCLD)

Glamor stocks thrived early in 2024. The Information Technology sector and just about anything AI-related soared through mid-February. A rotation then took place under the market’s surface. Value and cyclical industries took charge; Energy and Financials, along with Communication Services, posted the best Q1 sector returns. In all, the Nasdaq 100 underperformed the S&P 500 as relative strength deteriorated among many tech subindustries, including Software & Cloud Computing, over the back half of the first quarter.

I reiterate a hold rating on the WisdomTree Cloud Computing Fund ETF (NASDAQ:WCLD). I see the fund as having a premium valuation, though likely deserved given the fund’s focus on owning companies with high margins and strong top-line growth, while its technical situation remains lukewarm.

Tech Stocks Middle of the Pack Through Q1

According to the issuer, WCLD seeks to track the price and yield performance, before fees and expenses, of the BVP Nasdaq Emerging Cloud Index, an equally weighted Index designed to measure the performance of emerging public companies focused on delivering cloud-based software to customers.

The ETF is used to target exposure to emerging, fast-growing U.S.-listed companies (including ADRs) that are primarily focused on cloud software and services and may replace or complement growth-oriented and technology sector investment strategies. WCLD generally owns high-growth companies, with the potential for better sales growth, margins, and operating leverage.

The fund is about flat on the year, but it has lost some of its size. Total assets under management are now $653 million, down from $735 million when I last reviewed the ETF in Q4 2023. Income investors will shy away from WCLD since it does not pay a dividend, but its annual expense ratio is below that of many of its software-industry fund peers at just 0.45%.

Share-price momentum, as hinted at earlier, is unimpressive, earning the fund a soft C- ETF Grade by Seeking Alpha. While liquidity is strong given average daily trading volume of nearly 400,000 shares, I encourage investors to use limit order since WCLD’s 30-day median bid/ask spread averages nine basis points. Finally, risk metrics have been weak since its 1-year historical standard deviation is lofty at 27%, though the fund’s equal-weight construction approach limits concentration risk.

WCLD plots on the right side of the style box with significant mid- and small-cap exposure. WisdomTree points out that as of March 27, 2024, the ETF has 47% in mid-caps and 14% allocated to small caps. On a forward basis, WCLD trades at a high 37.5 price-to-earnings ratio and sells for 5.6 times sales while its long-term EPS growth rate is near 10%.

Digging into the index the fund tracks, WCLD aims to take advantage of positive disruptions in the tech sector. As the world continues to transition to the cloud, long-term opportunities present themselves through companies engaged in creating the needed infrastructure and associated services with the new way of sharing information and data.

The issuer notes three primary categories of cloud computing: Software as a Service (SaaS), Platform as a Service (PaaS), and Infrastructure as a Service (IaaS). Further advancements in AI and the IoT and ongoing shifts among enterprise software preferences should all be tailwinds for cloud computing stocks. With product advantages of speed, ease, low cost of implementation, efficient software updates, and scalability, companies should continue to invest heavily in the cloud.

For the companies WCLD holds, high recurring revenue, sticky client retention (with longer revenue periods), and lower costs compared to dated information storage and sharing technology, there is a bevy of profitable advantages.

WCLD targets cloud companies with 15% revenue growth over the past two years for new portfolio adds with a 7% requirement for current holdings. The index is not afraid to go small – the minimum market cap is just $500 million which could offer significant upside for investors should US small caps return to favor this year. The equal-weight methodology also results in the fund having a significant SMID bent – that has likely led to its weak relative performance to begin 2024.

WCLD Index Process

Longer-term, WCLD’s ownership of high-margin companies supports a premium valuation multiple. The secular growth story is as strong as ever, particularly as AI becomes a mainstream component of enterprise budgets. Sales growth among WCLD’s components is well above both the Nasdaq 100’s average and that of the S&P 500.

WCLD Targets High-Margin, High-Revenue Growth Companies

WCLD’s current allocation is almost exclusively in the Information Technology sector with modest exposure to Financials, Communication Services, Health Care, and Industrials. A domestic portfolio, the equal-weight strategy ensures that individual positions don’t command a major chunk of the ETF.

WCLD: An Equal-Weight, Tech-Heavy Portfolio

Seasonally, WCLD tends to perform best from May through August, so exercising some prudence with your purchase over the next few weeks is warranted. The seasonal trend has played out so far on the year.

WCLD: Bullish Seasonal Trends May through August

The Technical Take

I expressed concern regarding WCLD’s technical view and momentum in my previous analysis. It turned out that caution was for good reason. WCLD is about flat on the year through March. What’s more, the ETF has potentially printed a bearish false breakout by rallying above the $35 mark at its year-to-date peak in mid-February.

That move also came on a weaker RSI momentum reading. With WCLD now back below the July 2023 and August 2022 peaks, I see the possibility of a further correction to the rising 200-day moving average currently just above $32. What’s encouraging, however, is that the pullback over the past handful of weeks has the hallmarks of a bull flag pattern despite a trendline break. So, there are mixed technical signals here.

Big picture, the ETF remains in an uptrend off its bear-market low from November 2022. A series of higher highs and higher lows, along with the positively sloped 200dma, asserts that the bulls are still in control of the broad trend.

I’d like to see improved RSI and a sustained rally through $37 but cannot rule out the chance of a decline to the long-term trendline – currently near $28. If we see a breakout, then a measured move upside price target of $48 would be in play based on the height of the ascending triangle pattern, added on top of the $35 pivot point.

Overall, WCLD’s chart is mixed with near-term downside momentum within a longer-term uptrend.

WCLD: Bearish RSI Divergence, False Breakout In-Play

The Bottom Line

I reiterate a hold rating on WCLD. Long-term fundamentals and some near-term seasonal trends favor this quantitative, rules-based index fund, but a premium valuation and mixed technicals suggest a cautious approach over the coming months.