Why the Selloff Can Be a Data Center Stocks Buying Opportunity

DCK Investor Edge

This year has been a bumpy ride for owners of publicly traded data center stocks. So far in 2018, long-term buy and hold investors in the largest data center operators have not been rewarded by that strategy, especially when compared to the last two years.

Nobody knows if last week's scary price correction was a normal part of a bull market or signaled a shift in investor appetite for global equities – especially the growth technology names. A more hawkish Fed (rising interest rates), inflation concerns, China and US tariff spats, and a strong US dollar have created an environment where the major US stock indices (Dow Jones 30, S&P 500, and Nasdaq 100) have all been hammered over the past week or so.

As the year has progressed, however, semi-active investors and traders who have bought the dips in data center stocks have fared much better than those pursuing a simple buy-and-hold strategy. This is because the dips have been relatively sharp, while rebounds have occurred quickly – measured in weeks and months, not years.

Tale of the Tape

The following charts illustrate the situation facing investors just a few weeks prior to publicly traded data center REITs reporting third-quarter results. Note that they only reflect price performance and not quarterly distributions, which paid by most REITs, including the data center ones.

Related:Why Data Center REITs are Facing a Rough Start to 2018

In the unlikely event you happened to buy the largest publicly traded data center operators (Digital Realty, Equinix, CoreSite Realty, CyrusOne, QTS Realty, and Switch) on January 1, 2018 here are the results.

Here’s what the drastic drop over last week’s five trading days looked like:

The last time data center REIT stocks took a beating was in May/June of this year. But investors who initiated or added to positions during that period were rewarded. Of course, last week has impacted the price appreciation in data center stocks:

Except for Switch, which went public a year ago, all May/June purchases were in positive territory prior to last week. Alos, shares of CyrusOne, QTS, and Digital purchased in May are still in positive territory.

Investor Edge

Investing is a marathon, not a sprint. When it comes to your investments, have you done your homework or sought advice from a trusted financial professional? While it would be nice for publicly traded stocks to always increase in value, we all know that is just not going to happen.

Here are some reasons why investors may want to consider a "hybrid" when it comes to accumulating shares of the publicly traded data center operators.

Enterprise Demand

The digital transformation of traditional enterprise is in the early innings, with a long runway for growth over the next decade. Third-party data center operators can provide strategically located space (near populated urban areas), reliable power and cooling, plus secure and convenient connectivity options to access multiple network and cloud providers. This is all at a fraction of the cost (per MW) of having built your own data center on premises.

The ability for enterprises to colocate servers near customers, vendors, and IT services firms and easy access public cloud nodes through physical fiber cross-connects or virtual connections utilizing SD-WAN fabrics all serve to make third-party data center providers attractive and cost-effective.

The option to “land and expand” (contract to take additional space in the same campus over time) and/or quickly spin up servers in another region or continent make trusted data center operators into partners rather than just landlords providing a commodity.

Hyperscale Demand

If you believe hyperscale cloud computing and SaaS providers, social media, growth of big data, and AI, wireless data, 5G and IoT, streaming content, hybrid IT, and outsourcing trends create a long-term tailwind for data centers – it is important to stay the course and maintain an allocation to this growing asset class.

Hyperscale cloud platforms’ data center requirements have grown exponentially over the past 18 months. They often take down massive data halls and entire facilities to satisfy requirements of 6MW to 10MW with data center REITs, 16MW to 32MW, or more.

As hyperscale deployments continue to grow in size and lease duration (now 10 to 15 years), the operational track record and credit quality of the landlord is increasingly coming into play. Publicly traded data center REITs have longer track records, more transparent balance sheets, and better access to equity and debt markets than many privately held competitors.

Hybrid Investing Approach

Data center REITs pay quarterly distributions, which historically have gone up at least once a year. The dividend growth and current yield create a safety net that helps put a floor under share prices and underpin price appreciation over time.

Sector pioneer Digital Realty has led the way, raising its distribution to shareholders every year since its 2004 IPO and growing earnings through the Great Recession. These dividends are one reason a buy-and-hold approach to data center stocks makes sense for investors with a time horizon of years or even decades until retirement.

Consider a Trading Bucket

In a world of online brokerage accounts, it’s never been easier for retail investors to take advantage of a price dislocation. But this flexibility has a downside. Novice investors who bought shares without due diligence may panic and sell when prices fall, as they have this past week.

Taking time to understand company fundamentals, familiarity with management, comfort with the firm's strategy, balance sheet, and earnings growth can give retail investors an edge. It is easy to purchase an additional tranche of shares when there is panic selling in the market – if you already have a plan in place.

Those less expensive shares can be sold for future short-term gains or used to opportunistically add to an existing partial position. This approach can make Mr. Market's wild roller-coaster ride seem more like an opportunity than a “nail biter.”