Jim Cramer's 'quick and dirty' tricks for buying cloud stocks

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01. so tonight we're helping you figure out which cloud stocks to double down on to wheat this and which ones well maybe you got a cut loose some of we know this whole group has gotten a lot cheaper over the past eight weeks but we need a way to distinguish between the high-quality names that have been dragged down by the rotation and the lower quality names that never should have been up in the first place when you make these kinds of decisions you need to be ruthlessly logical not emotional I always try to check the emotions to the door we're in triage mode right now and that means we need to be as objective as possible that's why we've put together a simple screener for the software-as-a-service Docs we're gonna run our whole cloud universe through through these two filters one is fundamentals and one is for evaluation anything that passes both filters well then you got my blessing to buy down here after the big sell-off basically we're doing a quick and dirty analysis of the cloud stocks to separate the wheat from the chaff and this is done by real portfolio managers every single day I want to teach you how to do it at home it's a quick and dirty rule of thumb that Wall Street's been using to assess the enterprise software stocks for ages you know what it's called and I've only heard it once among our guests it's called the rule of 40 and it's quite simple if you're running a software as a service company the rule of 40 you're just above 40 says it's your revenue growth plus your profit margin should be greater than 40 percent if it's below 40 here in trouble again weren't you guys motor we want a simple rule it tells us which of these cloud stocks need to be able to Tatom from our portfolios I like this rule of 40 because it recognizes that there are two ways to win the healthiest cloud stocks read they're growing very rapidly and losing money or their growth is slowing but they've got increasingly stronger knees if a company has a 30% revenue growth and a 20% profit margin it passes the test if it's got 70% revenue growth and then negative 20% profit margin that also passes however if you're only growing in a 50% clip and you got a negative 15 percent margin well I'm way to say it that's 35% combined it falls below our rule of 40 threshold like I said it's a quick it's a quick and dirty way to look at this but this is how venture capital firms and hedge funds and companies themselves like to assess the trade-off between growth and profitability then we talk about every night here now let's put it into practice revenue growth is straight forward remember that's just the sales line but there are a lot of ways you can measure margins some more generous than others because we want to keep it simple we're using the adjusted earnings before interest taxes depreciation and amortization or eBay top margin so who passes a new fails all seven Cloud Kings pass mostly with flying colors Twilio you know what how much should be like Twilio twelve that was the highest scores the companies expect to grow at a 72 percent clip this year further bolstered by a 10% EBIT da so this is our winner okay really terrific adobe comes in second with only a twenty four percent growth weight because it's much more profitable with a forty four percent EBIT dom margin reports this week I think it could be very very good and that's Thursday just you know now after the cloud Kings the quality really starts to drop off our cloud princes Atlassian Koopa software HubSpot New Relic ouch they don't fare as well neither New Relic nor octave makes the cut even before New Relic cubes disappointing forecast this morning they're slowing growth was a problem octa on the other hand is growing in a 41% clip but it's negative nine percent EBIT on margin drags it down