Cloud computing giant Oracle (ORCL -1.21%) has delivered impressive gains in the past year, rising more than 48% on the market as compared to the 25% gains registered by the Nasdaq Composite index over the same period (as of this writing). Its performance was driven by the fast-growing demand for the company's cloud infrastructure for handling artificial intelligence (AI) workloads.
However, Oracle's rise over the past year has made the stock expensive. It now trades at 45 times trailing earnings as compared to its five-year average earnings multiple of 24.
Even analysts aren't expecting much upside from the stock in the coming year. It carries a median 12-month price target of $205 as determined by 39 analysts covering the stock, a jump of 11% from current levels.
Buying the stock for such limited potential upside given Oracle's expensive valuation may not look like a very good idea. However, there is a chance that it may be able to do better than that and deliver stronger gains to investors in the coming year. Let's look at why.
Oracle's capacity expansion should lead to stronger growth
The demand for cloud infrastructure for AI model training and inferencing has been increasing rapidly. Gartner estimates that the global infrastructure-as-a-service (IaaS) market was worth $140 billion in 2023. The research firm says that this market is set for exponential growth based on the increasing deployment of generative AI applications in the cloud.
Goldman Sachs is forecasting IaaS revenue to grow to $580 billion in 2030. This opportunity has already supercharged Oracle's cloud infrastructure business. Its IaaS revenue in the second quarter of fiscal 2025 (which ended on Nov. 30, 2024) increased 52% year over year to $2.4 billion.
That number could have been higher, but the company faced capacity constraints as the demand for its cloud infrastructure powered by graphics processing units (GPUs) from the likes of Nvidia was higher than supply.
This is why Oracle is focused on significantly expanding its cloud capacity across the globe. The company currently serves 17 cloud regions globally. It plans to expand into another 35 regions across the world in partnership with major cloud service providers such as Microsoft, Amazon, and Alphabet's Google.
And now, management has entered into a joint venture with SoftBank, OpenAI, and the Abu Dhabi-based AI investment vehicle MGX to build 20 AI data centers in the U.S. These parties plan to invest $100 billion initially to build out AI infrastructure, and to take that figure up to $500 billion over the next four years.
Oracle's focus on enhancing its capacity should allow it to corner a bigger share of the massive opportunity in the IaaS market by the end of the decade. The company's fast-growing revenue pipeline indicates that it is on track to deliver impressive growth in the near term as well.
Management reported remaining performance obligations (RPO) worth $97 billion in the fiscal second quarter, an increase of 49% from the year-ago period. This is why analysts are forecasting revenue growth to accelerate from 9% in fiscal 2025 to 12.5% in fiscal 2026. This improvement is expected to filter down to the bottom line as well, with earnings expected to grow 14% in the next fiscal year to $7.03 per share following a 10.7% increase in the current one.
How much upside can investors expect?
We have seen that Oracle's valuation is on the richer side now, following its impressive gains in the past year. The good part is that the company may be able to justify its expensive valuation thanks to its sizable RPO, which is the value of unfulfilled contracts that are expected to be recognized as revenue in the future.
Assuming the company manages to deliver $7.03 in earnings per share in fiscal 2026 and trades at 33 times earnings at that time -- in line with the Nasdaq-100 index's earnings multiple (using the index as a proxy for tech stocks) -- its stock price could hit $233. That would be a gain of 26% from current levels.
So, the possibility of the stock outperforming the consensus price target in the coming year cannot be ruled out even if it trades at a discount to its current valuation. As such, investors looking to add an AI stock to their portfolio can still consider buying Oracle since it seems built for more upside.
