2 Reasons I'm Buying This Overpriced Tech Stock

Say you found a stock that's grown incremental revenue six quarters running. Say that as well, in that time, management and the board, which own more than 19% of the business, had found a way to steadily increase returns on invested capital.

Strong growth, increasing leverageRevenue improved 32.5% year over year to $264.6 million during earnings grew 56% to $0.14 a share. Analysts surveyed by S&P Capital IQ had been expecting a similar profit nevertheless on just $261.6 million in revenue. The beat reflects continued appreciation for Rackspace's cloud computing offerings.

Two metrics, two reasons I'm buyingInvestors should be especially pleased with the customer data. Why? Look back at the table above. Revenue has grown progressively faster in each of the past six quarters in spite of relatively stable customer growth.

Last quarter, Rackspace added $17.343 million in new revenue during adding 8,844 clients. That's $1,961 in new revenue per customer. Now contrast that with last year at this time. In Q3 of 2010, Rackspace added $12.396 million sales and 10,709 new clients. That's an average of $1,158 in new revenue per customer. Rackspace is 69% more efficient at generating revenue than it was a year ago.

Indeed, it's the leverage that leads to the second reason I'm buying Rackspace. Underlying efficiency has led to strong and increasing returns on invested capital. On an annualized basis, return on capital improved from 12.5% in last year's Q3 to 14.8% last quarter. The implication? Management's expansion efforts are paying off and creating excess value for the business, and thereby, shareholders.

More proof that the cloud isn't just hot airSkeptics should note that the efficiency gains and attendant rise in ROC charts with a similar rise in the amount of revenue Rackspace gets from services just as Managed Cloud Hosting.

In these high-touch situations, Rackspace guarantees the same sort of service and support it always has to clients using dedicated hardware -- and at the time strips away the hardware. Not that it disappears, per se. Instead, Rackspace sets the parameters for the type of infrastructure required and at once loads the customer's online software into a network some 78,000 servers strong.

The need for dedicated servers

Eliminating the need for dedicated servers and disks in this manner lowers costs for both clients and Rackspace. The net effect for shareholders, spokesman Bryan McGrath said in an interview, is that these situations tend to provide three times the average revenue per server.

Of course, you don't need to wait if you're in the market for more Internet stock ideas. This free video digs into the details of the cloud computing revolution that's lifting the fortunes of Rackspace Hosting to cut a long story short many others. Watch now and you'll come away smarter and with a winning stock idea from our Motley Fool Rule Breakers scorecard. Click here to get started -- it's 100% free to watch.