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Heed This Market’s Lessons With CrowdStrike Stock

There are a number of reasons why cybersecurity play CrowdStrike (NASDAQ:CRWD) looks like an ‘avoid’ at this point. CRWD stock is extremely expensive, based on both revenue and earnings. Valuation has only expanded as the stock has staged an epic rally from March lows.

cybersecurity stocks
Source: Piotr Swat / Shutterstock.com

But those reasons to look elsewhere — and other aspects of the CRWD story that suggest potential caution — exist, and have existed, for growth stocks across this market. Most have proven not only to be winners, but to have significantly outperformed. It seems unlikely at this point that CRWD stock will be the exception.

That’s not to say the concerns here don’t have some justification. They do. Rather, it’s that the rules of this market suggest CrowdStrike still has upside left. And until those rules change, investors should play by them.

CRWD Stock Is Too Expensive

Admittedly, on its face CRWD looks far too expensive. At a current price of $97, shares trade at a whopping 38x trailing twelve-month revenue. Using consensus earnings per share estimates from next year (fiscal 2022), the price to earnings multiple sits around 500x.

But, again, consider the rules of this market. Calling a stock “too expensive” has been a good way to miss out on gains — or bear losses, if an investor shorts a stock based on valuation. Shopify (NYSE:SHOP) has looked dearly valued at best since it traded below $200. (Indeed, I myself made that incorrect argument.) By the standards of the automotive industry, Tesla (NASDAQ:TSLA) was a clear fundamental sell at $400; it just cleared $1,000.

Obviously, there’s some selection bias at play here. SHOP and TSLA are among the biggest winners in the entire market. And a stock has to run pretty far to get to be “too expensive” in the first place.

Still, those are far from the only examples. Over the past decade — and during the past few years in particular — expensive stocks have continued to rally, while “cheap” names generally have struggled. It’s unlikely that CRWD will be the exception.

There’s another factor to consider. CRWD is expensive on near-term numbers. But the high price-to-earnings multiple is an artifact of relatively thin margins. And the price-to-revenue multiple is going to come down in a hurry.

After all, CrowdStrike grew its top line 85% in the first quarter. Even assuming growth slows in coming years, valuation is going to come down in a hurry. That’s true in terms of sales. And given enormously high margins on added revenue, it will be true from a profit perspective as well.

The Stock Has Run Too Far

Investors might also see recent trading as a concern. CRWD stock has tripled from March lows. Surely, the easy money has been made.

To some extent, that’s probably true: it’s obviously unlikely that the stock will triple again over the next three months. But, again, recent history is instructive.

Investors could have taken profits in SHOP, TSLA, Amazon (NASDAQ:AMZN), Pinduoduo (NASDAQ:PDD), and myriad other winners. Most would have done so too early.

Looking at past prices is known as “anchoring” — and it’s often an erroneous strategy. A stock that trades at $5 isn’t cheap because it used to trade at $30. Similarly, a stock like CRWD that used to trade at $30 — during a panicked reaction to a pandemic — isn’t necessarily expensive at $90.

Here, too, there’s another useful example. CRWD stock didn’t see much of a reaction to last week’s blowout earnings report. The stock gained 6.3% the day of the after-hours release — but fell the next day. It still trades modestly below where it closed on earnings day.

That trading might suggest that the rally into earnings priced in the good news from Q1. But the same could have been said about Zoom Video Communications (NASDAQ:ZM).

That company posted a literally historic earnings report last week. The market mostly shrugged. But a 7.6% rally Wednesday moves the stock back near all-time highs, and sets up a another leg in what has been a huge rally. It wouldn’t be at all surprising to see CRWD follow a similar pattern.

Buy the Business, Not the Stock

From a broad standpoint, focusing on valuation and post-earnings trading ignores the investing strategy that has worked in recent years. And that strategy is simple: buy the business, not the stock.

The best businesses have seen their share prices rally, even with valuation concerns. The cheapest stocks — retail is a great example — have struggled to rally.

Admittedly, to some investors, that strategy is precisely the problem. It’s a sign that “valuation doesn’t matter,” or that the Federal Reserve has distorted valuations in the market.

And it’s possible at some point that strategy will stop being the correct one. Value investing may come back into favor.

In the meantime, however, CRWD stock remains close to a perfect stock for this market. It has a huge opportunity. It’s executing well. Growth is spectacular.

For most names in this market, those attributes have more than offset worries about valuation or a few quiet sessions of trading. I don’t expect CRWD stock will be any different any time soon.

Vince Martin has covered the financial industry for close to a decade for InvestorPlace.com and other outlets. He has no positions in any securities mentioned.

Article printed from InvestorPlace Media, https://investorplace.com/2020/06/heed-lessons-market-crwd-stock/.

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