Cloudflare (NYSE:NET) is a great company, but NET stock is very expensive.
Cloudflare trades at $114 per share. That’s a market cap of over $36 billion for a company that expects revenue of $632 million for all of 2021.
I get nervous when stocks start selling for 10 to 20x a company’s revenues. At more than 60x revenue, you can have it. But Cloudflare stock is down 12% in the last week so some will tell you to buy the dip.
To which I ask, “What dip?”
Before getting into the price and valuation of NET stock, it’s useful to talk about what its company does.
Cloudflare sells itself as network protection. Its cloud-based software builds ad-hoc private networks for companies among the public clouds. This also assures fast content delivery to nodes on the network.
Assuring network speed is important for companies with remote workers. Assuring security is even more important. Cloudflare grew out of Project Honeypot, an early effort to monitor internet abuse by attracting bad actors to its internet address. The company then built reverse proxy servers to prevent connections to the bad addresses. The co-founders are now billionaires.
The pandemic exploded demand for what Cloudflare does. This increase is permanent. The market for this kind of protection is expected to reach $4 billion in 2023. Cloudflare is the market leader.
NET stock beat estimates in its second quarter, announced Aug. 5. Revenues of $152 million were up 53% from the previous year, beating estimates by $5 million. The company added 140 large customers and had 1,088 by the end of June. Gross margins were 77%, and cash flow from operations was $7.5 million. Cloudflare wisely invested ahead of future growth, however, creating a net loss of $35 million, 12 cents per share.
What’s NET Stock Worth?
What the value of Cloudflare should be depends on what you are willing to pay for that growth.
Oppenheimer analyst Timothy Horan recently announced that growth is priced too high, and downgraded the stock. As is true in other markets, he also cited competition from Microsoft (NASDAQ:MSFT) and Amazon (NASDAQ:AMZN).
But if your only competition comes from major cloud companies, you don’t have much to worry about in an increasingly multi-cloud world. That’s why our Muslim Farooque is telling readers to buy the dip. He calls Cloudflare an excellent long-term play but worries, like me, about the current stock price.
Our Mark Hake echoes those concerns. Even the latest bullish evaluations, 2023 revenue of $1.09 billion and free cash flow of $218 million, are more than built-into the stock price.
There are companies priced to perfection that continue to rise. Nvidia (NASDAQ:NVDA) is one such company in the hardware space. Shopify (NASDAQ:SHOP) comes to mind in the software space. The dip becomes Godot, and never comes. Bargain hunters are left on the sidelines.
The Bottom Line
It’s possible that once the dip in NET stock comes, it will be a permanent one.
As numbers get bigger, they get harder to grow. As profits arrive, growth investors depart. We’ve seen this with companies like Amazon, which no longer deliver alpha even as the bottom line balloons.
A stock market correction, created by external events like China, American political malfunction or a major inflation scare, could change this equation. A 10% market correction would likely send NET stock down 20% because its valuation is so extreme.
If you have a lot of cash waiting for a crash, then put Cloudflare on the post-crash buy list. If you have big profits in Cloudflare today, take some off the table.
On the date of publication, Dana Blankenhorn held long positions in AMZN, MSFT and NVDA. The opinions expressed in this article are those of the writer, subject to the InvestorPlace.com Publishing Guidelines.
Dana Blankenhorn has been a financial and technology journalist since 1978. He is the author of Living With Moore’s Law: Past, Present and Future available at the Amazon Kindle store. Write him at firstname.lastname@example.org or tweet him at @danablankenhorn. He writes a Substack newsletter, Facing the Future, which covers technology, markets, and politics.