On Nov. 4, Cloudflare (NYSE:NET), the cloud software company, released stellar third-quarter results, including revenue that was up 51% year-over-year (YOY). The problem is NET stock already reflects much of the upside available in the stock.
Moreover, even though analysts raised their near-term revenue estimates, their out-year forecasts now show lower revenue numbers. So Cloudflare is growing at a fast clip right now, as many corporations today don’t want the expense of maintaining their own servers and related security.
This also means that within several years competitors will enter the market and start to catch up. Which will ultimately slow Cloudflare’s revenue growth.
Therefore, at $156.25 on Dec. 7, NET stock had a market capitalization of $51.4 billion, according to Seeking Alpha. Analysts now forecast 2023 revenue at $1.18 billion and 2024 revenue is forecast at $1.85 billion. However, this 2024 forecast is down from $2.12 billion, as I mentioned in my last article on Cloudflare.
Where This Leaves Cloudflare Stock’s Value
This puts Cloudflare on a forward price-to-sales (P/S) multiple of 24 times. But, actually, it is really higher than that. This is because we have to use the present value for the 2024 revenue figure.
For example, using a 10% discount rate for three years, the 2024 revenue estimate of $1.85 billion is actually worth 75.1% of that number, or $1.39 billion.
As a result, the real forward P/S figure for NET stock is higher at 37 times, instead of just 24 times. This means that it is much more expensive than before.
So Cloudflare stock may not fall from here. But you can be sure that much of the upside is already “in” the stock price for the next three years.
After all, revenue for 2022 will likely be just $647 million. The market already assumes that by 2024 it will triple to $1.85 billion over the next three years.
A cheaper and reasonable ratio would be 20 times sales on a future value basis. That would lower its market value to $37 billion (i.e., 20 x $1.85b). This is 28% lower than Dec. 7’s market value of $51.4 billion
It also implies that NET stock should be priced at $112.50 based on its Dec. 7 price of $156.2. This is 72% of the price.
Most Price Targets Are Too High
Now when it comes to Cloudflare’s price targets, much of the Street does not agree with me.
Most analysts have a much higher price target for NET stock. For example, TipRanks reports that 15 analysts have written about Cloudflare in the last three months. Their average price target is $208.08 per share. This is 33% over today’s stock price of $156.25.
That price target is also well over my price target of $112.50. However, in the last two months, I raised my price target from $100 to $112.50. So, I guess I am slowly warming up to the stock. However, to my credit, in the same period, the stock fell from $182 on Oct. 21 to $156.25.
What To Do With NET Stock Going Forward
The point is that despite posting excellent earnings for Q3, Cloudflare stock fell since it already reflects much of the potential upside. And even if it doesn’t keep falling, the company may have to “grow” into that high revenue and earnings estimates from analysts.
This means that the stock could end up treading water for a good while as its revenue and earnings catch up with its already high valuation. That is one exception to my view that NET stock could end up falling from here to $112.50.
Assuming this happens, investors will still not make much money at today’s price. Their best bet would be to wait for an opportunity to buy in at a bargain price, closer to my price target of $112.50.
On the date of publication, Mark R. Hake did not hold any position (either directly or indirectly) in the securities mentioned in this article. The opinions expressed in this article are those of the writer, subject to the InvestorPlace.com Publishing Guidelines.