With very few exceptions, growth stocks are under extreme pressure. For a while, that included Cloudflare (NYSE:NET) stock as well.
NET stock was hitting new all-time highs as recently as mid-November while the rest of its peers were in the gutter. At that point, most growth stocks were down 40% to 50% or more after a painful couple of months.
You could argue that the latter two picks — Nvidia and Adobe — are large or mega-cap stocks exempt from the “growth stocks” moniker.
Regardless though, the point is that Cloudflare was one of the few stocks dodging the growth-stocks bear market, but that observation is no longer true. Down 40% from the Nov. 18 high and we’ve seen a lot of hot air come out of this name.
Does that make it a buy? Well, it’s complicated.
Cloudflare Has Growth But Isn’t Cheap
Cloudflare is a cloud-based company that is generating some pretty impressive growth. There has been much debate about Cloudflare vs. Fastly (NYSE:FSLY) given the work both have done in the edge cloud.
One can argue about the quality of each service, but the growth doesn’t lie. While Fastly sits with out-year annual revenue growth forecasts ranging between 16% and 20%, Cloudflare boasts much more impressive estimates.
Consensus expectations call for 50% revenue growth this year, 37% growth in 2022 and 32% growth in 2023.
The growth investor in me says the stock can only stay down for so long with estimates like this. However, the traditional investor in me pumps the brakes a bit upon seeing the valuation.
Shares currently trade at 68 times this year’s revenue expectations and 50 times next year’s estimate. Conversely, FSLY stock trades at a much more reasonable 13 times this year’s estimates and 11 times 2022 expectations.
To me this feels like the market’s way of betting on Cloudflare to win the edge-cloud. Perhaps they are right, but the valuation certainly gives some pause.
For investors, this is a pain point they have to juggle: Growth vs. valuation.
During a bull market, the valuation doesn’t seem to matter all that much. Investors will bid stocks higher regardless of the cost, as long as the company continues to deliver. In a bear market though, the same is not true.
On Nov. 4, Cloudflare delivered a top- and bottom-line earnings beat and provided an above-consensus outlook for its fourth-quarter sales and earnings. It’s as if the market has completely forgotten about that report, though.
Cloudflare as a business is in a bull market, but NET stock is in a bear market. When that bear market changes, Cloudflare stock should rip.
Trading NET Stock
As the headline alludes to (and to which we just discussed), Cloudflare has a high valuation, but it’s mired in a bear market along with its peers. Bear markets are tough.
The losses compound on each other, not only weighing on our portfolio value but also on our psyche. Making things even more difficult is the not-bear market in the overall U.S. equities market.
The Nasdaq lags the S&P 500, but both are just a stone’s throw from the all-time highs. Not only does that create a sense of frustration as growth stocks badly lag the indices, but it also creates another potential risk. That being that a correction in the general stock market is unlikely to bode well for the already-suffering growth stocks.
The optimist in me wants to believe that NET stock has had a five-wave “ABCDE” correction down to the weekly VWAP measure. That came with a near-test of the 200-day moving average.
The realist in me knows that bear markets can persist for longer than expected and the selling may not be finished yet. Further, while NET stock is down big, it’s down less than many of its peers.
My concern is that the market will want to erase the stock’s earlier fourth-quarter rally — the one that took Cloudflare stock from $110 to $220 in less than two months.
A decline back to this key area would also give us a test of the 50-week moving average. Further, it would equate to a 50% peak-to-trough decline.
That said, when the bear market finally ends in NET stock and growth stocks as a whole, the rally could (and likely will) be violent.
On the date of publication, Bret Kenwell held a long position in FSLY, TTD and NVDA. The opinions expressed in this article are those of the writer, subject to the InvestorPlace.com Publishing Guidelines.