Last Week, Cloudflare (NYSE:NET) posted fourth-quarter results and announced an acquisition. Ahead of the report, NET stock traded above $120. That set Cloudflare shares on a “sell on the new” event despite its strong results.
Among the content delivery networks, Cloudflare is a contender. It is in a good position to take market share from Amazon.com’s (NASDAQ:AMZN) Amazon Web Services (AWS) and Microsoft’s (NASDAQ:MSFT) Azure.
That would justify NET stock’s astonishing price-to-sales ratio of 62times.
NET Stock Backs Off
Cloudflare’s share price will depend on the market’s sentiment for Nasdaq. Last Friday, investors sold shares when the stock met resistance at the 50-day and 200-day simple moving averages.
Investors cannot possibly predict when the market panic will end. January 2022 inflation is at 7.5% year-over-year. This is at too high a rate for the government to ignore. Macroeconomic headwinds will hurt software stock valuations in the next week.
The under-performance in NET stock gives growth investors another entry point. The company posted exceptionally strong revenue growth, dollar-based net retention, and record operating cash flow.
Strong Fourth-Quarter Results
Cloudflare posted revenue of $193.6 million, up by 54% Y/Y. For 2021, it reported $656.4 million in revenue, up by 52% year-over-year. Dollar-based net retention was 125%, thanks to strong demand from large enterprise customers. Q4 cash flow of $40.6 million is just a start. In the near term, the company will let free cash flow fall in the negative zone for the next two quarters. It needs to invest in its network. Cloudflare is also redesigning its physical offices in preparation for a post-COVID world.
In the second half of the year, the company will be free cash flow positive again. Cautious investors will mistakenly assume the cash burn adds risks for investing in this technology company. The opposite is true: Cloudflare must leverage its economies of scale and network effects. This will increase the pace of its business growth. Furthermore, it will innovate to achieve higher efficiencies.
Cloudflare needs to increase operating margins from its existing network. It will increase network traffic with higher efficiency. This will lower the cost of running a private connection over the public internet. It will add another provider to its network. Then, it will optimize for performance and reliability.
The strong backbone gives Cloudflare’s customers the confidence in getting the best network. On top of that, they may subscribe to its zero-trust offering.
Cyberattacks are the modern equivalent of ransoms. In light of the virtualized workspace, corporate customers require a zero-trust network. Cloudflare has an attractive offering because the end-user connects to the office network without being exposed to the public internet.
On Feb. 10, Cloudflare announced the acquisition of Vectrix. This adds a modern cloud access security broker (CASB) functionality to its zero-trust platform. Cloudflare One may scan third-party tools like Google Workspace, AWS, and GitHub. It will detect risky activities like file sharing and user permission misconfigurations to prevent a security hole on client networks.
The supply chain disruption risks raising costs and adding uncertainties to Cloudflare’s growth. Fortunately, the company leveraged its business relationship in the last year. It has an efficient procurement. It keeps its costs down by utilizing its software-defined network.
Technology investors may consider CyberArk Software (NASDAQ:CYBR). The cybersecurity firm posted a strong subscription bookings mix of 71% in the fourth quarter. CYBR stock has a P/S of 12 times. The stock is relatively undervalued compared to NET stock.
CrowdStrike Holdings (NASDAQ:CRWD) has a compelling suite of security solutions. It trades at a P/S of 31 times. Shares are relatively expensive compared to the technology index. Still, investors should anticipate higher cyberattack frequencies driving demand for CrowdStrike’s solutions.
Wall Street analysts have a $275.61 price target on CRWD stock. This optimistic upside forecast will require a revision. Though 21 of the 24 analysts rated the stock a buy, the most recent price target offering is over three weeks ago. Analysts will need to adjust for valuation multiple compression in the months ahead.
Nasdaq’s decline suggests that investors are unwilling to buy stocks trading at high P/S multiples. Analysts will need to lower the price target to account for Cloudflare’s higher expenses in the next two quarters.
Cloudflare’s weak value score of 31/100, as shown above, would encourage investors to wait for a better price. The stock has a good return on invested capital, earning it a 47/100 on its quality score.
Given Nasdaq’s volatility is only in the early phases, patient shareholders should wait for panicking investors to hurt Cloudflare’s share price. When that happens, the stock becomes an attractive long-term holding.
The CDN firm is suitable for investors who have a 12-36 month time horizon. The stock will continue to swing wildly, so expect its value to fluctuate in the short term.
On the date of publication, Chris Lau did not have (either directly or indirectly) any positions 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.
Chris Lau is a contributing author for InvestorPlace.com and numerous other financial sites. Chris has over 20 years of investing experience in the stock market and runs the Do-It-Yourself Value Investing Marketplace on Seeking Alpha. He shares his stock picks so readers get original insight that helps improve investment returns.