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Wall Street JournalCloudflare Gains 12.6% YTD: How Should Investors Play the Stock?
Cloudflare NET shares have gained 12.6% in the year-to-date (YTD) period. However, NET stock has underperformed the Zacks Internet Software industry, Zacks Computer and Technology sector and the S&P 500 index’s return of 26.3%, 26.9% and 22.9%, respectively, YTD.
Given this underperformance, investors are wondering whether this slow growth in stock price reflects underlying weaknesses, or is it a temporary stagnation that offers a buying opportunity.
Sluggish Growth Hurts Cloudflare Stock’s Performance
NET stock’s underperformance can be attributed to the company’s decelerating growth, which has raised concerns about its near-term prospects. Notably, Cloudflare has experienced impressive growth since its IPO in 2019. However, recent quarterly reports indicate a slowdown. The company's revenue growth, while still robust, is not as explosive as in previous years.
Cloudflare enjoyed nearly 50% year-over-year top-line growth until 2022. However, the growth rate decelerated to 33% in 2023. Current estimates for 2024 and 2025 suggest further deceleration to around 27%.
Similarly, Cloudflare has seen tremendous improvement in its bottom-line results over the past few years, turning profitable on a non-GAAP basis in 2022 and registering a robust 272% increase in 2023. However, earnings growth for 2024 and 2025 is projected to be around 45% and 18%, respectively.
Going ahead, near-term prospects might be hurt by softening IT spending as enterprises postpone large tech investments due to macroeconomic uncertainties and geopolitical issues. This makes the company's near-term prospects appear cautious.
Cloudflare YTD Performance
Image Source: Zacks Investment Research
Cloudflare’s Elevated Valuation Raises Concerns
Cloudflare appears overvalued from a price-to-earnings (P/E) perspective. The stock is currently trading at a forward 12-month P/E ratio of 116.13X, significantly higher than the Zacks Internet - Software industry average of 35.41X. This premium valuation raises concerns about the stock’s sustainability, signaling potential downward risk.
Though slowing growth and stretched valuation remain concerns, it's not all gloom and doom for Cloudflare. The company’s robust market position and sustained focus on expanding its presence in the AI market offer significant long-term growth opportunities.
Cloudflare’s Robust Market Position Aids Customer Growth
Cloudflare has built a solid reputation for its innovative solutions in content delivery, Internet security and edge computing. The company's mission to build a better Internet has resonated with a wide range of customers from small businesses to large enterprises.
Its extensive global network, combined with a strong focus on performance and security, has been driving customer growth. In its most recent earnings report for the second quarter of 2024, Cloudflare’s total paying customer base soared 21% year over year to 210,200.
NET added 168 new customers who contributed more than $100,000 in annual revenues during the quarter, bringing the total count of such customers to 3,050. This growth is supported by a high net retention rate, indicating strong customer loyalty and the ability to upsell additional services.
Expansion in AI Space to Drive NET's Growth
Cloudflare has been expanding in the artificial intelligence (AI) space by launching innovative products. So far this year, NET has launched security products for AI, including Firewall for AI and Defensive AI. Firewall for AI protects Large Language Models from cyberattacks by providing a security layer. Defensive AI protects devices exposed to the Internet from AI-based cyberattacks.
Cloudflare has also expanded in the AI space through partnerships with Hugging Face Hub, CrowdStrike CRWD, Microsoft MSFT and NVIDIA NVDA. Cloudflare’s collaboration with Hugging Face enabled developers with the capacity to develop AI applications on NET’s global network with just one click from Hugging Face.
NET’s collaboration with CRWD combined Cloudflare’s Zero Trust protection and CrowdStrike’s AI-powered cybersecurity solutions to prevent breaches on a large scale. Cloudflare has also partnered with many other industry leaders in 2024 to expand its expertise beyond AI.
Cloudflare’s collaboration with Microsoft was focused on allowing enterprise customers to deploy AI models across devices, network edges and cloud environments by utilizing ONNX runtime. In 2023, NET also announced its plan to use NVDA’s GPUs and Ethernet switches in its global network to bring AI close to its users.
What Should Investors Do?
Although Cloudflare’s strong market position and expansion in the AI market are encouraging, high valuation warrant caution. The company's slowing growth rates and macroeconomic uncertainties pose near-term risks.
Keeping these factors in mind we suggest investors to wait for a better entry time in this Zacks Rank #3 (Hold) stock. You can see the complete list of today’s Zacks #1 Rank (Strong Buy) stocks here.
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