NET stock could be at the start of a very long correction

As I write this, Cloudflare (NYSE:REPORT) the stock is trading at $ 131. Without beating around the bush, this is a good deal.

Source: Igor Golovniov / Shutterstock.com

Well, that seems like a good deal at least. Cloudflare is a stable company with growing business, and that growth is expected to continue for the foreseeable future.

There are two main ways to look at the prospects for Cloudflare going forward. Either it enters a continued decline from unsustainable price points, or this company is expected to hit even higher highs.

Let’s start with the reasons to believe that NET stock should logically increase.

A closer look at NET Sknock

Cloudflare is a cloud-based website security platform that continues to perform well. The company’s general metrics indicate that the future is bright.

Between 2018 and 2020, Clouflare experienced strong growth in its turnover. The $ 193 million in total revenue in 2018 grew to $ 431 million by 2020. This is a compound annual growth rate (CAGR) of 50% over the period.

Expectations are that Cloudflare will achieve $ 647 million in revenue, which is expected to drop to $ 884 by the end of 2022. That’s a CAGR of 43.21% over the two-year period from 2020 to 2022, below the 50% between 2018 and 2020. Nonetheless, Cloudflare is doing well.

A particular strength of the company is that large customers are on the increase. Large clients – those who generate more than $ 100,000 in annual revenue – represent greater than 50% of the company’s total turnover.

The positive thing to note here is that based on Q3 revenue, Cloudflare recorded 67% CAGR from this revenue stream. This suggests that the company could recoup those 50% of compound annual growth rates in revenue in the future.

In fact, Cloudflare saw 51% year-over-year revenue growth between Q3-20 and Q321. The company had 1,320 large customers in Q3-21, up from 736 in the third quarter of 2020. Again, this reinforces the idea that Cloudflare could once again reach an overall CAGR of 50% in the future by targeting significant growth. client.

This is the biggest bullish thesis for NET stocks, but Cloudflare faces significant hurdles.

The decline abounds

The argument is that Cloudflare has essentially become overvalued and overvalued. NET action started in 2021 at $ 75. Even after its recent slowdown, Cloudflare is still up 75% year-to-date.

Most rating metrics suggest that Cloudflare is still overvalued even after the downturn. Its current price / sales ratio is 67. That’s worse than 98% of its software industry peers.

My colleague Ian Bezek summarized the meteoric rise in Cloudflare’s PS ratio in his recent article. His claim that the NET stock is at the start of a prolonged correction certainly makes sense given the outlook.

Cloudflare, on the other hand, started trading around 15 times revenue after its own IPO in 2019. The stock has gradually grown to around 30 times revenue at the start of the pandemic. It climbed to 60 at the start of this year and leveled off there for a while. In October, shockingly, NET stock exceeded sales 100 times. This is ridiculously excessive.

Again, even though the NET stock’s P / S ratio fell to 67, it remains among the lowest 2% of performers in the industry. This very strongly suggests that Cloudflare could continue to experience a market that considers it ridiculously expensive. Even at 67 times the sales.

What to do

My thinking is this: Cloudflare is subject to continued correction. It is safer to err on the side of caution now. At the very least, take the time to look at the NET stock for now. It will experience jerking rather than constant correction if it rolls over at all.

That said, Wall Street analysts are giving solid projections when it comes to target prices. Their average price target stands at $ 212.50, it is trading at $ 144 today. That’s probably inflated considering the rapid increase based on the PS ratio over the past few quarters, but remains encouraging.

Cloudflare remains fundamentally a strong company. No one disputes that. The question now is what do investors subjectively think about company valuation metrics?

As of the publication date, Alex Sirois does not have (directly or indirectly) any position in any of the titles mentioned in this article. The opinions expressed in this article are those of the author, subject to InvestorPlace.com Publication guidelines.

Alex Sirois is an independent contributor to InvestorPlace whose personal equity investing style focuses on long-term, buy and hold stock selections that create wealth. Having worked in multiple industries, from ecommerce to translation to education and using his MBA from George Washington University, he brings a diverse set of skills through which he filters his writing.

Ann J. Cox