Richard Branson, the founder of London-based Virgin Group, once joked: "If you want to be a millionaire, start with a billion dollars and launch a new airline." Alternatively, you can achieve the same feat by investing in a high-growth company that addresses expanding markets over the long term.
Luckily, Elastic (ESTC -2.11%) seems to fit these alternate criteria. But you need one more condition besides its operational performance to consider Elastic as a millionaire-maker stock: Its stock price must provide significant upside potential.
Strong growth potential in compelling markets
Elastic's core business consists of selling software that searches for, analyzes, and visualizes any kind of data at scale. Management estimates the company's total addressable market to be $45 billion, which gives the company plenty of room to grow, since its trailing-12-month revenue of $342.25 million represents just a tiny portion of that overall market.
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And with its strategy of offering part of its software for free together in the hopes of attracting paid subscriptions, the company has been posting solid growth. During the latest quarter, revenue increased to $101.1 million, up 59% year over year. And management forecasts revenue to grow by 53.1% during fiscal 2020, based on the midpoint of guidance.
In addition, with its recent acquisition of the endpoint protection vendor Endgame in October, Elastic made its first step into the cybersecurity market.
This transaction should create significant synergies: The company's search capabilities help operators analyzing logs -- records of events -- generated by cybersecurity solutions such as endpoint protection to detect threats and respond to them.
With this acquisition, Elastic expanded into the endpoint security market that is forecasted to grow 7.6% annually and reach $18.4 billion by 2024, according to MarketsandMarkets. In the long term, Elastic could merge its research capabilities with any cybersecurity solution, which would expose the company to the much broader global security market estimated at $268 billion in 2024.
Growing markets attract strong competitors
Elastic is facing strong competition in its core search market, though. With its simple and integrated search and monitoring solutions, Datadog grew its revenue by 88% during the last quarter. New Relic, another actor in this market, expects to grow its revenue from $542.9 million over the last 12 months to $1 billion in fiscal 2023, thanks to its new programmable and customizable offering. Also, Splunk, a much larger competitor with revenue of $626 million last quarter (up 30% year over year), partnered with the tech giant Cisco, which offers endpoint security analytics capabilities based on Splunk's technology.
Besides, setting aside specialized endpoint protection vendors such as CrowdStrike (which almost doubled its revenue during the last quarter), the endpoint security market is becoming crowded. In addition to the many legacy cybersecurity vendors such as Palo Alto Networks, Cisco, and Check Point Software Technologies that have been addressing this market for many years, some other large tech players recently entered into this market as well. For instance, VMWare spent $2.1 billion last year to acquire the cloud-native endpoint specialist Carbon Black, and BlackBerry acquired another endpoint protection company, Cylance, for $1.4 billion.
Millionaire makers need not apply
With this intensifying competition, Elastic will need solid execution to gain market share. And the upside potential of its stock price seems limited, since the company's high valuation indicates the market expects high revenue growth over the long term.
The company's market capitalization of $5.75 billion corresponds to a multiple of 13.8 times the midpoint of its forecasted revenue range during fiscal 2020. Besides, with its high research and development and sales and marketing expenses -- 91% of the company's revenue during the last quarter -- to support its revenue growth, profits seem far away. Management expects non-GAAP (adjusted) negative operating margin in the range of 22% to 23% during the full fiscal year.
Thus, because of its demanding valuation, Elastic could be a millionaire-maker stock only if it outperforms its competitors over the long term. Given the huge uncertainties that correspond to such an outcome, prudent investors will have trouble seeing strong performance gains and would be better off avoiding this risky growth stock.
