Adding to a stock that's already in your portfolio may not be as exciting as buying a new shiny one, but it could prove to be more rewarding. I just added to my Cloudflare (NET 1.44%) position, as I've recently gained a better appreciation of how this cloud infrastructure company is positioned to grow for years to come. Let's look at the three reasons why I added more and explore whether you might want to do the same.
1. Its business is improving with scale
Cloudflare's mission is to "help build a better internet" and provide customers with the infrastructure to offer fast, reliable, and secure connections to their websites. Its network serves over 3.5 million paid and free users and is exposed to 57 billion cyberthreats per day in 175 countries around the world. As the network defends against these attackers, it learns and becomes better for all customers. Today, its network can reach 99% of the connected global population in less than 100 milliseconds. But what's even more impressive is that it uses this scale to its advantage when releasing new products and features.
Image source: Getty images.
Before any new application or upgrade is released, it undergoes a massive beta test. Customers using the free service can sign up to participate in these testing cycles, which provide Cloudflare's tech team with real-time feedback and valuable insights they couldn't have gotten through a regular development test cycle. Rustam Lalkaka, Director of Product, emphasized the importance of collecting this data in a recent investor day presentation:
From the start of the company, [we] have invested in building out an infinitely scalable network deployed on dumb commodity hardware that uses really, really smart software and lots of data to build products at sort of unimaginable speed... And as we get larger and collect more and more data, all that gets sent back into that platform. We think... our network is impossible to replicate.
This approach to innovating on a massive scale is starting to pay big dividends.
2. It's winning larger customers
In the most recent earnings release, CEO and founder Matthew Price highlighted five $1 million customer wins in the quarter. These deals totaled a strong $15 million and ranged from a $1 million three-year deal to an $8.5 million four-year deal. But these deals are just the tip of the iceberg.
The company is growing its footprint with large customers in the $100K, $500K, and $1M brackets, and these customer segments are growing faster than the overall customer count. These wins are because of the company's sticky ecosystem and its effective land-and-expand growth model.
Image source: Cloudflare.
These enterprise customers are becoming more important to the company, as they've grown from 21% of the revenue in 2017 to 46% in 2020. This stable source of subscription fees enables the company to fund innovation efforts and further expand its addressable market.
3. It's expanding its addressable market
In 2018, Cloudflare estimated its addressable market at $32 billion annually for what CFO Thomas Siefert described as "a suite of products to protect network infrastructure and targeted several large and well-established IT markets." Since then the company has expanded beyond its application services roots to add network services and zero-trust security services. These new additions bring its total addressable market for 2022 to $86 billion, growing to $100 billion by 2024. This massive opportunity doesn't even include other potential growth avenues the company is exploring, such as 5G cellular networks, consumer-facing products, and Internet of Things network infrastructure.
With its $431 million in trailing 12-month revenue, the company barely tapped its massive market opportunity, giving it plenty of room to run.
Cloudflare's bottom line for investors
Cloudflare is riding tailwinds of digital transformation and the migration to the cloud that will power growth for many years to come. But investors who want to get in on this stock should understand that it doesn't come cheap. With a nosebleed price-to-sales ratio of 60, the market has priced in high revenue growth assumptions. If growth slows or a future earnings report doesn't meet analysts' expectations, the stock could take a tumble.
But, for me, the risk is worth the reward. Cloudflare is growing stronger as it captures larger customers and strengthens its already-broad set of offerings. And it's only begun to make headway into its massive and growing market opportunity. Patient investors who get in on this stock today should be rewarded over the long term with a market-beating stock.
