Should You Ignore CrowdStrike's High Valuation?

Many high-growth tech stocks that generated massive gains in 2020 fizzled out this year as the market rotated toward value stocks. That sell-off burned many investors, but also created buying opportunities in promising stocks that overheated during the pandemic.

Yet other pricey stocks that seemed ripe for pullbacks remained resilient. One such stock was CrowdStrike (CRWD 1.79%), the cybersecurity company that more than quadrupled in value last year. 

Image source: Getty Images.

I expressed my admiration for CrowdStrike back in February, but said I didn't want to pay the wrong price for the right company. The stock dipped in March but quickly recovered and remains up about 10% for the year. Let's see if investors should ignore CrowdStrike's high valuation and buy the stock.

How expensive is CrowdStrike's stock?

The company went public in June 2019 at $34 per share. It closed the first trading day at $58, giving it a valuation of $11.4 billion -- or 46 times its $259.8 million in revenue in fiscal 2019.

Today, the stock trades in the low $240s, which gives it a market cap of about $54.5 billion. Its rising share count, which supports its stock-based compensation, caused its share price to rise at a slower rate than its market cap. In other words, one share of CrowdStrike today represents a smaller slice of the company than it did right after its initial public offering (IPO).

CrowdStrike's current market cap is 62 times higher than its revenue in fiscal 2021, which ended this January. It also trades at 40 times this year's estimated sales of $1.36 billion.

In terms of profits, CrowdStrike trades at a whopping 345 times forward earnings (on a non-GAAP basis) -- but that forward price-to-earnings (P/E) ratio could contract quickly if its profits continue rising by double digits.

For now, however, CrowdStrike's valuation looks frothy compared to other cybersecurity companies like Palo Alto Networks and Check Point Software.

Data source: Yahoo! Finance, June 18, 2021. P/S ratio = price-to-sales ratio.

Why are investors paying a premium for CrowdStrike?

Investors are paying such a high premium for CrowdStrike for four main reasons.

First, it doesn't install on-site appliances like other cybersecurity companies. Instead, it offers its end-to-end security platform entirely as a cloud-based service -- which is easier to scale than on-site appliances and generates predictable recurring revenue. Older cybersecurity companies are gradually making that transition by complementing their appliances with cloud-based services, but CrowdStrike remains the leading cloud-native player in the market.

Second, CrowdStrike is growing much faster than most other cybersecurity companies. Its revenue soared 93% in fiscal 2020, grew 82% in fiscal 2021, and is expected to rise another 56% this year.

Third, its profitability is improving. It turned profitable on a non-GAAP basis in 2021, and analysts expect 44% earnings growth this year.

Lastly, CrowdStrike's core growth metrics are all headed in the right direction. It ended the first quarter of fiscal 2022 with 11,420 subscription customers -- up 82% from a year earlier.

Sixty-four percent of those customers have adopted four or more of its cloud-based modules -- up from 55% a year ago. Its dollar-based net retention rate, which measures its year-over-year revenue growth per existing customer, has also consistently remained above 120%.

Those growth rates indicate that CrowdStrike's strategy of "landing and expanding" -- in which it signs customers on to a single module to cross-sell additional ones -- is paying off and widening its moat.

Does CrowdStrike's potential for disruption justify its valuation?

It's easy to see why the bulls love CrowdStrike -- it enjoys a first-mover advantage in the cloud-native cybersecurity space, its growth rates are stellar, and its ecosystem is sticky. But it's also easy to see why the bears are still skeptical -- the stock is priced for perfection, so an unexpected earnings miss could quickly sink the stock.

I believe investors can nibble on CrowdStrike right now since the market could keep ignoring its frothy valuation as long as its core metrics keep rising. But investors shouldn't be surprised if the stock suddenly plummets -- and they should be ready to accumulate more shares if it finally does.