Nasdaq will also add CrowdStrike to the Nasdaq-100 Equal Weighted Index and the Nasdaq-100 Technology Index. It will replace Maxim Integrated Products (MXIM) across all three indexes. Let's see why this announcement attracted so much attention and why it boosted CrowdStrike's stock price. We'll also consider if all this buzz makes it a more worthwhile investment.
How are companies added to the Nasdaq indexes?
The Nasdaq-100 includes 100 of the Nasdaq's largest non-financial companies in terms of market capitalization. The Nasdaq-100 Equal Weighted Index allocates one percent of the index to each company to offset the distortion caused by larger companies. The Nasdaq-100 Technology Index, which is also equal weighted, only includes the Nasdaq's 100 largest tech companies.
Why did investors cheer CrowdStrike's inclusion?
CrowdStrike was founded ten years ago and went public in mid-2019. It often takes companies a lot longer than two years to join Nasdaq's indexes, so CrowdStrike's inclusion can be considered a major milestone.
When a company is added to the Nasdaq-100 indexes, it's automatically added to the exchange-traded funds (ETFs) and mutual funds which track them. ETFs and mutual funds are both popular investments for investors who don't want to manage individual stocks, so purchases of those funds should passively boost CrowdStrike's trading volume and stock price.
Does the inclusion make CrowdStrike a better stock?
CrowdStrike went public with an IPO price of $34 in June 2019, opened at $63.50 per share on the first day, and is currently trading in the $260s. CrowdStrike generated multibagger gains in such a short time for two main reasons:
First, CrowdStrike provides its end-to-end security platform as a cloud-native service without any on-site appliances. Most traditional cybersecurity companies, including Palo Alto Networks (PANW -1.94%), originally installed on-site appliances but are gradually expanding their cloud-based services.
Cloud-based services are easier to scale than on-site appliances, can be updated immediately over the internet, and generate stable, recurring revenues. CrowdStrike's dollar-based net retention rate -- which has consistently remained above 120% since its IPO -- indicates it's locking in customers and consistently cross-selling new services.
Second, CrowdStrike is showing spectacular growth. Its revenue surged 93% in fiscal 2020 and rose 82% in 2021. Analysts expect 56% growth in 2022. In the first quarter of fiscal 2022, its number of subscription customers grew 82% year over year to 11,420. Sixty-four percent of those customers had adopted four or more of its cloud modules -- up from 55% a year ago.
However, CrowdStrike isn't profitable by generally accepted accounting principles (GAAP) measures. Yet its share count has increased nearly fivefold over the past two years as it raised cash with a secondary offering and buoyed its salaries with stock bonuses. Its stock now trades at a whopping 44 times this year's sales.
By comparison, Palo Alto Networks grew its revenues 25% in fiscal 2021, which ended in July, but its stock trades at just seven times this year's sales. Palo Alto, which has a market cap of $43 billion, notably hasn't yet been added to the Nasdaq-100 index, even though it generated nearly five times as much revenue as CrowdStrike last year.
On its website, Nasdaq notes that a stock's inclusion into a major stock index is often associated with "increased investor demand, elevated stock valuations, and decreased cost of capital." In other words, CrowdStrike's frothy valuations could get even frothier as a Nasdaq-100 component.
The bottom line
CrowdStrike is a solid cybersecurity company, but its stock was already expensive prior to its addition to the Nasdaq-100. That inclusion might generate some near-term tailwinds for CrowdStrike, but long-term investors should focus on its fundamentals and valuations instead of its market capitalization.
Investors can consider nibbling on CrowdStrike ahead of its second-quarter earnings report on Aug. 31, but they should realize its stock is already priced for perfection. More reasonably valued cybersecurity stocks like Palo Alto might generate more sustainable long-term gains.