Down 57% From Its High, Is Cloudflare Stock a Smart Buy Right Now?

Last week, the U.S. Labor Department said that the consumer price index (CPI) -- a popular measure of inflation -- jumped 7% in December 2021, the largest increase in nearly four decades. To make matters worse, the CPI has now exceeded the Federal Reserve's target inflation rate of 2% for 10 consecutive months. Not surprisingly, the central bank has already accelerated the taper of its bond-buying program. 

Similarly, analysts believe the Fed will raise interest rates three or four times in 2022, and those expectations have weighed heavily on richly valued growth stocks like Cloudflare (NET -1.90%). Since peaking in November, the cloud computing company's share price has plummeted 57%, as investors have contemplated the current macroeconomic environment. Even so, the stock still trades at a pricey 49 times sales.

So, is this a buying opportunity for long-term investors? Let's dive in.

Image source: Getty Images.

Big market opportunity

Cloudflare's robust portfolio comprises security, networking, and application services, as well as an array of developer tools, all of which aim to accelerate the performance of corporate resources (e.g., software and websites) and infrastructure. At the same time, those cloud services help clients operate more efficiently by eliminating the need for costly and complex on-site hardware. As a whole, that value proposition has made Cloudflare a key part of many organizations' digital transformation strategy.

Of particular note, Cloudflare One is a secure access service edge (SASE), a cloud platform that blends security and networking services, making it possible for employees to access corporate resources quickly and securely from any device or location. Cloudflare Workers is an edge development platform that allows clients to build scalable applications directly on Cloudflare's fast, secure network. As more work is done remotely and more businesses prioritize a high-quality digital experience, Cloudflare One and Workers should be significant growth drivers.

As a whole, management puts the company's addressable market at $100 billion by 2024.

Strong competitive edge

Cloudflare has achieved tremendous scale. Its global platform spans 250 cities and interconnects with 10,000 other networks, putting its servers within 50 milliseconds of 95% of the world's population. That gives the company a significant edge in terms of speed, especially when compared to smaller players in the industry. But what about cloud titans like Amazon Web Services (AWS) and Microsoft?

Cloudflare has an edge there, too. Specifically, its platform is cloud-agnostic, meaning it can accelerate performance and security across private data centers, public clouds, and multi-cloud environments, affording clients the flexibility to work with the cloud vendor (or vendors) of their choosing. Not surprisingly, the platform's cloud-agnostic nature has led to strong demand. Nearly 20% of the web relies on Cloudflare's network, while Fastly ranks second with less than 2%.

Also of note, Forrest Research recently recognized Cloudflare Workers as the best edge development platform on the market. The report ranked Workers higher in terms of current strength and growth strategy than any competing platform, including those provided by cloud titans like AWS and Microsoft.

Suffice it to say, Cloudflare has established a strong competitive position, and the company is executing on its massive market opportunity.

Impressive financial performance

In the most recent quarter, Cloudflare surpassed 132,000 paying customers, up 31%, and the average customer spent 24% more over the past year. That compounding dynamic has translated into impressive top-line results.

Source: YCharts. TTM = trailing-12-months.

On the bottom line, Cloudflare is still free cash flow negative, but the loss is narrowing. More importantly, the company has $1.8 billion in cash and short-term investments on its balance sheet compared to $1.5 billion in total liabilities. That means Cloudflare can afford to burn cash for at least a few years while its business scales without issuing additional debt.

Worth the risk

Cloudflare's growth strategy hinges on expanding its portfolio of products, and the founder-led management team has demonstrated its capacity for innovation many times over. For instance, the company recently launched R2 Storage, a service that will support Cloudflare Workers by enabling developers to efficiently store application data -- in fact, the company aims to undercut AWS on price by at least 10%.

Also noteworthy, research company Gartner believes that 60% of enterprises will have plans in place to adopt SASE solutions like Cloudflare One by 2025, up from just 10% in 2020. That trend should be a significant tailwind for the company, helping it add new customers and expand its relationship with existing ones.

Put simply, Cloudflare has many factors working in its favor -- a big market opportunity, a strong competitive position, a history of execution, an innovative culture, and the tailwinds of digital transformation. From that perspective, I think this $30 billion company could grow tenfold over the next 15 years -- so the stock does indeed look like a smart buy right now, but only for risk-tolerant investors.

At 49 times sales, shareholders should expect a bumpy ride, especially while the current macroeconomic headwinds persist. More importantly, just because the stock is down 57%, that doesn't mean it won't get cut in half again. For that reason, rather than investing all at once, it makes sense to build a position through dollar-cost averaging.