More and more companies these days depend on network infrastructure to function and compete. Cybersecurity, speed, and reliability are must-haves for these networks, especially when downtime means lost profits. One way to keep that network up and running efficiently is through the use of edge computing. It's an in-demand service and its addressable market is expected to reach over $87 billion by 2026, according to a MarketsAndMarkets report.
With data centers in over 250 cities worldwide, Cloudflare (NET 1.86%) is a major player in the growing edge computing sector. But you might not think that based on its stock performance over the past few months. Let's take a closer look at this stock and see if we can determine why the stock is where it is now and what its performance might be going forward.
Image source: Getty Images.
Why Cloudflare?
So what is the big deal with edge computing and content delivery networks anyway? It turns out even data has to follow the laws of physics. Information can only travel so fast through networks, therefore the closer a computer is to the data center, the less lag time a website or other network operation has reaching that computer. With this in mind, Cloudflare has strategically built its 250 data centers around the globe so that 95% of the world's population resides within 50 milliseconds of one. Quite simply, Cloudflare's technology allows websites and other networked computer services to run faster.
Cloudflare also provides customers with cybersecurity services. Its network includes protection against distributed denial-of-service (DDoS) attacks, which are a significant headache for enterprises. These attacks attempt to knock servers offline by overwhelming them with a flood of traffic. According to Cloudflare, its solution successfully mitigated the largest DDoS attack ever reported in the summer of 2021. The company also provides its clients with VPN, content filtering, analytics, firewalls, and many other services. This is how Cloudflare pursues its stated mission to "build a better internet."
Impressive Q4 earnings
Cloudflare released its Q4 and full-year 2021 earnings earlier this month, and some impressive metrics were reported. Total paying customers now stand at around 140,000. More importantly, its large customers (who provide the bulk of the company's sales) increased from 828 at the end of 2020 to 1,416 at the end of 2021. Cloudflare reported its large customers (at least $100,000 in annual sales) have increased at a compound annual growth rate (CAGR) of 69% since 2018. This is a critical metric as these large customers help Cloudflare grow into its total addressable market, which is expected to reach $100 billion by 2024.
Revenue for 2021 came in at $656 million, an increase of 52% over 2020, thanks to large investments in sales and marketing. By comparison, revenue in 2016 was $85 million for the whole year. That's a sevenfold revenue increase with a 51% CAGR. Management is projecting another 41% to 42% increase in 2022.
Cloudflare has shown it can successfully acquire customers, now it's paramount to keep them and monetize them. Other earnings reporting suggests Cloudflare's products are sticky and that the company is successfully expanding services to existing customers. In Q4 2021, Cloudflare reported a 125% dollar-based net retention rate (basically, existing customers are spending 25% more on average with the company compared to the prior year).
Cloudflare's valuation is still a concern
Valuation has long been a concern for investors in Cloudflare stock. Its price-to-sales (P/S) ratio reached over 100 for a period in 2021, which is extremely inflated. It has since dropped considerably but still trades at a P/S ratio over 45. The chart below compares this to other fast-growing tech companies Zscaler and CrowdStrike. While the P/S ratios have come down from their peaks for all three companies, they remain well above pre-pandemic levels.
NET PS Ratio data by YCharts
Cloudflare's stock peaked in November 2021, reaching over $221 per share. Since then, the stock has dropped more than 57%, along with many other growth stocks. The market has been spooked by rising inflation and other macroeconomic issues, and these have hit the growth sector hardest.
While Cloudflare as a company appears to have a terrific future, it seems that Cloudflare stock is still trying to find its bottom. Given the instability in the current market, Cloudflare stock is a risky play at this time but it might be worth dipping into for those with a long-term investment mindset that can ride out the short-term volatility that is like to come.
