You only need two things to make money in the stock market: time and a portfolio of high-quality stocks. To be clear, that doesn't mean you need to be right every time you buy a stock. It just means you need to research what you're buying before you invest. Look for businesses that have durable competitive advantages and big market opportunities.
Personally, once I've identified a stock I want to buy, I rank it as either gold, silver, or bronze based on my conviction. I tend to allocate a little less capital to my low-conviction ideas and a little more to my high-conviction ideas. Cloudflare (NET 1.81%) falls into the high-conviction category, and with the stock trading 52% below its high, you can buy a few shares on sale right now.
Here's what you should know.
Image source: Getty Images.
The business model
Cloudflare is the highway of the internet. Its global cloud platform interconnects with 10,000 other networks -- including internet service providers, public cloud vendors, and large enterprises -- which positions its servers within 50 milliseconds of 95% of internet users worldwide. That infrastructure is a significant competitive advantage, and it allows Cloudflare to accelerate and secure its clients' applications and networks.
Despite facing intense competition from vendors like Amazon and Microsoft, Cloudflare has differentiated itself in a few key ways. For instance, its platform is designed to be infrastructure-neutral. Vendors like Amazon and Microsoft tend to favor their own technologies, but Cloudflare works with on-premise data centers and public clouds. Its platform gives clients visibility and control over their entire IT ecosystems.
Additionally, Cloudflare offers a free service tier that has drawn a significant number of non-paying users to its platform. In fact, its content delivery network powers 19% of the internet -- more than every other cloud vendor combined. How is that an advantage? Cloudflare leverages those free users to test new products and gather data, and it uses that data to inform and accelerate development decisions.
Finally, Cloudflare has innovated at an incredible pace over the last decade, building a robust portfolio of application, network, and security services. The company also offers developer tools that help clients build websites, software, and services on its cloud platform. In fact, Forrester Research recently recognized Cloudflare as the leader in edge development, citing its stronger current offering and stronger growth strategy.
The market opportunity
Digital transformation has become an imperative. Enterprises must keep pace with technology if they hope to remain competitive, and that has Cloudflare growing like wildfire. It surpassed 140,000 paying customers in 2021, up 26% from the prior year, and the average customer spent 25% more. As a result, revenue soared 52% to $656 million and the company generated positive cash from operations of $65 million, up from a loss of $17 million in the prior year.
Looking ahead, Cloudflare has plenty of room to grow. Management puts its addressable market at $86 billion in 2022, but expects that figure to reach $100 billion by 2024. And one product accounts for about half of that figure: Cloudflare One.
Cloudflare One
Organizations have traditionally protected their sensitive data by routing all traffic through a central corporate hub. That's where security policies have been enforced and threats have been blocked. But that approach is costly -- both in terms of hardware and IT manpower -- and it's becoming increasingly irrelevant, because many corporate resources now live in the cloud.
Cloudflare One, a secure access service edge (SASE), allows clients to provision network connectivity and security through the internet, without investing in costly on-premise appliances. That means traffic is no longer routed through a corporate hub. Instead, requests are routed through Cloudflare, where traffic is inspected and zero-trust security policies are enforced. That makes it possible for employees to quickly and securely connect to corporate resources (and the internet) regardless of device or location.
By 2025, research company Gartner believes at least 60% of enterprises will have plans to implement SASE solutions, up from just 10% in 2020. That accelerated adoption should be a powerful tailwind for Cloudflare.
The potential for 5x returns
Despite falling sharply from its high, Cloudflare stock still trades at a pricey 53 times sales. With a valuation like that, investors should expect volatility. The stock could easily get cut in half again. However, Cloudflare is an impressive business with a massive market opportunity, and despite the rich valuation, I think the stock is worth buying. In fact, if revenue continues to grow at a rapid clip, I think this $36 billion business could grow fivefold (or more) in the next decade.
