What happened
Shares of Cloudflare (NET -0.23%) sank 35% in May, according to S&P Global Market Intelligence. The global cloud services provider posted its first-quarter earnings that were above analyst expectations; however, investors still decided to sell off the stock in the days and weeks following the report. We can also factor in the decline of the Nasdaq 100 and technology stocks, which continued last month.
So what
On May 5, Cloudflare reported its earnings for the first three months of 2022. The company generated revenue of $212.5 million in the period, up 54% year over year, and adjusted earnings per share (EPS) of $0.01. Both numbers beat analyst expectations heading into the period, which typically means that the stock would be up in the weeks following the report. But that is not the case with Cloudflare, as we can see, with shares down over 30% in such a short time period.
Image source: Getty Images.
So what happened? Why did Cloudflare's stock go down so much? I can think of two reasons. First, investors may have been disappointed with the company's full-year guidance for $955 million to $959 million in revenue. If it can hit the high end of this guidance, this would equate to 46% revenue growth for the year, which could have been below what investors were expecting.
Second, Cloudflare has negative cash flow right now, with negative $64.4 million in free cash flow just in Q1. Investors have gotten nervous about money-losing companies to start 2022, as opposed to loving them in 2020 and 2021. Continued cash outflows for Cloudflare may not be what investors want to see right now, even if it is the right move for the company over the long term, which has caused the stock to drop.
Don't count out broad market volatility, either. The Nasdaq 100 index was down as much as 8% at one point in May, showing the broad pessimism for many investors right now. This pessimism could have impacted Cloudflare's returns last month.
Now what
As of this writing, Cloudflare stock is down 58% year to date, and now has a market cap of $18 billion. Assuming it can hit the high end of its revenue guidance, the stock trades at a forward price-to-sales ratio (P/S) of 18.8, which is not cheap no matter how you slice it. The company is growing quickly and has high gross margins of 78%, so an inflated P/S doesn't necessarily mean Cloudflare will be a bad investment at these prices. But if you're an investor in the stock, you need to believe it can keep up strong double-digit revenue growth for many years.
