The Pareto Principle suggests that 20% of the stocks in a portfolio will ultimately generate 80% of the profits. Unfortunately, it is impossible to pick big winners with absolute certainty, but investors can set themselves on the right track by identifying businesses with strong revenue growth and big market opportunities.
Cloudflare (NET 1.40%) checks both of those boxes. Better yet, $1,000 invested in the stock today could grow tenfold to $10,000 over the next decade.
The fastest cloud provider
Cloudflare is an up-and-comer in the cloud computing industry. Its global network interconnects with every major internet service provider and cloud vendor, which positions its hardware within 50 milliseconds of 95% of internet users worldwide. That means its cloud platform is very fast. In fact, internal studies suggest that Cloudflare is the fastest cloud provider in 71% of the top 1,000 networks around the globe.
Building on that foundation, Cloudflare provides network, security, and application services that accelerate and protect enterprise infrastructure -- everything from software to servers -- while eliminating the need to manage expensive hardware in private data centers. Put simply, Cloudflare makes the internet faster and safer for its customers, while reducing IT costs and complexity.
That has translated into strong demand. Cloudflare saw its customer base rise 20% to 151,000 in the past year, while the average customer spent 26% more. In turn, revenue soared 53% to $813 million, and the company generated $36 million in cash from operations. That meager cash flow is unlikely to impress many investors, but Cloudflare values its addressable market at $115 billion (and rising), and management plans to operate at breakeven while growth remains strong.
In the short run, that aggressive growth strategy will mask profitability. But Cloudflare achieved a gross profit margin of 77.5% over the past year, signaling that it could become a cash-generating machine as its business scales.
Two significant opportunities
Going forward, investors should be especially excited about two products. First, Cloudflare One is a secure access service edge (SASE), a fancy term for a solution that blends cloud networking and security services. To that end, SASE infrastructure has become a key part of digital transformation because it allows employees to quickly and safely access corporate resources from any device or location. In fact, research company Gartner believes 80% of enterprises will have adopted SASE architecture by 2025, up from 20% in 2021.
Of course, Cloudflare One pits the company against tough competition, but CEO Matthew Prince recently told investors, "We are going head-to-head with Zscaler and Palo Alto Networks more and more, and we like our win rates when we do." That should give investors confidence, and the secular shift to SASE architecture could be a tremendous tailwind for Cloudflare.
Second, Cloudflare Workers is a development platform that allows businesses to build applications and write code directly on the Cloudflare network, which makes those applications and services fast and secure by default. Cloudflare also provides developer tools for webpages and streaming platforms, and Workers is making waves in the industry. Forrester Research recently recognized Cloudflare as the leader in edge development, citing a stronger current offering and a strong growth strategy than any other vendor.
To reinforce its leadership, Cloudflare recently launched R2 object storage (in beta), and it announced the D1 database, both of which make Workers more useful. Specifically, R2 is well-suited for unstructured data like photos, videos, and graphics, while D1 is designed for the fast storage and retrieval of structured data. All applications require some type of data storage, and most modern applications utilize unstructured and structured data.
Collectively, Cloudflare One and R2 account for most of Cloudflare's $115 billion addressable market. However, the D1 database is not yet reflected in that figure, because it has not gone live. But Prince expects D1 to "quickly become one of the largest databases in the world."
The potential for 10x returns
Cloudflare currently has a market cap of $25.7 billion, and the stock trades at 31 times sales. But if the company achieves annualized revenue growth of 30% over the next decade, its market cap could grow tenfold to $257 billion, while its price-to-sales ratio dropped to a more reasonable multiple of 23.
Of course, that estimate includes a good amount of speculation, but even if Cloudflare doesn't produce tenfold returns by 2032, this growth stock still looks like a market-beating investment.