Fast-growing cybersecurity company CrowdStrike (CRWD 2.03%) reported strong fiscal second-quarter results earlier this week. Its fiscal second-quarter revenue and adjusted earnings per share both came in higher than analysts' consensus forecasts, as annual recurring revenue soared 59% year over year, surpassing $2 billion for the first time. Following the report, a handful of analysts raised their 12-month price targets for the stock, with many of these price targets representing significant upside from where the stock is trading today.
Yet shares have been falling. What gives? Is this just market noise, or is there good reason for the stock to come down?
While it's true that CrowdStrike's business has been firing on all cylinders, there has been significant pressure on growth stocks in 2022 as investors appear to be more sensitive to valuation risk. CrowdStrike is among the growth stocks that may simply be trading at too high a price tag.
Is the growth stock's valuation too high?
With CrowdStrike's fiscal second-quarter revenue surging 58% year over year and non-GAAP earnings per share more than doubling year over year to $0.36, this is the type of company that deserves to trade at a sky-high valuation. But how high is too high? CrowdStrike may be pushing the limits.
The company's market capitalization of more than $39 billion is a towering figure next to its underlying fundamentals. The stock trades at more than 21 times revenue and 69 times free cash flow.
But looking at CrowdStrike on a price-to-free cash flow basis instead of a price-to-earnings basis is being generous. It excludes the company's generous stock-based compensation to employees -- a vital (and recurring) component of profitability for tech investors to consider, as tech companies often pay it out heavily. CrowdStrike's stock-based compensation, for instance, was more than $400 million for the trailing-12-month period.
One profitability metric that includes stock-based compensation is CrowdStrike's GAAP net income. On a trailing-12-month basis, CrowdStrike reported a net loss of $173 million.
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Big expectations
The fact is that the current stock price is baking in not only years of strong revenue growth from here, but also a path to substantial profitability. But with over $400 million of stock-based compensation getting paid to employees in the trailing 12 months, CrowdStrike will need significantly higher revenue levels before it starts generating earnings that are meaningful in the context of a $39 billion market capitalization.
It's certainly possible that CrowdStrike will pull off the sustained levels or rapid growth rates over the next five to 10 years that would be required to help the company achieve substantial profitability relative to its market capitalization. But a lot can happen over such a long period, including intensified competition from both new and existing industry players.
Unless a case can be made for a strong degree of certainty that CrowdStrike's cybersecurity solutions will dominate competition for the foreseeable future, investors may want to stay on the sidelines given the growth stock's sky-high valuation today.
Sure, CrowdStrike offers an outstanding product that helps customers consolidate their security and investment technology stack and often even save money relative to legacy solutions. Even more, the company's cybersecurity solutions are likely better than many of its competitors' offerings. All of this positions CrowdStrike well for continued strong growth. But the stock's high price tag today leaves little room for error in Wall Street's rosy expectations for this company.
Fortunately, in investing, it's totally fine to stay on the sidelines and to look for better places to invest. With CrowdStrike stock, it may be wise to do so.
