Money is made in bull markets, but fortunes are made in bear markets. So goes the Wall Street adage about the excellent opportunity to buy stocks when demand is low, and prices plummet. Corrections offer a chance to sniff out companies that have real potential to make hefty profits down the line. Finding those winners often requires going a bit deeper in your stock analysis. What separates winning stocks from the pack?
Product demand is a great place to start. Cybercrime is a constant threat, costing the global economy billions annually. Cybersecurity is a priority, so more money is spent on protection services. Another separator involves remote work. There are advantages to letting workers do their jobs where they can be most productive. But it also vastly increases the need for endpoint security -- the type provided by CrowdStrike Holdings (CRWD -0.83%).
CrowdStrike has many impressive metrics that help set it apart, but let's focus on three. The company is hiring a record number of new employees, it continues to post fantastic retention data, and its long-term profit model is solidifying.
1. Employment: Who hires into a potential recession?
With a recession increasingly likely, many companies have started reducing their workforces. Job cuts are a hallmark of economic downturns. Just like you probably don't put on a raincoat unless there's rain in the forecast, companies don't hire unless they expect growth.
Big tech players Meta Platforms and Alphabet are among a growing list of companies that announced plans for staff reductions this year. Not so for CrowdStrike.
"We are also executing our 2023 hiring plan and are pleased to report that we added a record number of net new hires for the second consecutive quarter," CFO Burt Podbere said on CrowdStrike's recent fiscal 2023 second-quarter conference call. "Bringing on and retaining top talent is a cornerstone to supporting our product road map, future growth, and market share gains in new markets."
The need to secure businesses, governments, and infrastructure grows whether a recession comes or doesn't. CrowdStrike's hiring is an excellent indicator to shareholders that the company can withstand a broader economic downturn.
2. Revenue retention: Customers are sticking and spending
CrowdStrike has posted a gross retention rate of over 97% every quarter since fiscal Q2 2019 (ended July 31, 2018). It was 98.1% in the latest quarterly report. Its net retention is equally impressive, besting 120% over this time. The former indicates customers are pleased with the product and renew subscriptions, while the latter shows they also spend more on CrowdStrike's products each year.
It's no surprise that annual recurring revenue exploded to over $2 billion in fiscal Q2 2023 (ended July 31, 2022) because of this customer retention success. The rapid rise is depicted below.
The hiring outlined above is partly a reflection of this trend of revenue retention. It also plays to management's confidence in planning for continued rapid expansion.
3. Turning a profit: Is CrowdStrike's model achievable?
CrowdStrike has a long-term target model that calls for an operating margin of over 20% of sales and a free cash flow (FCF) margin of over 30% of sales. After years of brisk growth, there are signs that these two targets can be reached. The company has an enviable gross margin of 77%, and free cash flow is exploding.
CrowdStrike generated just $12 million in FCF in fiscal 2020 but $442 million in fiscal 2022. FCF has leaped to $293 million on 54% growth through the first half of fiscal 2023. Operating expenses as a percentage of revenue are also dropping, just as the growth plan predicts. Management is executing the plan, and profits are coming into focus.
It all adds up to a potential investment winner
The stock market tends to overcorrect during good times and bad. With CrowdStrike stock down about 45% from 52-week highs, it may have already overcorrected. In fact, it has a price-to-sales (P/S) ratio just above its March 2020 pandemic lows. But business is up, and the performance indicators above are bullish. Investors outperform the market over the long term by capitalizing on these market inefficiencies. And they don't have to time the exact bottom to make healthy long-term profits.
Investing in a bear market is tough. Everyone's financial situation is different, but a disciplined strategy like dollar-cost averaging and diversity is prudent. If you are a tech investor looking for long-term growth and a stock that looks historically undervalued, CrowdStrike should be on your radar.