Recession fears have scared investors out of the market this year, and many excellent growth stocks have fallen sharply as a result. For example, cloud computing specialist Cloudflare (NET 2.33%) has seen its share price plunge 80%, though nothing material has changed about its business. In fact, Cloudflare has continued to innovate and grow like wildfire. But shortsighted traders are simply unwilling to pay up for growth stocks amid the uncertain economic environment.
Fortunately, that creates a buying opportunity for long-term investors. Here is why Cloudflare could grow fivefold in the next five years.
Cloudflare operates the world's fastest cloud network and developer platform
Cloudflare provides application, network, and security services that accelerate and protect business-critical software and infrastructure. Its global cloud platform spans more than 100 countries and interconnects with 11,000 other networks, including every major enterprise, cloud vendor, and internet service provider. That immense scale is a big advantage.
Specifically, Cloudflare operates the fastest cloud platform on the planet, topping larger vendors like Amazon Web Services (AWS) and Alphabet's Google Cloud Platform (GCP). In fact, Cloudflare can deliver content to 95% of internet users in just 50 milliseconds.
But the company also benefits from another key advantage: neutrality. Its platform was engineered to support multi-cloud strategies, meaning it works alongside public clouds like AWS and GCP to give customers unified control over their IT environments. Given its speed and neutrality, Cloudflare leads the content delivery network software market by a wide margin.
Additionally, the company supplements its portfolio of cloud services with Cloudflare Workers, a suite of developer tools that helps businesses build software, websites, and streaming video experiences. Management says Workers is the fastest developer platform on the planet, and Forrester Research recently recognized Workers as the best edge development platform on the market.
Cloudflare has parlayed its strong market presence into monster financial results. Its customer count increased by 18% to 156,000 over the past year, and the average customer spent 24% more. In turn, third-quarter revenue climbed 47% to $254 million, and the company reported non-generally accepted accounting principles (GAAP) net income of $0.06, up from $0.00 in the same period last year.
That said, management plans to run the business at breakeven for the foreseeable future. But Cloudflare sits in front of a large and growing total addressable market (TAM) -- $135 billion by 2024, up from $115 billion in 2022 -- so it makes sense to grab market share as quickly as possible.
Cloudflare should benefit from tremendous tailwinds in zero-trust security
Cloudflare splits its TAM into four segments: application services, network services, zero-trust security services, and storage services. But two products, in particular, represent a big chunk of the total TAM. The first is Cloudflare Workers and its adjacent storage solutions: R2 object storage for unstructured data and D1 database for structured data. The company recently launched R2, and D1 will enter beta before the end of the year. Those products make Workers even more useful, as developers no longer need to provision third-party storage solutions when building applications and websites.
The second exciting growth opportunity is Cloudflare One, a secure access service edge (SASE) product that blends network services and zero-trust security services. In a nutshell, Cloudflare One provides users with fast, secure connections to corporate applications, cloud services, and the open internet from any device or location. By 2025, 80% of enterprises will adopt SASE products, up from 20% in 2021, according to IT research specialist Gartner. That means zero-trust security should be a massive tailwind for Cloudflare.
With that in mind, the company achieved an annual revenue run rate of $1 billion in the third quarter ($254 million in revenue multiplied by four is $1.02 billion). However, management says that figure will grow fivefold to $5 billion over the next five years. That implies annualized revenue growth of 38% through 2027.
Better yet, CEO Matthew Prince says that goal is achievable "without having to build or buy any new products or companies." But Cloudflare is an innovation machine, so the company could grow even faster.
Cloudflare stock could soar 400% in the next five years
Cloudflare stock currently trades at 16 times sales. That multiple is a bargain compared to the three-year average of 41 times sales, though it may seem expensive compared to other tech companies. However, investors should bear in mind the medium-term target of $5 billion in sales by 2027.
Cloudflare expects revenue to grow quickly in the coming years, and that will put downward pressure on its price-to-sales ratio. Alternatively, it could allow the stock price to appreciate rapidly without any change in the price-to-sales ratio. For instance, the stock could grow fivefold (or 400%) over the next five years, and as long as Cloudflare hits its medium-term financial target, the price-to-sales ratio would remain constant.
That's why this monster growth stock is worth buying.
