What happened
Cloudflare (NET -1.63%) stock has seen precipitous sell-offs in the current bear market. The web-services company's share price has plummeted roughly 65.5% since the market peaked on Jan. 3 last year, according to data provided by S&P Global Market Intelligence.
While the company's valuation has been crushed, Cloudflare has actually continued to post strong business performance, and much of the big valuation contraction has been driven by unfavorable macroeconomic developments. High inflation, rising interest rates, and other pressures have caused investors to flee companies with heavily forward-looking valuations, but it doesn't look like the company's long-term growth story has been derailed.
So what
The Federal Reserve's approach to interest rate policy will be one of the key catalysts for Cloudflare's stock performance in 2023. If the central banking authority continues to raise rates at a rapid clip, there's a good chance the company's valuation will remain under pressure. Alternatively, a more dovish approach to rates could pave the way for a dramatic share price recovery.
While macroeconomic shifts will likely have an outsize impact on Cloudflare's stock performance, the company should continue to see solid demand for its content delivery network (CDN) services and protections against distributed denial of service (DDoS) attacks.
Cloudflare's number of customers generating over $100,000 in annualized revenue has grown at a 61% compound annual growth rate over the last two years, reaching 1,908 clients in the cohort at the end of the third quarter. Customers already using the company's services also increased their spending 24% compared to the prior-year period in Q3. These catalysts helped the company's sales increase 47% year over year and reach $253.9 million in its last reported quarter.
Facing a weakening macroeconomic backdrop, Cloudflare's midpoint guidance calls for revenue growth to decelerate to 41.5% year over year in the fourth quarter. All things considered, that still represents fairly strong growth, and it looks like the market has overreacted to the near-term pressures facing the business.
Now what
With the stock trading at roughly 11 times expected forward sales, Cloudflare still has a heavily growth-dependent valuation even after big pullbacks for the stock.
NET PS Ratio (Forward) data by YCharts
While Cloudflare's lack of substantial profits may continue to work against its valuation in the current, risk-averse market climate, it looks like the company should be able to shift into delivering strong earnings growth once it shifts some emphasis away from rapidly expanding its sales base. The company recorded a 78.1% non-GAAP (adjusted) gross margin last quarter, and the web services specialist still has an absolutely massive market opportunity ahead of it.
Cloudflare's category leading DDoS protection and CDN services position it to play a key role in the growth of the overall internet, and I think the stock stands out as a worthwhile buy for long-term investors in 2023.
