Shares of Cloudflare (NET -0.94%) have been in the doghouse for months. Down 38% over the last 12 months, it's understandable why some investors have given up hope on the cloud application provider.
Yet now could be precisely the wrong time to ditch Cloudflare. Indeed, with growth stocks starting to show their first signs of life in over a year, now might be the time to load up on shares of Cloudflare.
Let's have a closer look to see why.
Image source: Getty Images.
Is Cloudflare's business thriving or surviving?
Clouldflare is a young company. If it were a person, it would be a toddler. And, if you've ever had an experience with toddlers, you know they exhibit one trait above all else: volatility.
In much the same way, Cloudflare is still finding its footing. The company reported a decent third quarter (the three months ended on Sept. 29, 2022), with some metrics improving and others declining. Total paying customers rose to 156,000; large customers (those with over $100,000 in annual revenue) grew to 1,909. However, those positive developments were matched by deterioration in other key metrics.
Image source: Cloudflare Q3 2022 earnings presentation.
Non-GAAP (adjusted) gross margin fell to 78% from 79% a year earlier. Dollar-based net retention (a key metric for SaaS companies) fell to 124% after peaking at 127% in the first quarter of 2022.
Overall, the results paint the picture of a business still finding its way forward, which is what you'd expect from a young company that is firmly in its growth stage.
How much is Cloudflare growing?
For Cloudflare, growth is the name of the game. Without it, the company is not an intriguing investment. Fortunately for Cloudflare, it is growing -- rapidly. However, the pace of growth has slowed somewhat.
NET Revenue (Quarterly YoY Growth) data by YCharts.
Revenue growth fell to 48% in the third quarter of 2022. That's down from 54% in the prior quarter and below its three-year average of 51%. That might seem like nitpicking, but for a hypergrowth stock like Cloudflare, it matters. Any sign of slowing growth can send shares into a nosedive.
Is Cloudflare a buy right now?
Even though we're less than a month into 2023, there are signs that this year will be better for growth stocks. For example, the Vanguard Growth ETF has outperformed the Vanguard Value ETF year to date by more than 5%. Compare that to last year, when Value bested Growth by 29%.
As for Cloudflare itself, the company remains a promising one. Customers and revenue continue to grow as organizations flock to Cloudflare's integrated cloud application model to help rationalize and manage their bloated digital footprint.
Because of that, I think Cloudflare is a buy right now. That said, don't be surprised if this toddler of a company metaphorically glues the cat to the carpet by reporting a bad quarter every now and then. After all, that's what toddlers do.
