While many of the tech stocks that grew during the height of the pandemic have seen their growth slow dramatically, the true leaders haven't. Even though their stocks have been heavily sold off, these companies are the best tech investments.
They have proved their technology isn't just a fad, but rather represents a fundamental shift in business models. Plus, you can pick up shares cheaper than in the previous two years.
One of the primary examples of a company with these characteristics is Cloudflare (NET 1.44%). Its stock is down about 70% from its all-time high, yet the company has delivered impressive growth. So is now the time to purchase Cloudflare stock?
Cloudflare has a strong value proposition
Cloudflare helps its clients host websites. Because that is all it is focused on, it can provide its customers with the fastest and most secure websites.
Cloudflare's value proposition is based on the fact that networking equipment is expensive and quickly becomes outdated, not to mention the expensive tech team needed to maintain a website. But those expenses are vastly reduced when the nuts and bolts of hosting a website are outsourced to Cloudflare.
Plus, with data centers in more than 275 cities (including some in China), 95% of the world's population is within 50 milliseconds of one of those data centers, giving its customers' websites unparalleled speed.
Cloudflare has over 162,000 paying customers, with more than 2,000 of them paying at least $100,000 annually (up from 1,416 customers in 2021).
During its time as a public company, Cloudflare has consistently grown its revenue, although it is starting to slow down.
NET revenue (quarterly YoY growth) data by YCharts. YoY = year over year.
While that deceleration might worry some investors, 2023 is still shaping up to be a great year, with management guiding for 37% growth at the midpoint.
However, investors have grown tired of high-growth, unprofitable stocks. So how does Cloudflare shape up on that end?
Cloudflare has responsibly grown its expenses
Unfortunately, the company isn't profitable, at least on the basis of generally accepted accounting principles (GAAP). When stock-based compensation is subtracted, Cloudflare generated $21.6 million in net income in the fourth quarter, compared to just $100,000 last year. On a GAAP basis, those numbers were a $45.9 million loss this year and a $77.5 million loss in 2021.
While Cloudflare still has a way to go before turning profitable, it's improving. Over the past year, many companies struggled with operating expenses rising faster than revenue, but Cloudflare was an exception.
| Line Item | Q4 YoY Growth |
|---|---|
| Revenue | 42% |
| Sales and marketing | 37% |
| Research and development | 29% |
| General and administrative | 34% |
| Total operating expenses | 34% |
Data source: Cloudflare.
It might seem obvious, but expenses rising slower than revenue is crucial. And Cloudflare is among a select few that achieved that. So how did it accomplish this? By using data.
Cloudflare has access to e-commerce data through its clients and noticed a slowdown in internet activity by these domains back in December 2021. It then used this data as a reason to slow hiring. By doing this, Cloudflare didn't have to endure the painful layoffs and expensive restructuring faced by some other companies.
For the 1,300 positions Cloudflare filled in 2022, it said there were over 400,000 applicants, so the company may have gathered some of the best candidates for its openings, thanks to the blunders of others.
With Cloudflare still rapidly growing, making smart business decisions, and responsibly increasing its operating expenses, the stock seems like a great buy.
Any stock purchased at the wrong price can still be a poor investment. And at around 20 times sales, Cloudflare's stock isn't cheap. But based on all the factors mentioned above, it's evident why Cloudflare likely deserves to trade at a premium valuation.
The company will need to maintain its strong execution in 2023 and beyond. Still, it has shown prowess in a challenging operating environment, which gives me confidence that the business will be fine no matter the economy.
Cloudflare looks like a great buy at these prices, but investors will need to be patient with this stock because its high valuation could lead to significant price swings as investor sentiment changes.
