In the face of some sales-growth deceleration and macroeconomic pressures depressing valuation for growth stocks, Cloudflare (NET -1.47%) has seen a dramatic pullback from its previous valuation peak. The web-services specialist's share price currently trades down approximately 74% from the high that it reached in November 2021.
Should investors be buying the dip on this formerly high-flying growth stock, or is it still too risky for long-term investors at today's prices? Read on to see why two Motley Fool contributors come down on opposing sides of the bull vs. bear debate on Cloudflare stock.
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Bull case: Cloudflare is a clear-cut category leader
Keith Noonan: Across Cloudflare's core content-delivery network (CDN), domain name system (DNS) services, and software for protection against distributed-denial-of-service (DDoS) attacks, you'd be hard pressed to find companies that play a bigger role in keeping the modern internet online, accessible, and functioning at a high level.
Cloudflare grew revenue 42% year over year in the fourth quarter, reaching $274.7 million. In addition to adding 134 new customers generating at least $100,000 in annual sales each, the company also continued to expand relationships with those already using its services. Cloudflare's clients increased their spending 22% compared to the prior-year period, and the combination-customer additions and net-revenue retention helped post top-line growth and deliver best-ever operating income and free cash flow (FCF). With a 28% margin, the business posted operating income of $78.1 million, and it recorded $33.7 million in FCF on a 12% margin.
Cloudflare ended the year with 85 customers accounting for more than $1 million in annual sales each. The company has now grown the number of customers generating more than $1 million in annual sales at a 71% annual growth rate from 2019 through 2022.
While the tougher macroeconomic backdrop will tamp down on Cloudflare's sales growth this year, the company should actually have opportunities to increase market share. As CEO Matthew Prince said during the company's last earnings call, "There's no better time to outpace the competition and continue to deliver products on our customers' 'must-have' list." The web-services specialist will have the opportunity to emerge from the current batch of challenges with an even stronger market position and reap the rewards when economic conditions become more favorable.
For risk-tolerant investors seeking stocks that have the potential to deliver market-crushing gains over the next decade, I think that Cloudflare is one of the best buys available right now.
Bear case: Cloudflare faces slowing growth ahead
Parkev Tatevosian: The argument against Cloudflare stock centers around the stock having a premium valuation amid an industrywide slowdown. Potential (and current) customers are evaluating their expenses, looking to cut costs wherever possible. Any discretionary expense might be on the chopping block.
The aggressive rise in interest rates in 2022 to combat rising inflation will also be a headwind. Higher rates increase the cost of capital, which has the ultimate effect of forcing businesses to prioritize nearer-term cash flow rather than long-term growth. In an environment where enterprises are increasingly focused on costs, spending on Cloudflare products and services could be constrained.
NET Revenue (Quarterly YoY Growth) data by YCharts.
Cloudflare's revenue growth is already slowing. The chart above illustrates Cloudflare's year-over-year revenue growth has somewhat decelerated for the past couple of quarters. Meanwhile, the company is not yet profitable on the bottom line, generating an operating loss of $51 million in its latest quarter on revenue of $275 million.
NET PS Ratio data by YCharts.
Cloudflare's stock is trading at a price-to-sales (P/S) ratio of 18.6, which is not a cheap valuation. I would not be enthusiastic about paying a premium value for a business under these circumstances. I prefer to wait for a lower entry point or for industry headwinds to show clear signs of easing.
Is it time to buy Cloudflare stock?
For investors looking to minimize downside risk, Cloudflare stock could still be too richly valued at current prices. Even after big sell-offs, the company trades at a growth-dependent valuation, and this type of valuation profile is decidedly out of favor with the market right now.
Alternatively, the company is a clear-cut leader in service categories that look primed to see strong growth over the long term, and the business has shown signs that it is capable of scaling in a cost-effective fashion. For risk-tolerant investors looking for tech stocks capable of delivering multibagger returns, Cloudflare could have the makings of a worthwhile buy at today's prices.
