The S&P 500 (SNPINDEX: ^GSPC) dropped into a bear market in early 2022, but the benchmark index has rebounded 10% in 2023, and history says the next bull market is coming. The S&P 500 has recovered from every past drawdown, and investors should expect the same outcome this time.
Cloudflare (NET -0.23%) has seen its share price drop 72% amid the bear market, but the future still looks bright for this up-and-coming cloud computing company. Here's why.
Cloudflare makes the internet faster and safer
Cloudflare offers a broad range of cloud services that improve the performance and security of business-critical software and infrastructure. It also provides developer tools that empower businesses to build performant applications and websites. The company has distinguished itself through engineering expertise and immense scale. Cloudflare operates the world's fastest cloud network and developer platform, and it powers about 20% of the web.
Cloudflare is also infrastructure agnostic, meaning it can accelerate performance and improve security across any infrastructure. That includes private data centers and public clouds, or any combination of the two, meaning Cloudflare is a valuable partner even for businesses that rely on products from cloud titans like Amazon Web Services or Microsoft Azure.
That compelling value proposition has consistently led to strong financial results, and that trend has continued in spite of macroeconomic headwinds. Cloudflare increased its customer count by 13% to 168,000 over the past year, and the average customer spent 17% more. In turn, trailing-12-month revenue climbed 44% to $1.05 billion, and the company reported $195 million in cash from operations, up from $6 million in the prior year.
Investors have good reason to believe Cloudflare can maintain that momentum. Speed and security are important attributes for any software system, and businesses that fail to adequately protect and connect users risk losing customers, employees, or sensitive data. That means demand for Cloudflare's services should continue to grow as the world becomes increasingly digital.
Cloudflare is chasing a massive market opportunity
Cloudflare estimates its addressable market will reach $204 billion by 2026. That figure represents the sum of three broad product categories, and the company already has strong competitive positions in all of them. The first category is application services, which includes CDN software and web application and API protection platforms. Cloudflare is a leader in both verticals, but it should be able to extend its leadership to other verticals given that it operates the most performant cloud network in the world.
The second category is network services and zero-trust security services, an area where Cloudflare is well positioned to take share with its secure access service edge (SASE) product Cloudflare One. The combination of freemium pricing and unmatched performance has drawn a tremendous number of users to Cloudflare. As discussed, about 20% of the web runs on its network, and handling all that traffic gives the company a material advantage. Cloudflare has deep insight into performance issues and security threats across the internet.
The third product category is developer services, another area where the company is poised for growth. In late 2021, Forrester Research recognized Cloudflare as the leader in edge development platforms, but it has since reinforced its leadership with new storage solutions. R2 Storage supports unstructured data like documents, images, and videos. R2 is a faster and cheaper alternative to Amazon S3 Standard. Similarly, D1 database supports structured data. Every application and website requires a database, and D1 means businesses can build applications on Cloudflare without provisioning an external database.
The case for market-beating returns
Looking ahead, management expects revenue to increase nearly five-fold to $5 billion by the third quarter of 2027, which implies annualized growth of 41% during that time period. Better yet, that forecast refers to organic revenue growth, meaning it does not account for any new products the company may develop in the interim.
With that in mind, Cloudflare stock trades at 19 times sales, a bargain compared to the three-year average of 41.8 times sales. That valuation multiple is certainly not cheap, so the stock could be volatile in the near term, but the rapid revenue growth forecasted by management will put downward pressure on the price-to-sale ratio. For instance, if Cloudflare's market cap doubled from $20 billion to $40 billion over the next four-and-a-half years, shareholders could see annualized returns of nearly 17% -- a figure that should easily beat the market -- while the valuation multiple fall to a much cheaper 8 times sales.
That's why this growth stock is worth buying.
