Share prices of Confluent (CFLT 2.98%) are up significantly so far in 2023 with gains of 49%. That comes despite a sell-off last week on news of a downgrade report by a Wall Street analyst.
Confluent's stock price fell by nearly 7% on June 14 after investment and financial services firm Guggenheim Partners downgraded the stock to neutral from buy. The firm also withdrew its one-year price target of $29 on the stock and didn't issue a new one. Confluent is still trading above Guggenheim's earlier price target, but the firm's decision not to issue a new one didn't sit well with investors.
The pullback isn't surprising considering that the multi-cloud data platform company's stock still trades at an expensive 15 times sales, and it could have done with a positive rating from a Wall Street firm.
Is Confluent's recent slide an opportunity for savvy investors to buy this cloud stock?
Confluent stock is overpriced right now
Confluent continues to trade at an expensive valuation even after its latest pullback. It is also worth noting that the stock became expensive this year following its impressive rally. It was trading at just over 11 times sales at the end of 2022. Buying Confluent at its current valuation does not look like a smart thing to do, especially considering the near-term slowdown in the company's growth.
Confluent provides a cloud-based data streaming platform that allows its customers to make decisions about their data in real time instead of requiring them to store it in silos and process it at a later stage. While the company points out that it has a massive total addressable market worth $60 billion, the weakness in overall cloud spending on account of the challenging macroeconomic environment is affecting its growth.
During its May earnings conference call, management said that it witnessed "a substantial change in the economic environment, including abrupt changes in interest rates, an economic slowdown, a significant drop in funding for private tech companies, and the recent challenges in banking." These factors are the reason why the company expects its 2023 revenue to increase by 30% to $762.5 million at the midpoint of its guidance range. That's a stark slowdown when compared to the 51% revenue growth that Confluent delivered in 2022.
So it is easy to see that the stock is expensive relative to the growth the company is expected to deliver in 2023, which is why investors would do well to wait for a better entry point. However, if the stock loses altitude and starts trading at a more enticing valuation, it could be a good idea to start buying, as Confluent stands to win from a huge end-market opportunity that could accelerate its growth in the long run.
Buying the stock at cheaper levels could be a smart long-term move
Compare its revenue to the size of its massive addressable market, and it's clear that Confluent is only scratching the surface of its potential so far. Even better, the company forecasts that its total addressable market will expand to $100 billion by 2025. The good part is that the company is setting itself up to take advantage by building a healthy customer base, and also by winning a bigger share of customers' wallets.
Confluent had nearly 4,700 customers at the end of the first quarter, an increase of 14% over the prior-year period despite the economic headwinds. It was even more interesting to see that it managed to drive stronger customer spending during the quarter. There was a 34% year-over-year increase in the number of Confluent customers providing more than $100,000 in annual recurring revenue. Meanwhile, the number of customers spending more than $1 million annually rose at a steeper 53% pace.
The robust increase in customer spending explains how it recorded a dollar-based net retention rate of 130% last quarter. The metric compares the revenue generated by a company's customers at the end of the prior-year period to the revenue generated by the same customers in the latest quarter. So a reading of more than 100% indicates that its customers are spending more on its offerings.
Confluent could continue attracting more customers to its data streaming platform and winning a growing share of their wallets. That's because, according to a 2022 report published by Forrester Research, a typical large customer could lower its costs by $2.6 million over a period of three years and enjoy a healthy three-year return on investment of 257% by buying Confluent's solutions.
As a result, Confluent is expected to maintain healthy levels of growth.
CFLT Revenue Estimates for Current Fiscal Year data by YCharts.
Meanwhile, analysts, on average, forecast that Confluent's bottom line will rise at an annualized pace of 100% over the next five years. As such, it won't be surprising to see this cloud stock turn out to be a winner in the long run, which is why investors should consider buying it if it drops to a reasonable valuation.
