Cloudflare (NET 1.44%) stock has regained its mojo in recent months after crashing big time earlier this year. In April, the internet infrastructure services provider downgraded its full-year guidance, owing to macroeconomic pressures that elongated its sales cycle and led customers to tighten their belts.
Shares of Cloudflare are up 27% in the past six months, and it looks like investors have confidence in the company's long-term prospects despite the near-term challenges it's facing. The company released third-quarter results on Nov. 2, and the stock has been heading higher since then, even though guidance turned out to be below expectations.
CFO Thomas Seifert said on the latest earnings conference call that with "broadening geopolitical uncertainty and increasingly mixed macroeconomic data points across geographies, the business environment in which we operate remains challenging to predict." This led Cloudflare to deliver muted guidance.
However, a closer look at the company's numbers and the pace at which it is growing, even in challenging times, will tell us just why investors have been buying Cloudflare stock.
Cloudflare is growing at a healthy pace despite challenges
Cloudflare reported Q3 revenue of $335.6 million, an increase of 32% over the prior-year period. The cloud specialist's non-GAAP (generally accepted accounting principles) net income also nearly tripled to $0.16 per share. Wall Street expected $330.6 million in revenue, but an increase in the company's customer base, combined with improved spending, allowed it to clear the analyst consensus.
The company exited Q3 with 182,000 paying customers, up 17% year over year. The number of large customers, which Cloudflare defines as those who have generated annualized revenue of more than $100,000, increased 34%. Cloudflare reported a dollar-based net retention rate of 116% in Q3, up one percentage point sequentially.
This metric compares the annualized revenue from its paying customers at the end of a quarter to the annualized revenue generated by the same customer cohort in the same period last year. This means a reading of more than 100% indicates Cloudflare customers have either increased their usage of its offerings or adopted more products from the company.
Also, the company's guidance wasn't all that bad, even though it was below analysts' expectations. Cloudflare has guided for $352.5 million in revenue (at the midpoint) for the current quarter, just missing the $356.3 million analyst estimate. Still, the company is on track to deliver year-over-year revenue growth of about 28% in Q4, and its full-year revenue is anticipated to increase 32% to $1.28 billion, which is respectable considering the company has faced a challenging year.
One of the reasons why that may be the case is Cloudflare's focus on improving the efficiency of its sales force. The company has brought on new sales personnel in the past six months, and it has increased its sales pipeline by 1.6x year over year. This probably explains why Cloudflare struck a spate of new deals last quarter, and analysts are anticipating the company to sustain solid levels of growth over the next couple of years as well.
Data by YCharts.
It isn't surprising to see why Cloudflare's annual revenue growth is forecast to remain around 30% for the next couple of years. The company currently serves a huge addressable market worth an estimated $146 billion. By 2026, the size of that market is expected to jump to $204 billion. Given that Cloudflare has tapped into only a small part of this huge opportunity, the company should be able to sustain its robust growth.
How much upside can investors expect?
According to the previous chart, Cloudflare's revenue could jump to $2.1 billion in 2025. The company is currently trading at 17 times sales, which is on the expensive side. However, it's worth noting that Cloudflare's top line has increased at a solid rate over the past three years, while its sales multiple has headed south.
Data by YCharts.
This suggests the company has been able to justify its rich sales multiple over the years by sustaining strong levels of revenue growth. Assuming Cloudflare trades at a slightly discounted 15 times sales at the end of 2025 and hits $2.1 billion in revenue, its market cap would increase to $31.5 billion, a 50% increase from current levels.
As such, Cloudflare remains a solid growth stock for investors to follow, as it's navigating the current macro headwinds well.
