Microsoft co-founder Bill Gates says artificial intelligence (AI) is the most revolutionary technology he has seen in decades. He formed that opinion after watching ChatGPT ace a college-level biology exam that included open-ended essay questions. Gates shared his thoughts in a recent blog post:
The development of AI is as fundamental as the creation of the microprocessor, the personal computer, the internet, and the mobile phone. It will change the way people work, learn, travel, get healthcare, and communicate with each other. Entire industries will reorient around it. Businesses will distinguish themselves by how well they use it.
Take a moment to consider how profoundly those technologies changed the world, as well as the wealth they created in the process. Such inflection points come along rarely, and many experts (including Gates) believe AI is the next one. The best way for investors to capitalize on that once-in-a-generation opportunity is to build a basket of AI stocks.
Here's why Cloudflare (NET 1.44%) belongs in that basket.
Cloudflare is a leader in developer services
To understand why Cloudflare should benefit from the artificial intelligence (AI) boom, investors must first know what the company does and how it compares to peers. The short answer is that Cloudflare makes the internet faster and safer. The longer answer is that it provides a broad range of application, network, security, and developer services that accelerate and protect corporate software and infrastructure.
Cloudflare has differentiated itself through performance and scale. It operates the fastest cloud network and developer platform on the market, and it handles about 20% of internet traffic. Its platform is also cloud neutral, meaning it improves performance and security across public clouds and private data centers. That makes Cloudflare a useful partner even for businesses that rely on other cloud providers like Amazon Web Services and Microsoft Azure.
The upshot of its unmatched performance is that Cloudflare has established a strong presence in several cloud computing verticals, including developer services. Forrester Research recently recognized Cloudflare as the leader in edge development platforms, citing a superior product (i.e., Cloudflare Workers) and a stronger growth strategy compared to other vendors.
Management believes that its value proposition for developers -- unmatched speed and cloud-neutral technology -- will make Cloudflare a key part of the AI value chain. The company is leaning into that opportunity. It recently announced Workers AI, a service that allows businesses to build AI applications and run machine learning models on its network. Workers AI is accelerated by Nvidia GPUs and supported by other Cloudflare products like R2 (object storage) and Vectorize (vector database).
It may be a few years before those innovations become meaningful revenue streams, but the company is very optimistic. CEO Matthew Prince says that "Cloudflare is the most common cloud provider used by the leading AI companies." He also believes Cloudflare is "uniquely positioned to become a leader in AI inferencing," a market that represents the biggest opportunity in AI.
Cloudflare is a leader in zero trust network security
Beyond developer services, Cloudflare also has a strong presence in several cybersecurity markets. Forrester Research recently named the company a leader in email security, and the International Data Corp. recognized its leadership in zero trust network access.
One reason for that success is the data advantage created by its immense scale. As previously mentioned, about 20% of internet traffic flows across the Cloudflare network. That gives the company deep insight into performance issues and security threats across the web, and it uses that information to continuously route traffic more efficiently and counter threats more effectively.
Cloudflare brings together network and security services with Cloudflare One, a secure access service edge (SASE) platform that protects and connects users to private applications, public cloud services, and the open internet. Cloudflare One addresses the widespread push to modernize network security. Consultancy Gartner believes 80% of enterprises will adopt SASE architecture by 2025, up from 20% in 2021.
Cloudflare is chasing a $200 billion market opportunity
Cloudflare values its addressable market at $164 billion in 2024, but sees that figure surpassing $200 billion by 2026. Developer services and network security services account for most of that total. Cloudflare already has a strong presence in both markets, meaning the company is well positioned for future growth.
Indeed, Cloudflare ranked No. 6 on the Fortune Future 50 List for 2023, an annual assessment of the world's largest companies based on long-term growth prospects. Making the list at all is an achievement, but taking sixth place is a testament to the company's tremendous potential. The authors attributed Cloudflare's high placement to opportunities in AI inferencing and cybersecurity.
With that in mind, analysts at Morningstar expect the company to grow revenue by 34% annually over the next five years, a reasonable estimate given that revenue increased by 46% annually during the past three years. In that context, the stock's current valuation of 23.5 times sales looks reasonable, and it's certainly a discount to the three-year average of 38.7 times sales.
That said, Cloudflare is not cheap and its share price will likely be volatile. But patient investors comfortable with price swings should feel confident in buying a small position in this growth stock today, especially as part of a broader basket of AI stocks.
