The list of companies associated with artificial intelligence (AI) is growing quickly. While some of these newcomers are loosely associated with AI, others have a strong connection.
One that belongs in the conversation is Cloudflare (NET 1.44%) Its large data center footprint is something that nearly all companies with AI workloads can benefit from. But is Cloudflare a solid investment right now? Let's find out.
Cloudflare has a wide variety of offerings for customers
Cloudflare's original purpose was a content delivery network (CDN), which places information closer to the end user on the internet. If a website is based in the U.S., but someone wants to access it in India, it takes a long time for that information to travel the globe. (A long time in this instance might be seconds -- but that could cause problems for some uses.)
However, Cloudflare has strategically placed data centers in over 300 cities and 120 countries to put this content as close as possible to the end user, speeding up the process.
When companies choose to host on Cloudflare, it provides them with top-notch cybersecurity. Instead of everyone with a website needing their own security solution, hosting on Cloudflare centralizes the protection. This allows the company to develop and maintain protection better than most, making it a logical choice.
Its data centers can also be used for another purpose: generative AI. When running a generative AI program, you're once again limited by the proximity of the generative AI server. With Cloudflare, you can run the tasks on its networks, improving the model's efficiency with best-in-class cybersecurity.
Cloudflare is a great way to invest in a branch of cloud computing, an industry that's expected to grow significantly over the next decade. But does it make sense to buy the stock now?
The stock would still be expensive even if it achieved its targets
It shouldn't surprise investors that a company like Cloudflare has a fair bit of hype around it. After all, its revenue grew 32% year over year in the third quarter, and it added nearly 30,000 customers over the past year, bringing its total to more than 182,000. Of that number, more than 2,500 pay $100,000 or more annually, up from 1,908 last year.
This all comes at a price, and Cloudflare's stock is highly valued.
NET PS ratio data by YCharts; PS = price to sales.
At 21 times sales, Cloudflare fetches a hefty premium to many of its tech peers. But is that warranted?
Cloudflare's long-term model projects an operating margin of 20% or more. If it could snap its fingers and achieve that with a tax rate of 20%, plus grow by 30% over the next three years, Cloudflare would produce hypothetical earnings of $425 million per year.
If you divide its current market cap ($26 billion) by that figure, you will get a forward price-to-earnings (P/E) ratio based on three-year projections. That comes out to 61 times earnings, which is a very expensive price to pay now, let alone for a company that must optimize its expenses and grow substantially for three years to achieve it.
Cloudflare could have multiple great periods over the next few years and succeed as a business, but the stock might not go anywhere due to the extremely high expectations already built into it.
