Cloudflare Has a Good Story That Must Avoid Becoming a Tall Tale

Stock Market

Investors in Cloudflare (NYSE:NET) stock are finding life in the middle to be baffling. In the past 12 months, NET stock was being overlooked for reasons that I would have to guess had to do with investors chasing other sectors.

An illustration a Cloudflare (NET) logo is seen displayed on a smartphone

Source: IgorGolovniov / Shutterstock.com

But that all changed in early summer. As our Louis Navellier points out the Colonial Pipeline breach and subsequent ransom put the issue of cybersecurity on the front burner for investors. And almost overnight, NET stock began what has become a meteoric ascent.  

However, the ascent was moving along in a fairly orderly fashion. That is until Oct. 1. At that point, NET stock went hyperbolic, nearly doubling its stock price in the six weeks from Sept. 29 to Nov. 18. The new catalyst appeared to be the Meta Platforms (NASDAQ:FB) – then Facebook – outage in early October.  

Finally, the company’s most recent earnings report in November pushed NET stock to the top that it couldn’t hold. The stock is down almost 30% in the last month. So that is leading many to ask whether the sell-off is over. 

I tend to follow the adage of not paying tomorrow’s price today. Of course, sometimes that’s impossible to avoid. That’s why if you’re a current NET shareholder, I’d sit tight. In fact, I may take the stock’s current price as an opportunity to buy. 

The tougher question comes if you’re looking to take a new position. For those investors I’d want to make sure that the company’s story of innovation doesn’t become a tall tale.

Innovative, But in No Rush to Profit 

Investors had to cheer the fact that Cloudflare showed a profit by GAAP measures in its most recent quarter. And CEO Matthew Prince reiterated the company’s goal of achieving a 20% operating margin.  

However, Prince also made it clear that the company was in no hurry to make that happen. In fact, Prince said, “As long as we can achieve extraordinary growth, we anticipate that we will pour our profits back into our research and development and sales and marketing machine.” He went on to say, “We anticipate that we will hover just below or above breakeven likely for years to come.”

On the surface, that’s not a particularly controversial comment. Particularly in the context that Cloudflare was going to continue to develop innovative products to fuel its growth. Nevertheless, I can’t help but look at those words, “As long as we can achieve extraordinary growth…” 

And I hope investors look at them too. So far so good. In the quarter just ended, Cloudflare’s revenue was 13% higher than the prior quarter. And the company posted double-digit sequential growth in three of the last four quarters.  

So maybe Prince knows of what he speaks. However, if that growth slows, Prince may only have himself to blame if investors decide to bail on NET stock.

NET Stock Is a Cautious Buy 

The risk of buying Cloudflare at its current price is that it may have further to fall. Of course, the risk of not buying NET stock is that the stock could be near a bottom.  

Alex Sirois wrote that Wall Street analysts gave NET stock a consensus price target of $212.50. According to MarketBeat data on Cloudflare, the consensus price target is $164.55. That’s a premium of about 20% from the stock’s current price. That seems much more realistic when you consider that the average gain in Dow Jones stocks over the past 10 years is 11.5%.  

If you can buy a stock with strong conviction that it can generate a return that’s 2x the average for its exchange, you do that. If you have that conviction in Cloudflare, then the stock would seem to be at a good buying point. But if you have any hesitancy at all, it’s OK to wait for a bullish confirmation.  

On the date of publication, Chris Markoch did not have (either directly or indirectly) any positions in the securities mentioned in this article. The opinions expressed in this article are those of the writer, subject to the InvestorPlace.com Publishing Guidelines.  

Chris Markoch is a freelance financial copywriter who has been covering the market for seven years. He has been writing for InvestorPlace since 2019. 

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