Without Profits, Cloudflare Stock Is Too Expensive No Matter What

Cloudflare (NYSE:NET) stock has performed extremely well in 2021. As of Oct. 20, it’s up 130%, opening at $175.80. With this in mind, many investors think that there are only two scenarios for NET stock. Either this momentum will continue, sending prices higher, or more prudent, conservative investors and traders will wait for a dip to occur to buy at a lower price and have a margin of safety. That being said, it’s never a good idea to chase a stock price higher if your only argument is that you don’t want to miss out.

Close up of Cloudflare logo at the Company's headquarters

Source: Sundry Photography / Shutterstock.com

My take on the matter is that NET stock now is too overvalued; a dip would not make it a bargain. Some investors may focus on technical analysis and argue that Cloudflare shows strong momentum. This is true, but the stock is also at extreme levels based on technical analysis indicators such as the popular RSI(14) indicator, which sits at 74.68. Anything above a 70 is considered overbought.

The truth is, of course, that we cannot predict the outcome with accuracy — maybe NET stock goes up, or maybe it goes down. Momentum stocks may continue to move higher and leave fundamental analysts like me questioning the logic. The stock market is not always rational. That being said, I’m interested in maximizing the shareholder’s value, valuation and financial performance.

The Value of NET Stock

Cloudflare offers a variety of cloud-based services to websites. Its portfolio of products is used to ensure reliable, secure performance for critical web infrastructure. It might be tempting to think that Cloudflare’s price corresponds to incredible shareholder value, but that’s not the case.

Shareholder value comes from creating profit. Do not confuse the stock price with shareholder value.

It is tempting to argue that with the NET stock having just hit an all-time high, management must be doing things right. However, Cloudflare has not achieved yet any profitability. Cloudflare is losing money and has had a net loss quarter after quarter.

There are several valuation metrics we can use to analyze whether NET stock is attractive or not beyond just income. The company has a trailing twelve months free cash flow loss of $53 million. The TTM price to sales ratio is 96.

On the other hand, revenue growth is strong. Year over year, Cloudflare’s quarterly revenue is up 53%. Investors consider NET stock a growth stock and completely ignore its valuation. There’s danger in that belief, though.

When Will Cloudflare Be Profitable?

Cloudflare had a gross margin of 77% in its most recent quarter. The Q2 financial results had a few impressive numbers. Besides 53% revenue growth, the company also highlighted record dollar-based net retention of 124% and 140 new large customers in the quarter.

CEO Matthew Prince said, “We had our strongest quarter ever as a public company, and our revenue growth continued to accelerate, growing 53% year-over-year.”

That doesn’t change the fact that Cloudflare is losing money consistently as of 2016. In 2020 the reported net loss was $119.37 million, compared to a net loss of $105.83 million in 2019.

Fundamentals other than revenue growth show that Cloudflare has many flaws. The company has no profits, negative free cash flow, and a valuation that flirts with extreme values on a relative basis.

I would avoid NET stock for now. Until I see revenue growth turn to profits, I consider Cloudflare a very expensive stock to avoid. The current stock price is very disconnected from its intrinsic value.

On the date of publication, Stavros Georgiadis, CFA  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.

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