Cloudflare Shows the Perils of Buying Growth

Stocks to buy
  • Cloudflare (NET) is growing fast but the stock was overpriced
  • Nothing is wrong with the business
  • Cloudless Cloud is still a thing
Exterior view of Cloudflare headquarters. NET stock.

Source: Sundry Photography / Shutterstock

Cloudflare (NYSE:NET) stock represents a fast-growing company in an important niche.

Just don’t make the same mistake I made and overpay for it.

I’m still underwater on Cloudflare buys I made in December, despite it gaining 37% over the last month. It may still be too expensive for a trading profit. Cloudflare opened for trade April 14 at about $121/share. That’s a market cap of $39.4 billion on unprofitable 2021 sales of $656 million.

What could have possessed me? That sales figure represented 52% growth over 2020. Shares had been trading at $211 in November. I “bought the dip” and it kept dipping, bottoming in late January at $82.

Why, you then ask, am I not taking my losses? That’s a good question.

NET Cloudflare, Inc. $114.47

The Bull Case on NET Stock

Growth is one reason.

Cloudflare next reports results on May 5, and analysts expect revenue to hit $202 million for the March quarter. The expected gain of 3 cents/share looks reasonable given the growth rate. For the year analysts expect growth of 42% and a small profit.

More important is what Cloudflare does. It operates its own Domain Name System, which it can use to stop Denial of Service attacks. In addition to its cloud security function, it can also create ad-hoc virtual private networks, using clouds and data centers in 100 countries, This includes mainland China, South America and many hard-to-reach locations in Africa. Cloudflare says it can give 95% of the world’s people latency as low as 50ms. I can’t always get that in my Atlanta home-office.

The result is the “Cloudless Cloud.” Cloudflare puts cloud services into remote data centers, making them ubiquitous, and creates new competition for companies like Amazon (NASDAQ:AMZN), Microsoft (NASDAQ:MSFT) and Alphabet’s (NASDAQ:GOOG, GOOGL) Google Cloud. But it’s complementary, like the small branches that give a tree its full canopy.

The Cloudless Cloud also lets Cloudflare pile on the innovation, like the new Cloudflare API Gateway. This will make it much easier for companies to manage their application programming interfaces (APIs), vital to their expansion. Cloudflare says APIs represent over 50% of its web traffic requests. The new system lets companies stop the abuse of APIs, secure them, and route requests without adding latency.

The Bear Case on NET Stock

The bear case is simple. You can overpay for growth.

The NASDAQ is down 14% so far in 2022. That’s midway between a correction and a bear market. Even the Cloud Czars are down. Analysts talk about the value of discounted cash flows, but it just means interest rates are rising. When money costs money, investors get choices. They can take the risks of growth in stocks or the riskless profit of bonds.

Cloudflare hasn’t helped itself by handing out $6.7 billion in easily earned stock grants to its co-founders. These are meant to maintain the founders’ control as they sell down their super-voting shares. That’s good for corporate democracy in the long run.

Then there’s Russia. Cloudflare isn’t leaving it. Cloudflare notes that it has no employees in the war zone, just software. But it’s not a good look. 

The Bottom Line

When tech stocks go down, they go down hard.

But there’s a difference between trading and investing. If you need your money right away, you can’t take a loss. If you have a few years to wait, you can.

I don’t need my Cloudflare investment to pay for my retirement. I’m still working and have plenty of cash. It’s in the growth side of my portfolio.

Growth stocks like Cloudflare are now out of fashion. That makes this a good time to buy them, and a dumb time to sell them. I may not break even for months, but over a few years I should do all right.

On the date of publication, Dana Blankenhorn held long positions in MSFT, AMZN, GOOGL and NET. The opinions expressed in this article are those of the writer, subject to the Publishing Guidelines.


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