Stocks to buy

Cloud services company Cloudflare (NYSE:NET) has rewarded its shareholders handsomely since its September 2019 initial public offering. NET stock is up a dumbfounding 625% since it went public at $18 a share. In the past three months alone, shares gained more than 50% as NET stock made new high after new high.

Source: Sundry Photography /

With an incredible business model and constant innovation, one could argue these returns are justified. However, for the stock to trade at nearly 64 times forward sales is a different proposition altogether.

I’ve got nothing against Cloudflare as a business. It’s a fantastic company with a healthy growth runway ahead. However, its stock valuation is a bit too lofty at this time. Therefore, it’s best to pick up NET stock on a dip.

Cloudflare Posts Strong Results

Cloudflare posted stronger-than-expected second-quarter results in early August. Revenue increased by 53% on a year-over-year basis to $152.4 million, beating estimates by over $6 million. Adjusted net loss narrowed by 24% to $7.3 million, or -$0.02 per share, also beating expectations.

In addition to overall revenue growth, the company gauges its growth based on net retention rates and gross margins. Both of these metrics also improved considerably from the second quarter of 2020. Cloudflare’s dollar-based net retention rate was 124% for Q2 2021, up from 115% a year ago. And adjusted gross margin increased to 78% from 76.8% during the same period.

The company attributed much of its growth to its large enterprise customers, which are those contributing over $100,000 in annualized revenues. It concluded the second quarter with 1,088 large customers, adding a record of roughly 140 large customers in the quarter, management said.

Looking ahead, Cloudflare expects revenue to increase roughly 60% year over year in the third quarter and around 46% for the full year.

The company’s results came in significantly better than those of rival Fastly (NYSE:FSLY). Fastly suffered a massive service outage during the quarter, which negatively impacted revenue. Fastly’s revenue increased by just 14% year over year in the second quarter. Additionally, it expects just 17% to 20% growth for the whole year.

Cloudflare clearly has the edge over competitor Fastly in terms of its growth projections. This has been reflected in the performance of NET stock, which is up more than 70% year to date compared to a 47% loss for FSLY stock.

Cloudflare on an Impressive Growth Trajectory

Given its 100% subscription-based revenue model, Cloudflare should be able to continue growing its revenues by double digits for the foreseeable future. Revenue increased at a 50% compound annual growth rate (CAGR) from 2016 through 2020 and has continued that momentum in the first two quarters of 2021.

The company is exploring new opportunities in the cloud, edge computing and the internet of things (IoT), thereby expanding its total addressable market as it focuses on growing its user base.

Moreover, as it continues to expand, its paying customers are likely to grow as well, with some becoming large customers. These clients are usually stickier and offer greater recurring returns, thus giving Cloudflare even more confidence in achieving strong revenue growth. The company’s net retention rate has consistently been above 110%, which means its customers are loyal and willing to spend more with Cloudflare.

Finally, gross margins are healthy at close to 80%, which is common for SaaS-based companies. Over time, Cloudflare’s operating expense base will become better leveraged, enabling it to achieve non-GAAP operating margins of over 20%, up from around 19% currently.

The Bottom Line on NET Stock

Cloudflare continues to execute well on its growth strategies, as evidenced by its stellar second-quarter results. The company still has several chapters to write in its growth story as it expands into more profitable business areas.

However, NET stock is trading at a premium value, which takes a little sheen off the investment. Therefore, it’s best to buy NET stock on dips or any self-correction.

On the date of publication, Muslim Farooque 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 Publishing Guidelines.

Muslim Farooque is a keen investor and an optimist at heart. A life-long gamer and tech enthusiast, he has a particular affinity for analyzing technology stocks. Muslim holds a bachelor’s of science degree in applied accounting from Oxford Brookes University.