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Is Cloudflare Stock A Buy Now?
Cloudflare (NYSE: NET) stock has been on a red-hot run on the stock market in the past six months. As of this writing, it's gained an impressive 60% thanks to the company's improving growth profile fueled by the adoption of its artificial intelligence (AI)-focused offerings.
Known for providing customers with cloud-based solutions that enable them to secure their internet connections, apart from improving the performance and security of websites and applications, Cloudflare's foray into AI has unlocked a new growth opportunity for the company. It sees a 26% jump to a whopping $222 billion in its total addressable market over the next three years.
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However, should investors consider buying Cloudflare stock right now following the impressive gains it has clocked in the past six months? Or should they stay away from it, considering its valuation? Let's find out.
Cloudflare stock is expensive right now
The remarkable rally in Cloudflare stock has brought its price-to-sales (P/S) ratio to 27. That's higher than the company's five-year average sales multiple and exceeds the S&P 500 index's P/S ratio of 3.1 by a huge margin. It is also worth noting that its forward earnings multiple stands at 150.
Cloudflare, therefore, is trading at a very rich valuation right now. The company will have to keep growing at an incredible pace to justify those multiples. However, the problem is that Cloudflare is currently navigating a tight IT spending environment. CEO Matthew Prince remarked on the company's November 2024 earnings conference call that customers are "closely scrutinizing every deal, emphasizing cost efficiency, and seeking meaningful ROI."
Prince also added that Cloudflare missed out on "some larger deals" in the U.S. in the third quarter of 2024 on account of a rejig in its sales force. The good part was that Cloudflare managed to raise its 2024 guidance slightly despite these challenges. It expects to clock 28% revenue growth for the year. Even better, the company managed to increase its paying customer base by almost 22% from the year-ago period.
AI has started moving the needle for the company
A closer look at management's comments on the previous earnings conference call indicates that AI could be helping Cloudflare mitigate the impact of the tepid IT spending environment. Its Workers AI platform, which allows customers to run AI models and build applications on Cloudflare's global server network, witnessed terrific traction.
One of its existing customers signed a $7 million contract for using Workers AI in Q3, up significantly from the initial contract worth half a million dollars it signed in Q2. This was just one of the examples of Cloudflare landing big contracts for Workers AI in the quarter. Management also highlighted other multimillion-dollar deals for Workers AI on the conference call.
This could be the beginning of a solid growth curve for Cloudflare as the demand for AI services in the cloud is expected to take off in the long run. Cloudflare already has a massive base of more than 221,000 paying customers and has started spending more money on its platform thanks to AI. As a result, Cloudflare will continue to build out its AI infrastructure by buying more graphics processing units (GPUs) in 2025 so it can support the growing demand for its services.
This investment should negatively impact its earnings growth this year. Consensus estimates are projecting a 15% increase in Cloudflare's earnings in 2025, to $0.85 per share, following an estimated jump of 52% last year. However, as the following chart tells us, its earnings growth is expected to accelerate from 2026 onward.
NET EPS Estimates for Current Fiscal Year data by YCharts. EPS = earnings per share.
So, Cloudflare stock may witness a correction as it tries to overcome the challenging spending environment and build out its AI infrastructure. At the same time, these factors could negatively impact its bottom line. If that's indeed the case and the stock is available at a cheaper valuation, it would be a good idea for savvy investors to buy it.
After all, Cloudflare's AI offerings have gained incredible traction in a short time, and the company's global network spans 300 cities. It could be at the beginning of a massive growth opportunity as it deploys GPUs to handle AI workloads in more locations. Also, its vast customer base should ideally open a nice cross-selling opportunity for AI services. Gartner, on the other hand, is forecasting a pick-up in global IT spending this year by a couple of percentage points to 9.3%.
All this indicates that Cloudflare could grow at a healthy pace in the long run, which is why buying this tech stock on the dip may turn out to be a smart move.
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Harsh Chauhan has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Cloudflare. The Motley Fool recommends Gartner. The Motley Fool has a disclosure policy.
