Stocks to sell

Cloudflare Is Still Overvalued Despite Higher Analyst Projections

Cloudflare (NYSE:NET) stock keeps pushing higher, even though its valuation is in nosebleed territory. I want to recommend investors buy NET stock, but I can’t do that in good conscience. In fact, at this point, the only thing I can do is point out how incredibly overvalued it seems to be, even as it continues on an upward trend.

Source: Sundry Photography / Shutterstock.com

In fact, since Sept. 29, when NET stock bottomed out at $112.34, it has taken off to reach $180.77 as of Oct. 18. The stock was at $175.45 as of Oct. 20 and has pushed even higher since then. This represents a gain of more than 56% in the past month and one week. And year-to-date (YTD), NET stock jumped from $75.99 to $175.45 — a return of 131%.

It seems unlikely this could kind of performance could be maintained, but that has not prevented the stock from flying higher in the past. Even the fact that NET stock is super overvalued has not prevented its spectacular rise.

Cloudflare Stock Appears Overvalued

Cloudflare’s gains are mostly an increase in its valuation multiples, not its underlying forecast revenue or earnings.

For example, as it stands now, Cloudflare is forecast to make $632 million in revenue in 2021. But since it has an incredibly high market value of $56.48 billion as of Oct. 20, that puts it on a price-to-sales (P/S) multiple of 85.5x.

That multiple would be incredibly high even if it were a price-to-earnings (P/E) ratio for NET stock. But since revenue numbers are by definition higher in absolute dollars than earnings, the multiple should actually be much lower.

Moreover, the 2022 P/S valuation is also much higher. According to Seeking Alpha’s survey of 19 Wall Street analysts, the average revenue forecast for 2022 is $846.7 million. That represents a 34% expected rise in sales next year.

It also puts NET stock on a forward P/S multiple of 63.8x. This, again, would be too high even for a P/E multiple.

It would be one thing if Cloudflare was going to show, say, a doubling in sales next year. But a 34% rise in sales is not so special for a fast-growing cloud software company.

Granted, since my last article on Sept. 20, Cloudflare’s forecast sales for 2022 have risen from $845.14 million to $846.7 million a month later. But does that really justify a 56% gain in NET stock in the last month? I doubt it.

What NET Stock Is Worth

Analysts now project that 2023 revenue could hit $1.1 billion and double to $2.12 billion by Dec. 2024. This is why the stock’s price is so high.

Given that Cloudflare’s market value is $56.48 billion, this puts its future P/S multiple at just 26.6 times sales for the year ending 2024. That is a much more reasonable number, but of course, it represents a forecast that is at least three years in the future.

In fact, if we bring the 2024 revenue forecast back to its present value using a 10% discount rate, it lowers the revenue figure from $2.12 billion to $1.593 billion. That raises the P/S multiple to 35.5x on a present value basis.

This is still way too high. A more reasonable ratio would be 20 times sales at the most. That would lower its market value to $31.86 billion, which is 43.6% lower than today’s market value. It implies that NET stock should be priced at $98.97 based on its Oct. 20 price, or approximately $100 per share.

So, here we have a fast-growing cloud software company that is at least 43% overvalued but still climbing.

The only thing I think value or growth investors can do is wait for an opportunity to jump in when the stock falters. At least then, you can justify the nosebleed valuation on a relative historical basis compared to its past overvaluation.

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

Mark Hake writes about personal finance on mrhake.medium.com and runs the Total Yield Value Guide which you can review here.