Shares of Cloudflare Are Dropping Today. See Our Analysis!

Software company Cloudflare stunned Wall Street today as it plummeted to $49.11, marking a -6.8% change compared to the S&P 500 and the Nasdaq indices, which logged -0.6% and -0.3% respectively. NET is -28.87% below its average analyst target price of $69.04, which implies there is more upside for the stock. As such, the average analyst rates it at buy. Over the last year, Cloudflare has lagged behind the S&P 500 by -59.9%, moving -75.8%.

Cloudflare does not release its trailing 12 month P/E ratio since its earnings per share of $-0.83 are negative over the last year. But we can calculate it ourselves, which gives us a trailing P/E ratio for NET of -59.4. Based on the company's positive earnings guidance of $0.15, the stock has a forward P/E ratio of 327.4.

The average trailing Price to Earnings (P/E) ratio of US-based technology companies is 26.5 as of third quarter of 2022. In contrast, the S&P 500 average is 15.97. The P/E ratio is the company's share price divided by its earnings per share. In other words, it represents how much investors are willing to spend for each dollar of the company's earnings (revenues minus the cost of goods sold, taxes, and overhead).

To better understand the strength of Cloudflare's business, we can analyse its operating margins, which are its revenues minues its operating costs. Consistently strong margins backed by a positive trend can signal that a company is on track to deliver returns for its shareholders. Here's the operating margin statistics for the last four years:

Date Reported Total Revenue ($) Operating Expenses ($) Operating Margins (%) YoY Growth (%)
2021-12-31 656,426,000.0 783,730,000.0 -19.39 16.82
2020-12-31 431,059,000.0 531,548,000.0 -23.31 38.02
2019-12-31 287,022,000.0 394,968,000.0 -37.61 14.64
2018-12-31 192,674,000.0 277,573,000.0 -44.06 n/a
  • Average operating margins: -31.1%
  • Average operating margins growth rate: 23.2%
  • Coefficient of variability (lower numbers indicate less volatility): 37.5%

Another key to assessing a company's health is to look at its free cash flow, which is calculated on the basis of its total cash flow from operating activities minus its capital expenditures. Capital expenditures are the costs of maintaining fixed assets such as land, buildings, and equipment. From Cloudflare's last four annual reports, we are able to obtain the following rundown of its free cash flow:

Date Reported Cash Flow from Operations ($) Capital expenditures ($) Free Cash Flow ($) YoY Growth (%)
2021-12-31 64,648,000.0 -92,986,000.0 -28,338,000.0 61.45
2020-12-31 -17,129,000.0 -56,375,000.0 -73,504,000.0 10.59
2019-12-31 -38,917,000.0 -43,289,000.0 -82,206,000.0 -19.58
2018-12-31 -43,281,000.0 -25,466,000.0 -68,747,000.0 n/a
  • Average free cash flow: $-63,198,750.00
  • Average free cash flow growth rate: 17.5%
  • Coefficient of variability (the lower the better): 37.8%

If it weren't negative, the free cash flow would represent the amount of money available for reinvestment in the business, or for payments to equity investors in the form of a dividend. While a negative cash flow for one or two quarters is not a sign of financial troubles for NET, a long term trend of negative or highly erratic cash flow levels may indicate a struggling business or a mismanaged company.

Value investors often analyze stocks through the lens of its Price to Book (P/B) Ratio (its share price divided by its book value). As of the third quarter of 2022, the mean P/B ratio of the technology sector is 5.57, compared to the S&P 500 average of 2.95. The book value refers to the present value of the company if the company were to sell off all of its assets and pay all of its debts today - a number whose value may differ significantly depending on the accounting method. Cloudflare's P/B ratio indicates that the market value of the company exceeds its book value by a factor of 27, so it's likely that equity investors are over-valuing the company's assets.

Since it has a negative P/E ratio, an elevated P/B ratio,and consistently negative cash flows , Cloudflare is likely overvalued at today's prices. The company has poor growth indicators because of no published PEG ratio and negative operating margins with high variability. We hope you enjoyed this basic overview of NET's fundamentals. Make sure to check the numbers for yourself, especially focusing on their trends over the last few years.

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The above analysis is intended for educational purposes only and was performed on the basis of publicly available data. It is not to be construed as a recommendation to buy or sell any security. Any buy, sell, or other recommendations mentioned in the article are direct quotations of consensus recommendations from the analysts covering the stock, and do not represent the opinions of Market Inference or its writers. Past performance, accounting data, and inferences about market position and corporate valuation are not reliable indicators of future price movements. Market Inference does not provide financial advice. Investors should conduct their own review and analysis of any company of interest before making an investment decision.