Falling -9.05% today, shares of Cloudflare are giving us reason to question their average rating of buy. Did analysts get things wrong about this stock? Let's dive into the numbers to see whether NET is overvalued at today's price of $52.18 per share.
The most common valuation metric for stocks is the trailing price to earnings (P/E) ratio. Cloudflare has a P/E ratio of -88.44 based on its 12 month trailing earnings per share of $-0.59. Considering its future earnings estimates of $0.25 per share, the stock's forward P/E ratio is 208.72. In comparison, the average P/E ratio of the Technology sector is 27.16 and the average P/E ratio of the S&P 500 is 15.97.
Cloudflare's P/E ratio tells us how much investors are willing to pay for each dollar of the company's earnings. The problem with this metric is that it doesn't take into account the expected growth in earnings of the stock. Sometimes elevated P/E ratios can be justified by equally elevated growth expectations.
We can solve this inconsistency by dividing the company's trailing P/E ratio by its five year earnings growth estimate, which in this case gives us a 66.22 Price to Earnings Growth (PEG) ratio. Since the PEG ratio is greater than 1, the company's lofty valuation is not justified by its growth levels.
We can also compare the ratio of Cloudflare's market price to its book value, which gives us the price to book, or P/B ratio. A company's book value refers to its present liquidation value -- or what would be left if the company sold off all its assets and paid off all of its debts today. I NET has a P/B ratio of 28.95, with any figure close to or below one indicating a potentially undervalued company.
Now we turn to the actual cash that Cloudflare has on hand after all of its inflows and outflows of capital have been accounted for -- including non business related items such as the cost of maintaining its debt. This final bottom line is called levered free cash flow, and for Cloudflare it stands at -$. This negative cash flow could mean the company may not be able to sustain its 0.0% dividend for much longer.
With most indicators pointing at a higher than average valuation with uncertain growth prospects, most analysts are either wrong about Cloudflare, or their research has uncovered one or more qualitative reasons to invest in the stock. For example, the strength of the management team and their plan for executing the business strategy may have convinced some analysts to give less weight to traditional quantitative factors.