Cloudflare, a provider of web, speed and security software (NYSE:NET) reported results that exceeded analyst expectations.

The stock is up about 5% in after-hours trading as investors loved to see accelerating revenue growth.

Management also gave out 1Q 2020 and full year 2020 revenue estimates that were 4% higher than current consensus, also positive for the story.

Cloudflare has been the weakest performing SaaS stock YTD and these results should help reverse this trend as we move through the next few months.

Software Stock Performance YTD

Source: YCharts

Revenue came in at $84 million, 6% better than consensus of $79 million and guidance of the same amount.

Revenue growth of 51% accelerated from last quarter’s growth of 48% which was well received by the market.

The earnings per share loss of -$0.06 beat consensus and management guidance of -$0.07/sh

The EBITDA loss of -$16.5 million, was 30% higher than the -$12.7 million loss analysts were expecting, but the market didn’t seem to care as long as revenue was accelerating.

Cloudflare is a leader in the product categories it offers, but the stock at $18 is already baking in all the good news. We need to see either an accelerating growth rate for more than 1 quarter or the stock to fall below $12 to get interested. A great company at the wrong price.

Cloudflare is trading at a 14.4x multiple of next year’s sales, about 10% below the trendline for the group.

The market expects 2020 revenue growth of 33% and if Cloudflare can beat that number, the multiple will no doubt expand as we go through the year, pulling the stock up with it. 

The company has more than 5 years of cash left so the market will likely be focused on growth, not profitability at this stage in the company’s development.

2020 Price to Sales Multiples for the SaaS Group (Software as a Service)

Source: YCharts

Sell Cloudflare Above $20, Buy Hand Over Fist Below $7.00

As market and stock sentiment changes, stocks waver between cheap and expensive all the time.

Because of this volatility, we recommend looking at stock prices through the lens of a buy and sell point, not just one fundamental value.

In the case of Cloudflare, we have defined potential buy and sell points based on the most expensive and cheapest multiple in the cloud services industry.

Grizzle’s Guide to Trading Cloudflare

If the stock approaches $20, or 16x price to sales, it will be trading very rich and should be sold.

Historically cloud stocks that approach 16x-20x price to sales don’t stay there for long, just look at competitor  ZScaler.

Any small earnings or revenue miss can have huge consequences for the stock.

Zscaler Price to Sales Multiple Down from 25x to 15x in 30 days

Source: Yahoo Finance

On the flip side, if the stock approaches $7.00/sh, a very reasonable price to sales multiple of 6x, investor’s should be buying with confidence.

Cloudflare is an excellent company, with an industry-leading footprint and a product offering that is second to none.

The problem with the stock is that investors already agree and at $18.00/sh are bidding the stock up to a level where management must beat expectations just to stay flat.

Very few investors make money buying stocks that are priced for perfection, and this time will be no different.

We are staying on the sidelines for now, but if the stock should fall towards $7.00/sh we will be buying with confidence knowing we own a piece of a quality company for a cheap price.

This is most definitely a stock to keep on the radar for the long term.

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The opinions provided in this article are those of the author and do not constitute investment advice. Readers should assume that the author and/or employees of Grizzle hold positions in the company or companies mentioned in the article. For more information, please see our Content Disclaimer.