The market has drastically reassessed its stance on growth stocks over the last couple of years. While soaring inflation, rising interest rates, and the looming specter of economic downturn have generally crushed share prices for companies that had heavily forward-looking valuations, there have been some great stocks caught up in this broader trend that will likely bounce back to deliver incredible returns for patient investors.

In an age when internet-based communications, platforms, and services have never been more central to business and everyday life, Cloudflare (NET) is arguably one of the most important companies, and its technologies will only become increasingly essential going forward. With the stock down 37% over the last year and 74% from its high, building a position in this web services leader at today’s prices is a move that could deliver tremendous returns for long-term shareholders.

Cloudflare is a leader in essential service categories
If a bad actor wants to take a website or application offline, one of the easiest ways to do it is to flood its servers with a deluge of spoofed access requests. This attempt to overwhelm servers is known as a distributed-denial-of-service (DDoS) attack, and it’s one of the most cost-effective ways for cyber criminals to bring down internet destinations if proper protections are in place.

The good news is that Cloudflare has extremely effective DDoS protections available for customers of virtually all sizes, and the cybersecurity provider continues to update its technologies to guard against new threat vectors.

To put catalysts shaping the demand backdrop in perspective, Cloudflare reports that the amount of web-based DDoS traffic increased 79% year over year in the fourth quarter. Additionally, the company saw the strength and duration of attacks increasing — with the number of attacks exceeding rates of 100 gigabits per second and the number of attacks lasting more than three hours up 67% and 87%, respectively, on a sequential basis.

Some industries that need high levels of security actually now see substantial portions of overall traffic to related web properties coming from DDoS traffic. Web-based DDoS attacks accounted for 35% of all traffic to internet properties in the aviation and aerospace industries, and DDoS traffic made up more than a third of traffic to properties in the gambling and finance industries as well.

In addition to its market-leading protections against DDoS attacks, Cloudflare also provides content-delivery-network (CDN) services. CDNs use a technology known as “edge computing” to shift computations to servers that are closer to users’ geographical location, in order to speed up the rate at which information can be sent and received around the web. With more applications and services being brought to the cloud and the complexity of web communications generally increasing, CDNs play a key role in ensuring that businesses’ services run efficiently and that individual users have smooth experiences.

Powered by strong demand for its core services, Cloudflare managed to grow revenue at a 51% compound annual growth rate from 2019 through 2021, and management’s most recent guidance suggests the business managed to grow sales roughly 48.5% in 2022.

Long-term investors could score incredible wins
Despite posting impressive sales growth and providing services that are basically essential for many companies in this day and age, Cloudflare’s valuation has gotten crushed as the market has moved away from growth stocks. The company’s share price has fallen precipitously from its peak, and the big sell-off has pushed shares down to levels that leave room for potentially explosive long-term upside.

Sporting a market cap of roughly $16.3 billion, Cloudflare trades at approximately 12.4 times expected forward sales. No doubt about it, that’s still a highly growth-dependent valuation, but the business is expanding at a rapid clip and remains in the early stages of tapping into a massive opportunity.

With its last quarterly report, Cloudflare’s midpoint guidance called for revenue of roughly $974.5 million in 2022, suggesting it would capture less than 1% of its $115 billion estimated total addressable market in the year. With the company anticipating that it will have a total addressable market of $135 billion in 2024, the web services specialist has the benefit of a large and growing market to tap into. Perhaps even more importantly, the business is gaining share much faster than the markets for its core services are expanding.

Cloudflare is already profitable on a non-GAAP (adjusted) basis. Sales are growing rapidly, and the company has a net cash position of roughly $1.6 billion it can use to fund internal growth initiatives or pursue strategic acquisitions. For investors seeking growth stocks worth owning for the long haul, I think there’s a very good chance Cloudflare can deliver incredible returns over the next decade and beyond.

— Keith Noonan

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Source: The Motley Fool