The Price Is Right For Cloudflare, Inc. (NYSE:NET) Even After Diving 32%

Cloudflare, Inc. (NYSE:NET) shares have had a horrible month, losing 32% after a relatively good period beforehand. Looking back over the past twelve months the stock has been a solid performer regardless, with a gain of 23%.

In spite of the heavy fall in price, you could still be forgiven for thinking Cloudflare is a stock to steer clear of with a price-to-sales ratios (or "P/S") of 24x, considering almost half the companies in the United States' IT industry have P/S ratios below 3x. However, the P/S might be quite high for a reason and it requires further investigation to determine if it's justified.

See our latest analysis for Cloudflare

What Does Cloudflare's P/S Mean For Shareholders?

Recent times have been advantageous for Cloudflare as its revenues have been rising faster than most other companies. The P/S is probably high because investors think this strong revenue performance will continue. However, if this isn't the case, investors might get caught out paying too much for the stock.

Keen to find out how analysts think Cloudflare's future stacks up against the industry? In that case, our free report is a great place to start.

Do Revenue Forecasts Match The High P/S Ratio?

There's an inherent assumption that a company should far outperform the industry for P/S ratios like Cloudflare's to be considered reasonable.

Taking a look back first, we see that the company grew revenue by an impressive 29% last year. Pleasingly, revenue has also lifted 154% in aggregate from three years ago, thanks to the last 12 months of growth. So we can start by confirming that the company has done a great job of growing revenue over that time.

Turning to the outlook, the next three years should generate growth of 27% per year as estimated by the analysts watching the company. That's shaping up to be materially higher than the 11% per year growth forecast for the broader industry.

With this in mind, it's not hard to understand why Cloudflare's P/S is high relative to its industry peers. Apparently shareholders aren't keen to offload something that is potentially eyeing a more prosperous future.

What We Can Learn From Cloudflare's P/S?

A significant share price dive has done very little to deflate Cloudflare's very lofty P/S. Generally, our preference is to limit the use of the price-to-sales ratio to establishing what the market thinks about the overall health of a company.

As we suspected, our examination of Cloudflare's analyst forecasts revealed that its superior revenue outlook is contributing to its high P/S. Right now shareholders are comfortable with the P/S as they are quite confident future revenues aren't under threat. Unless these conditions change, they will continue to provide strong support to the share price.

You should always think about risks. Case in point, we've spotted 1 warning sign for Cloudflare you should be aware of.

Of course, profitable companies with a history of great earnings growth are generally safer bets. So you may wish to see this free collection of other companies that have reasonable P/E ratios and have grown earnings strongly.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.