Cloudflare NET has enjoyed a remarkable 53.1% surge in the past six months, outperforming the Zacks Internet - Software industry, Zacks Computer and Technology sector and the S&P 500’s return of 19.6%, 9.3% and 12.4%, respectively. But with such a stellar performance, investors are left wondering — should they double down on NET, or is caution the wiser path?

Cloudflare Price Performance Chart

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Cloudflare’s Innovations Drive Market Outperformance

Cloudflare’s strong performance can be attributed to the innovations the company is bringing into the content delivery space. Cloudflare’s mission to build a better Internet has resonated with the diverse customer base, spanning small businesses and large enterprises. NET’s large-scale global network, along with its strong focus on performance and security, has positioned it as a leader in the industry.

In its third-quarter 2024 earnings, NET reported that it was able to secure 219 large customers who pay more than $100,000 annually. Cloudflare’s high customer acquisition is also supported by a high net retention rate, indicating strong customer loyalty and the ability to upsell additional services. Moreover, NET directly serves 35% of Fortune 500 companies, providing access to a high-quality and prestigious customer base.

Cloudflare has also made significant strides in integrating artificial intelligence into its offerings. Besides launching several AI-based products, the company also partnered with the AI industry leaders, including NVIDIA and Microsoft, in 2024. Strengthening portfolio and strategic partnerships ensure that NET’s products remain at the forefront of innovation, attracting investors’ attention to the stock.

Why Caution May Be Warranted for NET Stock

Despite Cloudflare’s exceptional performance and strong fundamentals, its current valuation raises concerns. While the company has shown impressive growth in customer acquisition and product innovation, such momentum has already been priced into the stock’s valuation, leaving limited room for error.

At present, Cloudflare appears overvalued from a price-to-sales perspective. NET stock is currently trading at a forward 12-month P/S ratio of 18.63, significantly higher than the Zacks Internet - Software industry average of 3.13. This premium valuation raises concerns about the stock’s sustainability, signaling potential downward risk.

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Cloudflare Experiences Sluggish Sales Growth

Although Cloudflare has experienced impressive growth since its IPO in 2019, recent quarterly reports indicate a slowdown. The company's revenue growth, while still robust, is not as explosive as in previous years.

Cloudflare enjoyed nearly 50% year-over-year top-line growth until 2022. However, the growth rate decelerated to 33% in 2023. Current estimates for 2024 and 2025 suggest further deceleration between 25% and 30%.

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Cloudflare Faces Intensifying Competition

The market for web infrastructure and security services is growing highly competitive, where several well-established players like Akamai Technologies, Inc. AKAM, Fastly, Inc. FSLY and Amazon.com, Inc.’s AMZN Amazon Web Services are vying for market share. Furthermore, new entrants and niche players are constantly emerging, adding to the competitive pressure.

Cloudflare has successfully differentiated itself with a comprehensive platform that integrates performance, security and reliability. However, maintaining this edge requires ongoing innovation and significant investment in research and development. The constant need to stay ahead of competitors poses a risk to Cloudflare’s growth and profitability.

What Should Investors Do?

While Cloudflare's recent stock surge and strong market position are encouraging, significant volatility and high valuation warrant caution. The company's slowing growth rates, competitive pressures and macroeconomic uncertainties pose near-term risks.

Therefore, we believe new investors should wait for a better entry point and existing investors should retain Cloudflare, which currently carries a Zacks Rank #3 (Hold), given the modest growth prospects and a stretched valuation in the near term. You can see the complete list of today’s Zacks #1 Rank (Strong Buy) stocks here.

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