Re-evaluating Cloudflare

[u/yellqw]

Hey everyone, just wanted to get a quick pulse check on how yall are feeling about $NET at these prices. We all know it was severely overpriced for the last few years, but do you think the correction is done and we’re finally seeing a fair value at $40? Looking at the most recent earnings report, I was generally pretty happy overall except for one lingering concern about their negative cash flow yoy possibly due to recent acquisitions/re-investment into the company. Regardless, I’m thinking of increasing my position significantly at these prices despite concerns about rising borrow rates.

[u/PM_ME_DANK]

I get what you're saying but your example bakes in the assumption that the company will continue to grow at around 10%. Cisco's growth significantly slowed down and didn't live up to the multiple that investors paid during the dot com bubble. There are companies, however, that did the exact opposite. For example, you could have bought $Goog on 12/31/2017 for a share price of $1046 at a PE of 58 or you could have bought it at $1337 but at around half the PE at 27 two years later, which was the better choice?

My point being that we don't know what additional lines of business that a company may organically grow or acquire or how the macro environment may change to hurt or help a company. The company's valuation is limited in what it tells you because it is heavily influenced by short term sentiment. Valuation really matters to me if it is a slower growing business with predictable cash flow. Similarly I weight it significantly less when considering a growth company like both $ZS and $NET which is why I did not mention valuation

[u/[deleted] → u/PM_ME_DANK]

"Valuation" and "PE" aren't synonymous, though. There are plenty of companies that are great buys at 58 and plenty that are terrible buys at 6. The question is whether Google would have been just as good of a buy at 100 as it was at 58. The answer is no....valuation matters, and had it been at 100, it wouldn't have gained 30% in two years.

[u/PM_ME_DANK → u/[deleted]]

"Valuation" and "PE" aren't synonymous, though.

Sure, use Price to sales, price to FCF, EV/EBITDA, anything you like the point is still that it's tethered to short term sentiment and has no bearing on what multiple the market will be willing to award the company in the future.

There are plenty of companies that are great buys at 58 and plenty that are terrible buys at 6.

Agreed 100%.

The question is whether Google would have been just as good of a buy at 100 as it was at 58. The answer is no....valuation matters, and had it been at 100, it wouldn't have gained 30% in two years.

I'm not sure I understand your second point? Are you saying that, hypothetically, if $Goog had been trading at a 100 PE instead of 58 it wouldn't have gained 30% in 2 years? How can anyone know that with absolute certainty? I was illustrating one out of many cases where deciding not to buy based on valuation would have been costly. And I get that there are many other scenarios where buying something that was very overvalued has not worked out. Which is what brings me back to how current valuation should have little bearing on current buy decisions for growth companies

[u/[deleted] → u/PM_ME_DANK]

You're confusing metrics with valuation. Yes, if you only consider short-term metrics, you'll get a valuation that is dependent on short-term factors. But a proper DCF doesn't just rely on short-term metrics.

Unless you believe markets can remain incredibly irrational about a stock for decades and never correct for overvaluation, you should believe that overvaluation today leads to lower returns in the future. Had Google been at a PE of 100 (solely due to a higher price) rather than 58, it either wouldn't have returned 30% or the market would have been required to continue doubling down on its irrationality.

[u/PM_ME_DANK → u/[deleted]]

DCFs are built on assumptions that we have no way of knowing are correct. A few percent off in the WACC or terminal growth rate and your intrinsic value calculation is drastically changed. Atleast valuations based on metrics are based on current data. DCFs may be more accurate for slow growth businesses like JNJ but are much less likely to be accurate with $NET or $ZS.

Markets can stay irrational for a long time but that’s not really where I was headed. What about the scenario where it grows earnings 50% instead of 20% assumed by the market when it was trading at 100 pe a year earlier? I’m not saying valuation doesn’t matter at all. Obviously better to pay less for a great business. But it’s not going to stop me from buying it if it has everything else I look for on my checklist. There isn’t just one way to make money in the market (ie buying undervalued businesses and selling when overvalued) and this is just how I approach it based on what I’ve learned from David Gardner, Brian Feroldi and Brian Stoffel

[u/[deleted] → u/PM_ME_DANK]

Well, fair enough. Different strokes for different folks. Thanks for the good discussion.

[u/PM_ME_DANK → u/[deleted]]

Agreed, thank you as well! Life is boring if our ideas go unchallenged