Don’t overstay your welcome.
I regard CrowdStrike (NASDAQ:CRWD) as among the highest quality tech stocks in the market today. The company is a market-leading “consolidator” in the ever-relevant cybersecurity industry. The rise of generative AI has increased the long-term demand for cybersecurity products, especially best-in-class offerings like those from CRWD. Yet the past few months have seen tech stocks rally in violent fashion and now too many years of growth have been priced into the stock price. I continue to see bright things ahead for CRWD, but the current valuation is not allowing for enough potential reward to compensate for the risk. It’s time to downgrade the stock ahead of earnings next week.
CRWD Stock Price
The recent tech recovery has been incredible, but CRWD’s rise stands out among peers. The stock is now trading at around all-time highs, fully recovering its 2022 losses.
I last covered CRWD in September, where I rated the stock a buy on account of how generative AI would increase the long-term demand for cybersecurity products. The stock is up a staggering 90% since then, and I’ll be honest, I did not expect the stock to run-up this much, this fast.
CRWD Stock Key Metrics
In its most recent quarter, CRWD generated 35% YoY revenue growth to $786 million, comfortably surpassing guidance of between $775.4 million and $778 million. I note that the 35% YoY growth rate represented minimal sequential deceleration from the 36.7% growth rate posted in the second quarter. CRWD generated $199.2 million in non-GAAP net income, beating guidance for $181.8 million, and the company even generated another quarter of positive GAAP profitability, with $26.7 million in GAAP net income.
Unlike in the second quarter, when the GAAP profitability was mainly due to higher interest income offsetting negative operating income, CRWD achieved GAAP operating profitability.
On the conference call, management committed to sustained GAAP profitability moving forward. It was just two quarters ago that management cautioned that they had not yet achieved “sustained GAAP profitability,” but it appears that management now has confidence that they can continue balancing top-line growth and GAAP profitability moving forward.
In spite of the roaring tech stock prices, the macro environment has in general remained tough for enterprise tech companies due to increased scrutiny on IT spending. CRWD has managed to thrive nonetheless in large part due to its wide product portfolio which has allowed it to drive strong growth rates from existing customers.
CRWD ended the quarter with $3.2 billion of cash vs. $742 million of debt. Between the net cash position and GAAP profitability, the company maintains a bulletproof balance sheet.
Looking ahead, management has guided for the fourth quarter to see up to $840 million in revenue, representing 31.8% YoY growth. Consensus estimates call for the company to generate $840 million in revenue and $0.12 in GAAP earnings per share.
Management acknowledged that the macro environment remains challenging, noting that “deals take longer” and that they’re seeing headwinds even in products like Falcon Flex. Even so, management believes that as a consolidator, customers are attracted to their ability to save money by moving to the CrowdStrike platform, and this is certainly showing in the numbers.
Is CRWD Stock A Buy, Sell, or Hold?
CRWD is a dominant endpoint protection company that has quickly positioned itself amidst growing AI threats.
I view CRWD as being positioned in one of the best sub-sectors in the market. Whereas tech stocks typically have secular growth, cybersecurity stocks have tailwinds for as far as the eyes can see, and CRWD is considered a market leading innovator in the sector. The company operates from a position of financial strength, and management expects non-GAAP operating margins to further increase to as much as 32% over the next 3–5 years.
At its 2023 Investor Briefing, management outlined plans to reach $10 billion in annual recurring revenue (‘ARR’) within 5-7 years.
Consensus estimates are more optimistic, calling for the company to reach $10 billion in revenue by year 5. Consensus estimates call for a rather modest pace of decelerating growth over the next decade.
CRWD trades at 100x earnings, but earnings are expected to rise rapidly due to operating leverage.
One rule of thumb that I learned from the 2022 tech stock crash was, “don’t buy tech stocks when their sales multiple is the same as their growth rate.” At 25x sales, CRWD stock is not trading too far off from its 30% top-line growth rate. As stated earlier, consensus estimates look rather aggressive from a revenue standpoint. If I assume that CRWD can generate 30% to 40% net margins over the long term and trade at 30x earnings in 2033 (implying a 9x to 12x sales multiple), then CRWD is priced for roughly 10.7% to 14.3% annual returns over the next nine years (perhaps around 11% to 15% inclusive of the earnings yield). While that would likely be enough to beat the broader market, I do not view the risk-premium wide enough given the aggressive consensus estimates, aggressive valuation assumptions, as well as the limited history of GAAP profitability. Perhaps if CRWD can continue building on its GAAP profitability and execute on sustaining aggressive top-line growth rates over the coming years, then I might reconsider my lack of optimism. However, current levels are pricing in too many years of growth for my taste, as I’d prefer 15% to 18% prospective return potential for a stock of this risk profile. It can be difficult to abandon CRWD stock as it soars higher and higher, but momentum cannot drive this one higher indefinitely. I have sold my shares and intend to wait for better entry points.