Are Darktrace shares a buy after growth upgrade?

The Darktrace share price is rising after the cyber security company issued a strong update. Roland Head takes a closer look at this recent IPO.

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The Darktrace (LSE: DARK) share price rose on Thursday morning after the cyber security company upgraded its growth forecasts for the year ahead. Shares in rival FTSE tech stock Avast were also higher, after the company said it was in bid talks with US peer NortonLifeLock.

Today’s news from both companies is a useful reminder that this sector is growing fast and likely to continue expanding. Based on today’s strong update from Darktrace, should I think about buying the shares?

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The next big thing?

Darktrace says its cyber security software is like an immune system that uses artificial intelligence to understand “the pattern of life for every user and device.”

That’s a big claim, but I think the logic behind it is quite convincing. Traditional security software tries to have a record of every known threat. But these keep changing. Being able to recognise any unusual behaviour and interpret it seems like a more forward-thinking approach.

Today’s update suggests Darktrace is continuing to attract plenty of new customers. Revenue for the year ending 30 June is expected to have risen by 40% to “at least $278m.” This increase reflects a 42% rise in customer numbers last year. Darktrace now has around 5,600 customers, up from 4,700 in April.

Management expects group revenue to rise by 29-32% during the current year, up from previous forecasts of 27-30%.

It sounds as if Darktrace’s sales machine is still firing on all cylinders. But with the shares up by 90% since the company’s April IPO, is there still room for growth?

Darktrace: still losing money

When a company spends most of its time talking about revenue, then there’s a good chance it’s not actually making any profit. That’s also true with Darktrace.

The company made an after-tax loss of $29m during the year to 30 June 2020. Broker forecasts suggest similar figures for 2021, 2022 and 2023.

The only guidance we have on profit is that the company expects to generate an underlying profit margin of between 1% and 4% this year, excluding certain costs. By comparison, Avast generated an equivalent profit margin of 55% last year.

In my view, this tells us Darktrace is still at an early stage in its development. I think it’s too soon to know how the business might look when it’s more mature.

Will I buy Darktrace shares?

But I’m impressed by the ideas behind Darktrace’s cyber security systems. However, comments I’ve heard from people who are more familiar with the firm’s products suggest they still needs a fair amount of installation and monitoring.

From what I understand, Darktrace isn’t (yet) fully automated and seamless to use. Again, this seems to support my view this is still an early-stage business.

Cyber security looks like a hot growth sector at the moment. With tech crime on the increase, I expect to see much more growth. However, Darktrace’s £4bn market-cap means it’s already valued at around 16 times forecast sales, even though it’s expected to lose money for several more years.

That’s too expensive for me. I don’t know enough to guess at whether Darktrace will be a big winner or an also-ran in this sector. I’ll continue to watch with interest. But I won’t be buying quite yet.

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Roland Head owns shares of Avast Plc. The Motley Fool UK has recommended Avast Plc. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.

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