Darktrace’s share price is rising. Should I buy the stock now?

Shares in cybersecurity company Darktrace are having a great run at the moment. Edward Sheldon looks at whether he should buy the stock.

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Shares in cybersecurity company Darktrace (LSE: DARK) are having a great run at the moment. Since the firm’s Initial Public Offering (IPO) in late April, the DARK share price has shot up from 250p (the IPO price) to 650p.

I’ve said before that Darktrace – which uses artificial intelligence technology to protect customers from advanced threats including ransomware and SaaS attacks – looks like an interesting company. Is it time to bite the bullet and buy shares? Let’s take a look.

Darktrace is generating strong growth

Darktrace certainly appears to have a lot of momentum right now. In a trading update posted on Thursday (its first since the IPO), the group said it expects to post revenue of $278m for the year ended 30 June, reflecting year-on-year growth of at least 40%. It added that it ended the financial year with approximately 5,600 customers, an increase of 42% year-on-year.

Demand for our Self-Learning AI solutions is robust, as advanced cyber-attacks continue to outpace the human capability of security teams,” said Darktrace CEO Poppy Gustafsson.

Looking ahead, the company expects to keep generating strong growth. For FY2022, it now expects year-on-year revenue growth of between 29% and 32% (up from previous guidance of 27% to 30%). However, it noted there will be normal quarterly seasonality patterns, including soft first-quarter sales.

Overall, the trading update was very encouraging, in my view.

Two risks to consider

I do have a couple of concerns about Darktrace shares however. One is in relation to profitability. For the financial year just passed, analysts expect Darktrace to generate a net loss of $5.5m. For FY2022, they expect that loss to balloon to $23.4m.

A lack of profitability isn’t unusual for an early-stage, high-growth technology firm. And I don’t see it as a deal breaker. However, it does add risk to the investment case. For starters, it makes the company harder to value. Secondly, the share prices of unprofitable companies tend to be more volatile. We saw this earlier in 2021 during the tech stock sell-off.

Another concern is the stock’s valuation, which is lofty at present. At its current share price, Darktrace has a market-cap of £4.5bn. Let’s say revenue for FY2022 is $361.4m (assuming 30% growth). That puts the stock on a forward-looking price-to-sales ratio of 17.2. I wouldn’t say that valuation is outrageous, but it’s certainly high. Plenty of stocks with similar valuations were crushed in the tech sell-off earlier this year.

It’s worth noting that most analyst price targets are below the current share price. For example, Piper Sandler has a price target of 600p, while Berenberg’s is 525p.

Should I buy Darktrace shares now?

Given the high valuation here, I’m going to keep Darktrace shares on my watchlist for now. The company’s growth is certainly impressive. However, at present, I’m not convinced the stock’s risk/reward profile is favourable.

Should you invest, the value of your investment may rise or fall and your capital is at risk. Before investing, your individual circumstances should be considered so you should consider taking independent financial advice.

Edward Sheldon has no position in any of the shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. 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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