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

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Shares in cybersecurity firm Darktrace (LSE: DARK) have pulled back recently. After starting the month at 765p, its share price has fallen to 615p. That represents a decline of around 20%.

I’ve said before that Darktrace looks like an interesting company. DARK uses artificial intelligence technology to protect its customers from advanced cyberthreats, including ransomware and SaaS attacks. Has the share price pullback provided me with an attractive buying opportunity? Let’s take a look.

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Darktrace is enjoying strong growth

The most recent trading update from Darktrace, posted on 15 July, was very encouraging, in my view. The group advised that for the year ended 30 June, it was expecting year-on-year growth of at least 40%.

For this financial year, it’s also expecting year-on-year revenue growth of 29-32% (an increase from its previous guidance). Overall, the update showed the company has plenty of momentum right now.

Fraud charges

There are a few risks to consider here however. One key risk is that founder and majority shareholder Mike Lynch is facing extradition to the US on fraud charges. The US Department of Justice (DoJ) has accused Lynch of 17 counts of conspiracy and fraud related to Hewlett-Packard’s purchase of Autonomy (which he also founded) in 2011.

There are several issues here. Firstly, if Lynch is convicted, he may be forced to sell his near-5% stake in the company. This could impact the share price. Secondly, a prosecution could put Darktrace and prospective shareholders at risk of money-laundering charges. Third, the court case could damage the firm’s reputation.

It’s worth pointing out that Lynch has denied the DoJ’s charges. However, the issue still adds uncertainty.

High valuation

Another risk is the stock’s valuation. Even after the recent share price pullback, the valuation is still quite high. For the year ending 30 June 2022, analysts expect Darktrace to generate revenue of around $363m (£263m). That means that at its current market-cap of £4.35bn, the stock sports a forward-looking price-to-sales ratio of about 16.5.

That valuation doesn’t leave a huge margin of safety. Having said that, I’ve seen much higher valuations than this in the cybersecurity sector. Crowdstrike, for example, currently sports a forward-looking price-to-sales ratio of about 37.

Lack of profitability

Finally, it’s worth noting that Darktrace isn’t generating consistent profits yet. For the year ended 30 June, analysts do expect a small net profit of $2.9m. However, for the year ending 30 June 2022, analysts expect a net loss of $2.9m.

The issue here is that the stocks of companies that aren’t profitable tend to be highly volatile at times.

Darktrace shares: should I buy?

Weighing everything up, I’m going to keep Darktrace shares on my watchlist for now. I think there are probably better growth stocks to buy right now.

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Edward Sheldon has no position in any of the shares mentioned. The Motley Fool UK owns shares of and has recommended CrowdStrike Holdings, Inc. 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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