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Is the Darktrace share price a ticking time-bomb?

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The Darktrace (LSE: DARK) share price has been in sparkling form since the company arrived on the London market. Priced at 250p a pop at the IPO, the very same stock is now changing hands for almost 570p each.

Can this incredible momentum continue or is this now a ticking time-bomb? Let’s start by looking at why investors have been queuing up to buy.

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Why the Darktrace share price has rocketed

Part of the reason for the huge rise in the Darktrace share price is the growing realisation of just how useful its tech is.

The company is a leader in the use of self-learning AI to help defend businesses against ransomware and cloud attacks. This is patently valuable since it takes some pressure off human security teams. To drive the point home, Darktrace was recently named as one of the most influential companies in the world by TIME magazine.

As one might expect from all this, the company doesn’t seem to have any problem attracting clients. Back in July, Darktrace announced it had ended its last financial year with roughly 5,600 customers. This reflects 42% year-on-year growth over the 12 months to the end of June. 

This is clearly good news for DARK’s top line. It now expects annualised recurring revenue (ARR) of $340m once foreign exchange fluctuations are factored in. That’s year-on-year growth of 44%.

But can this form continue?

It’s certainly possible. After all, the company’s already increased expectations for the current financial year. It’s now looking for the aforementioned ARR to be somewhere between 32% and 34% for FY22. That’s up from the 26.5% to 29.5% suggested at the time of its IPO.

However, no investment is risk-free. Despite it operating in a sector that’s likely to experience huge growth over the next decade, Darktrace’s success isn’t guaranteed.

My biggest concern relates to the valuation. Following its superb rise over the last few months, the business now has a market capitalisation of £4bn — almost 24 times forecast sales. Now, having optimistic investors is all well and good.

However, being priced to perfection can be problematic if a setback were to occur now. And all businesses encounter setbacks eventually. So if the valuation remains frothy then, yes, I think we could see a big drop in the Darktrace share price eventually.

However, there’s a chance of this happening in spite of whatever the company does. Concerns over rising inflation and the forthcoming stimulus taper in the US could really impact sentiment across global markets. In such a scenario, those companies that aren’t yet making profits, such as Darktrace, could be hit the most. 

There’s also the possibility early holders may want to bank some profit. We’ve already seen this happen before in highly promising UK-listed tech companies such as robotic automation specialist Blue Prism.

Buy on dips

I’m not sure the Darktrace share price is a ticking time-bomb. Even so, I’d be surprised if it doesn’t let off some steam soon. Whether this occurs next month (full-year numbers are confirmed on 15 September) or later down the line is hard to say. However, I’d need to give serious consideration to adding the company to my own portfolio if/when the opportunity to load up arises.

Short-term movements aside, I think Darktrace remains a very enticing growth play. 

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Paul Summers 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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