Indeed, at that point, Cloudflare was selling at a price-to-sales (P/S) ratio of 77. Darktrace was trading at a multiple of 29. The P/S ratio is my preferred method of analysing loss-making technology companies.
These numbers imply that the Darktrace share price could be worth more than double its current value. That is assuming the stock’s valuation moves in line with that of its US peer.
But is this a realistic prospect, and is it worth me buying the shares ahead of future gains?
Is the Darktrace share price undervalued?
One of the difficulties of analysing loss-making technology companies is that it is challenging to use traditional valuation techniques. These tend to rely on profits and cash flow. That is why I make use of the P/S ratio.
Unfortunately, this ratio is not entirely reliable. It only tells us what investors are willing to pay, and there is no guarantee investors will be willing to pay the same multiple for other companies.
That being said, it is clear that the Darktrace share price looks cheap compared to its US peers. In the highly fragmented cybersecurity market, this could inspire a potential offer for the group.
As the cybersecurity market grows, I think many of the sector’s constituents will try and merge to push down costs and leverage research and development spending. Estimates suggest spending on cybersecurity will reach $134bn globally in 2022. Darktrace currently only makes up a tiny percentage of this market.
According to current City projections, the group’s revenues will hit $367m in 2022. That leaves plenty of room for the firm to expand in the months and years ahead.
Growth on the cards
With such a long runway for growth in front of it, I do not think it is unreasonable to say the Darktrace share price has the potential to double in value over the next few years as growth materialises. That is assuming its valuation does not increase. If the valuation stays the same and sales expand, the stock price should reflect this growth. Its valuation could also increase, or a takeover offer may emerge. In either of these scenarios, the stock could double.
Of course, the company’s growth is not guaranteed. As I mentioned above, the global cybersecurity market is highly competitive. If Darktrace cannot maintain an edge in the industry, it may lose customers to peers. The group could also suffer a setback if it has a cybersecurity incident, which would also impact its reputation.
As such, while I am optimistic about the group’s long-term potential, I would not buy the shares today. I like to own companies that are already profitable, as this makes it easier to value the stock. Without profits, there will always be a risk that a business could run out of money. The Darktrace share price is too speculative for me right now.
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Rupert Hargreaves 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.