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Is the Darktrace share price slump a buying opportunity?

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The Darktrace (LSE: DARK) share price surged 50% higher in just six days in September, after the cybersecurity specialist reported a strong set of full-year numbers. But the gains didn’t hold and Darktrace shares are now trading around 20% below the record high of 1,003p seen on 23 September.

Why I’m interested

I’ve previously been cautious about Darktrace shares. This business is still loss-making and does not have the scale or profitability of larger rivals. But I was impressed by the firm’s recent results and am gaining confidence. I’m now considering opening a starter position in this stock.

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Cyber security is a fast-growing area. Most existing systems focus on identifying known threats and blocking them. The problem with this is that new forms of attack are constantly emerging. Keeping pace with this is a tough challenge.

Darktrace is taking a different approach. By using artificial intelligence, the company’s systems aim to understand what’s normal on your network — and what’s not. In theory, this should help Darktrace to stay ahead of potential attacks without the need for constant updates.

A revolutionary solution?

Darktrace calls its approach an immune system. The idea of a self-protecting, automated system certainly seems promising to me. Customers seem interested too. Total customer numbers rose by 45% to 5,605 last year, lifting run-rate revenue by 46% to $343.5m.

Each client appears to pay an average of about $61,280 per year for Darktrace’s services. This suggests to me that the company’s target market is small and medium-sized companies.

If I’m right, then I think Darktrace could have a long growth runway ahead of it. The company says it’s identified more than 150,000 companies that could potentially benefit from its technology. Winning just a small fraction of these could see the business double or triple in size again.

What could go wrong?

As a tech fan I’m interested in the Darktrace story. But as a potential investor I can still see some real risks.

One concern is that this is a relatively new and unproven business. Darktrace was only founded in 2013. It generated revenue of just $281m last year, reporting a net loss of $150m.

It’s also not yet clear to me how loyal customers are to Darktrace’s systems. The company says that its average contract length is three years. In the last financial year, 7.7% of existing customers left.

I think Darktrace still has a lot to prove. But I’m encouraged by progress so far. I’m also pleased to see the company is investing more in R&D, as well as marketing.

Darktrace share price: my verdict

I don’t know whether Darktrace will succeed in becoming a mainstream player in the cybersecurity sector. But I’ve seen enough to think that it could be a future winner.

In situations like this, I take a staged approach to investment. I’d be happy to buy a small number of Darktrace shares today. I’d then continue to learn about the business and monitor its performance.

Over time, I’d either buy more shares or sell my holding, depending on my view of the company’s future. This approach should help me to limit my potential losses, while still profiting from the company’s growth.

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Roland Head 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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