With the buzz around Artificial Intelligence (AI) right now, it’s perhaps unsurprising to see the Darktrace (LSE: DARK) share price moving higher.
After all, the technology behind the company’s cybersecurity solutions is AI. And according to its directors, the self-learning nature of AI keeps the business winning in its quest to develop ways to fight cyber threats, such as ransomware and phishing.
Earnings are building
But that’s all marketing puff until we see numbers to back up the rhetoric. And on that front, the news is improving.
After several years of losses, earnings first went positive in the trading year to June 2022. And looking ahead, City analysts expect big increases in the current trading year and into 2024.
Meanwhile, with the share price near 294p, the forward-looking price-to-earnings multiple is running at about 32. And although that may seem high at first glance, it’s set against the expectation of an almost 45% increase in earnings in the trading year to June 2024.
Nevertheless, it’s a valuation that appears to assume ongoing fast growth. And if the business can grow earnings at mid-double-digit percentages each year, it will be robust growth.
However, fast-paced growth is difficult for any business to keep delivering year after year. Yet the directors insist that Darktrace’s technology is used by some of the largest businesses globally. So maybe the company can find ways of keeping its customers loyal.
Can the company defend its niche?
Regular repeat custom would be an ideal platform to build upon. But the business will need strong barriers to entry for keeping the competition away. And it might have them, but I’d need to dig in deeper with my research to understand what they are.
If it turns out that a strong competitive advantage is not present, the growth numbers may tail off in the coming years. And on that theme, it bothers me a bit that the business model appears to rely on developing products using AI. If Darktrace can do it, why can’t others?
One of the debates surrounding AI technology is the way it can be used for multiple applications. Heck, some AI boffins are even worried that AI can use itself to take over the world! So why can’t another business simply use AI technology to compete directly with Darktrace in the cybersecurity market?
For now though, the trading figures are good. Revenue, earnings and cash flow are growing. And that means the performance of the business may be one of the biggest drivers of the share price.
The company arrived on the stock market in 2021 and topped out around 1,000p that year in what now looks like a frenzy of speculative excitement.
But by this January, it had dropped back to bottom-out around 210p. And at that point, it looks like the valuation matched with the improving fundamentals of the business.
There’s been a rise since that nadir, but over the past year the stock is down by just over 20%. Nevertheless, now that much of the speculative froth has blown away, I think it’s a good time for me to investigate this stock opportunity further.
