The last time I looked at the pros and cons of adding Darktrace (LSE: DARK) to my portfolio, I decided against it. I felt that it was unclear whether the business had a strong, sustainable competitive advantage. Added to that, Darktrace shares looked expensively valued to me.
Has anything changed?
The company updated the market today (11 January) on trading in the first half of its financial year and broadly speaking the tone was very upbeat.
Given that I take a long-term approach to investing, could Darktrace merit a place in my portfolio to be held for years to come?
Lingering doubts
In short, no. For now at least, I have no plans to add the shares to my portfolio.
The company uses a variety of metrics such as “annualised recurring revenue” that I feel do not help me as an investor understand what is happening on a statutory reporting basis. It did say that it expects year-on-year revenue growth for its first half of at least 27%, which is very strong. Its customer base was 13% larger than a year before. Clearly, Darktrace is in growth mode.
Valuation concerns
However the valuation still looks very pricey to me.
Using the most recent full-year figures, the price-to-earnings ratio is nearly 50 while the price-to-sales ratio is over five. Even if I think a company has strong growth prospects to grow into, I try to avoid a valuation I think is excessive.
Compared to the current business performance, I think Darktrace shares look overvalued.
But I am concerned that they are overvalued even when allowing for the prospects of future growth. After all, such growth is never guaranteed and there are risks along the way.
Demonstrated risks
Take the company’s difficulties adjusting its sales approach this year.
It said that in regard to its current financial year, “initiatives undertaken to ready its Go-to-Market strategy and teams for the next phase of its evolution had a larger impact on sales activity in the first quarter than expected”. In other words, the firm misjudged the commercial impact of some of its sales activities.
That is not necessarily bad. It said in today’s statement that the impact of those changes helped it achieve a strong second quarter. But it raises questions about whether management has all the commercial acumen it needs.
Disruptive strategy
I also feel that, if changing a sales strategy is highly disruptive, it can suggest customers see a product as dispensable. That again makes me concerned as to how strong a competitive advantage Darktrace has versus its many rivals.
As a long-term investor, I like the growth story in the cybersecurity space. Darktrace has demonstrated clearly that it is able to benefit from that.
But the shares continue to look expensive to me, so for now I remain on the sidelines.
