Cloudflare: Overvalued then, and still overvalued (NYSE: NET)

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price action paper

Cloudflare, Inc. (NYSE: NET) was a challenging requirement for us. We are very cautious in 2021 as we highlight its high valuation.We then turned bullish near the start In 2022, the sell-off in NET stock is thought to be complete soon. We were wrong! We turned bullish too soon and should not upgrade our rating.

So we ask ourselves that the market knows what we are doing wrong (don’t argue with the market. Instead, learn from the market). We realize this is the same argument we use in 2021: Valuation! Nothing has changed. NET stock was overvalued in 2021, overvalued in early 2022, and remains overvalued.

Therefore, we believe it is critical to view any opportunity in NET stock as a speculative risk. Investors should use price action as a key basis for evaluating how the market intends to value NET stock. Also, use a sell limit order to set a take profit entry. Also, use stop-loss risk management and proper stop-loss orders to prevent excessive drawdowns. The approach we use when entering a speculative opportunity should be our approach to NET stock.

As such, we share key levels that investors need to be aware of when evaluating entry/increase exposure opportunities in NET stock.

Given the current price action dynamics, we believe it is appropriate to change our rating from Buy to Hold. We will reassess our rating if price action becomes more constructive, or if it retests its near-term support in a bear trap.

Investors must watch out for the bull trap

Net Price Chart (Monthly)

Net Price Chart (Monthly) (Transaction View)

A cursory glance at its monthly chart reveals surprising clues to a major bull trap in November 2021. We saw a bull trap and were very cautious while waiting for the market to force a quick liquidation.

So, as expected, there was a sharp sell-off in December, leading us to believe that the decline is over as the market crushes greedy buyers at the top. However, we were wrong. We did not apply our price action discipline properly as we should wait for a retest of support.

Net Price Chart (Weekly)

Net Price Chart (Weekly) (Transaction View)

Zooming in on its weekly chart, we can better understand the sharp decline in December. The sell-off took NET stock to its 50-week moving average (blue line), which has held up for the past two years.

As a result, we turned bullish prematurely (and were proven wrong by the market) thinking the sell-off was over. But we should know better. Our price action guidelines often support effective retests, creating a proven bear trap before considering increased exposure. Without it, the short-term bottom is unlikely to last as the market continues to attract bargain hunting astutely.

This is exactly what happened. The market continued its savvy distribution phase from January to March, sharply and quietly attracting bargain hunters. Then, it formed another important bull trap in late March (which we also missed earlier), confirming the bearish bias for NET stock. Notably, this should give us a warning sign to reduce exposure to our early positions and bail out.

Otherwise, we should also use a stop-loss risk management strategy to prevent deep retracements in the event of a sharper sell-off.

Thus, another quick liquidation occurred after its three-month distribution phase as the market forced more selling.

Crucially, we did not observe any major bear traps that would help contain the selling pressure and reverse its momentum.

Cloudflare stock remains overvalued

in stock network
current market cap $13.44B
Hurdle Rate (CAGR) 30%
Projection through CQ2’26
FCF yield required for CQ2’26 2%
Assumed TTM FCF Margin for 2Q26 10%
Implied TTM revenue for CQ2’26 $7.68B

NET stock reverse cash flow valuation model.Data source: S&P Cap IQ, author

It’s easy to imagine why NET stock remains overvalued, even at current levels. First, we used an aggressive threshold rate of 30%, which we believe is appropriate for speculative growth stocks. However, we employ a relatively generous free cash flow yield (FCF) of 2%. Then, assuming a 10% FCF margin by CQ2’26, we ask Cloudflare to post $7.68B in TTM revenue by CQ2’26.

Until then, investors should note that Cloudflare is expected to post a -5.7% FCF margin in FY22. Its long-term model suggests a non-GAAP operating margin in excess of 20%. However, we believe Cloudflare to reach the profitability guided by its long-term model in FY26 is incredible.

Therefore, we are calling for Cloudflare to achieve a revenue CAGR of 73.9% in 2Q26. We think it’s safe to say that this is an “impossible” task for Cloudflare, even for the most optimistic investors.

NET stock to buy, sell or hold?

We rebalance NET stock from Buy to Hold. Our saving advantage is that we prudently capitalize our exposure to NET, limiting it to within 2% of our portfolio average cost.

As a result, we have not been significantly impacted, which reminds us that disciplined capital allocation is essential for “high growth” opportunities. However, given its weak FCF margin, NET stock should never be viewed as a high growth stock with other high FCF earnings.

It should be considered a speculative stock, so given its poor fundamentals and overvalued, we should use its price action to increase/decrease exposure.

NET stock is a sobering reminder and a lesson for us; we hope investors will learn from it.

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