Risk/Reward Rating: Negative
Crowdstrike (Nasdaq: CRWD) reported strong fiscal Q2 2022 earnings after the market closed on August 31, 2021. The shares responded by selling off over 4% the following day as the results were not enough to reignite upward momentum. Revenue grew an impressive 70% over last year’s Q2 and the top end of the company’s revenue guidance for the full year was raised to $1.409 billion which would register 61% growth over fiscal 2021.
Company Overview
Crowdstrike has become a leader in the IT security market in recent times. In fact, on the Q2 conference call, the CEO, George Kurtz, described the company as being in the “pole position” as the only cloud native, zero trust security provider offering protection across all three primary threat vectors: workloads, endpoints, and identity management. Furthermore, the company emphasized its competitive positioning in threat detection and breach prevention, rather than just malware prevention, as its key differentiator. This rings true in an age of massively distributed computing in which half of all security incidents involve the breaching of IT systems rather than the insertion of malware.
Financial Performance and Valuation
Given the muted stock reaction to the excellent financial results and competitive positioning, the market is signaling that the current valuation of Crowdstrike has priced in much of the good news. Reviewing the financial results and valuation supports this ‘priced in’ thesis. The following table provides a breakdown of key profitability metrics from the 8-K (Q2 earnings release) filed with the SEC and the recent 10-K annual report filed with the SEC (2022* numbers are the high end of the company guidance provided for fiscal 2022 ending 1-31-2022).
The first thing that jumps out from the historical financial performance is that in recent years revenue growth is beginning to noticeably decelerate. While 61% growth is impressive, it is now roughly half the growth rate achieved as recently as fiscal years 2018 and 2019. Of note, the company is not profitable on a GAAP basis (generally accepted accounting principles). The reported non-GAAP profitability is due to the exclusion of large stock-based compensation expenses (these expenses are included in official GAAP net income figures). The non-GAAP income growth is also decelerating rapidly at an estimated 87% growth for the current year compared to 201% in fiscal 2021. The financial performance story is one of impressive yet decelerating growth rates.
Valuation
While growth rates are decelerating, they remain at hypergrowth levels. Given the excellent growth and competitive positioning, the Crowdstrike investment thesis hinges on valuation as the company is clearly well positioned and is executing nicely.
The following table breaks down several valuation measures across multiple profitability and performance metrics from Crowdstrike’s 8-K (Q2 earnings release). I have provided comparable measures across several of these metrics for Palo Alto Networks (NYSE: PANW) which is a successful IT security company that is further along in its growth trajectory than is Crowdstrike. The Palo Alto data is from their recent 8-K filed with the SEC (Q4 earnings release). Adding a comparison company illuminates several opportunities and challenges for Crowdstrike going forward.
Please note that I will look at non-GAAP metrics, except for sales, for valuation purposes as Crowdstrike is not profitable under GAAP. At the current share price of $273.21, Crowdstrike is valued at an incredible 46.5x sales. This is an extreme valuation from a historical market perspective and is especially excessive given the rapidly decelerating growth rates as discussed above. To provide further context, Palo Alto produces nearly 4x the sales of Crowdstrike and is still growing revenue at an impressive 25% per year. Palo Alto demonstrates that Crowdstrike has plenty of growth runway on the horizon which highlights the excellent opportunity in front of the company. On the other hand, Palo Alto is valued at 9x expected sales compared to 46.5x for Crowdstrike.
The price-to-sales multiple comparison highlights the key risk theme running throughout the Crowdstrike valuation story: multiple compression. As Crowdstrike’s revenue growth decelerates towards the Palo Alto 25% growth rate from the current 61% growth rate, the valuation multiple on sales will contract rapidly from 46.5x sales towards 9x sales. The magnitude of this valuation contraction is enormous and may weigh heavily on the share price.
Looking at the non-GAAP income estimates, Crowdstrike is valued at an incredible 563x fiscal 2022 earnings estimates and 355x fiscal 2023 estimates. These are extreme forward valuation multiples in a historical market context. Palo Alto, for example, is expected to generate 6.6x more non-GAAP income in the coming year compared to Crowdstrike, yet Palo Alto’s price (market capitalization) stands at just 0.74x that of Crowdstrike’s. The reason for this glaring discrepancy is that Palo Alto is valued at 63x expected non-GAAP earnings for the coming year compared to 563x for Crowdstrike. Like the sales multiple, this highlights the extraordinary multiple compression risk faced by Crowdstrike shareholders.
Even if the company is wildly successful and grows its earnings by 6x the current level, the share price may actually be lower than it is today as demonstrated by the Palo Alto comparison. Adding potential insult to injury, this incredible hypothetical 6x growth in earnings may take 5 years or more to accomplish. The risk of multiple compression is acute for Crowdstrike’s stock price.
Summary
Crowdstrike is a great company performing at the top of its game, however, the valuation reflects this and then some. As a result, the risk-reward tradeoff facing current and prospective shareholders is heavily skewed toward risk with little realistic reward left on the table in the foreseeable future. The company should be placed on a watch list for high-risk, high-reward investors as a substantial share price decline could open the door to future opportunities. Turning to technical analysis and looking at the charts will illuminate the possible entry points to accumulate the shares should the opportunity present itself.
Technicals
Technical backdrop: Crowdstrike came public in June of 2019 near $64 and proceeded to trend down before reaching a bottom at $34 during the COVID market crash in March 2020. Since this bottom, the stock has staged an incredible run peaking at $289 in the past week. Stepping back to look at the 3-year weekly chart, the majority of the gains from the incredible rally (76%) occurred by December of 2020 (green line on the weekly chart below). Since December 2020, the upward momentum has largely stalled.
Crowdstrike 3-year weekly chart
The momentum stall zone at the green line on the weekly chart near $225 represents the nearest support level for Crowdstrike and was where the shares found a bottom as recently as August 16, 2021. Given the valuation extreme, this level is likely to be tenuous support. The next lower support zone is at the blue line on the weekly chart near $153 which represents key resistance levels from August through November of 2020 prior to the upside break out in December of 2020 (resistance becomes support and vice versa). This support level is on the table for a retest given the aforementioned valuation reality.
The next lower support level is at the purple line on the weekly chart near $117 which was key resistance in July of 2020. A retest of this level cannot be ruled out due to the valuation extremes. Zooming into the daily chart, all three support levels are shown.
Crowdstrike 1-year daily chart
Confirming the momentum stall since December of 2020, the current share price is not overly extended above the 50-day moving average (brown line on the daily chart) or the 200-day moving average (grey line on the daily chart). The 50-day moving average is at $257 and the 200-day moving average stands at $217. Given the momentum stall, and the alignment with the critical support level near $225 represented by the green line, the 200-day moving average is likely to offer the nearest support level rather than the 50-day moving average.
Looking at each of the three critical support levels represented by the colored horizontal lines, the price-to-sales valuation at each of these levels is 38x (green), 26x (blue), and 20x (purple). The lowest support level at 20x sales is likely to be the first potential opportunistic accumulation level for Crowdstrike’s stock as things stand.
Technical resistance: The stock should face stiff resistance nearby at the $285 area which was a ‘spinning top’ on August 30, 2021, when the shares reached an all-time high near $289.
Technical support: As discussed, the three well defined support levels are $225, $153, and $117. All are likely to be tested going forward.
Price as of this report 9-2-21: $273.21
Crowdstrike Investor Relations Website: Crowdstrike Investor Relations
Data in this report is compiled from the Crowdstrike investor relations website and SEC filings, and where applicable publicly available information regarding consensus earnings estimates.