Crowdstrike (NASDAQ:CRWD) is in a fascinating situation right now. CRWD stock represents one of the market’s leading growth assets. Up until a few months ago, Crowdstrike could do no wrong, and shares consistently made new highs.
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Now, the company continues to report amazing revenue growth. But the stock has fallen by nearly half as people rethink the exceedingly high valuations that they’d placed on software companies.
Here’s the thing though; even after falling from $298 to $155, CRWD stock is still really expensive. Why is Crowdstrike such a premium asset in the software market? And will the company’s strength make it able to withstand the brutal correction that the broader growth stock market is currently facing?
Security Is A Highly Fragmented Market; Huge TAM Remains
There’s one key point about the cybersecurity market that a lot of generalist investors might not understand. This is that security software is highly fragmented. That’s in sharp contrast to something like, say, cloud computing. There, Amazon (NASDAQ:AMZN), Microsoft (NASDAQ:MSFT), and a couple of other big names already dominate the market, leaving just crumbs for other competitors.
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In cloud security, however, it’s a far more open playing field. Palo Alto Networks (NASDAQ:PANW) is arguably the industry leader; it does around $5 billion per year in revenues. Even so, Palo Alto is hardly a dominant player; cybersecurity is closing in on a hundred billion dollar a year market if it’s not there already. Palo Alto’s overall market share is still in the single digits.
Someone like Crowdstrike has an even smaller position, at least for now. Over the past 12 months, Crowdstrike generated $1.3 billion in revenues, meaning it is just something like 1% of the overall industry. That’s what makes Crowdstrike so compelling compared to other software-as-a-service stocks. The addressable market is simply gigantic. And it’s still the early innings in terms of carving out market share.
Many SaaS companies are already starting to hit natural limits in terms of their growth. A SaaS company will often dominate a small niche, get most of the addressable market there, and then stumble once it tries to expand to other product categories with more competition. With security, however, even the bigger players like Crowdstrike and Palo Alto are still insignificant in the grand scheme of things and have tons of white space.
Moving From Individual Solutions to Ecosystems
A big reason why there are so many small security firms is that the industry has traditionally focused on delivering specific products. You call up a firm like Zscaler (NASDAQ:ZS) to get a cloud-based firewall, for example. But if you need a software-defined wide area network (SD-WAN) to encrypt traffic, it’s unlikely you’ll get it from the same vendor. This sort of fragmentation means that most large enterprises end up buying security products from a large number of suppliers.
Crowdstrike has built its business up until now on cloud-based endpoint detection and response (EDR) services. This level of security is integral to protecting customers’ networks from intruders. There are, however, a wide variety of competitors in the EDR field.
Now, Crowdstrike is launching an advanced extended detection and response (XDR) system. This could help differentiate Crowdstrike and make it clearer to potential customers why they should pick Crowdstrike instead of FireEye or Carbon Black or whoever else. Over time, Crowdstrike needs to offer a whole encompassing security platform instead of just individual services that customers buy as one piece of a far broader security stack.
The Risk: Becoming Just Another Niche Security Name
The issue with Crowdstrike is that investors are already viewing it as a successful platform company. That is to say that Crowdstrike can become one of the relatively few security firms like Palo Alto that can offer a wide array of services. If Crowdstrike is unable to broaden its product line, however, its valuation would likely drop sharply.
A great example of this is Crowdstrike peer FireEye, or what is now known as Mandiant (NASDAQ:MNDT). That firm provides cybersecurity threat detection and helps automate security responses to network breaches and intrusions. It has risen to prominence for identifying prominent cyberattacks.
However, FireEye/Mandiant has been a terrible investment. Shares opened around $35 in 2013 and quickly hit $80 on a wave of positive press coverage. By 2016, however, the stock collapsed to $15, and it’s spent most of the past five years trading between $15 and $20. Mandiant’s Price/Sales ratio dropped from a peak of 50x in 2014 to just 3x sales during the pandemic.
This highlights the risk for high-flying security names like Crowdstrike. CRWD stock is still selling at close to 30x revenues even after its sharp decline. Just based on the stock chart, it may look like a bargain here after dropping by so much. However, the valuation still demands a ton of future growth, and if Crowdstrike turns into a minor player rather than an industry leader, its valuation ratio will have further to fall.
CRWD Stock Verdict
At the end of the day, virtually every major commercial enterprise will need increasingly sophisticated cybersecurity tools. It’s just not an optional expense in today’s day and age. During the recent military escalation in Russia and Ukraine, we’ve heard numerous warnings that Russia may use cyberwarfare to attack rival governments and businesses. Spending in this domain is set to soar.
This macroeconomic backdrop is useful for putting Crowdstrike’s valuation in context. Even after falling 45%, CRWD stock is still unbelievably expensive. But it’s understandable why investors are still willing to pay a high multiple for Crowdstrike.
If the company is able to become the Amazon of cybersecurity, shares could have tons of upside in them going forward. Given the current market conditions for software stocks, however, Crowdstrike is likely to be a bumpy ride in coming weeks and months.
On the date of publication, Ian Bezek did not have (either directly or indirectly) any positions in the securities mentioned in this article. The opinions expressed in this article are those of the writer, subject to the InvestorPlace.com Publishing Guidelines.
Ian Bezek has written more than 1,000 articles for InvestorPlace.com and Seeking Alpha. He also worked as a Junior Analyst for Kerrisdale Capital, a sizable New York City-based hedge fund. You can reach him on Twitter at @irbezek.
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