The Darktrace (LSE:DARK) share price has been an explosive performer this year. Since its IPO listing at the end of April, the stock has increased by more than 90%. That’s certainly impressive for a newly minted public company. But what is behind this growth? And should I be considering this business for my portfolio?
The rising Darktrace share price
Darktrace is a cybersecurity company that provides its software as a service to customers. There are quite a few businesses operating within this space. However, what makes Darktrace unique is the use of machine learning to constantly improve its technology automatically.
The company describes its technology as an “Enterprise Immune System”. And that seems like an accurate title given how it works. The technology constantly monitors data flowing in and out of a system to identify any suspicious activity. Upon detection, the artificial intelligence portion of the software kicks in to determine whether or not there is a threat. And if there is, it creates a new line of defence to prevent that attack and any others of the same kind from getting through the firewalls.
Personally, the idea of a self-learning cybersecurity system sounds promising. And, according to the latest trading update, it seems 5,600 other companies agree with me. As a result of the growing adoption of this technology, the management team has forecast revenues for 2021 to be around $278m. What’s more, the bulk of this originates from a recurring revenue stream that is expected to continue growing by 32% to 34% over the next year. That sounds quite encouraging. So, I’m not surprised to see the Darktrace share price on the rise.
The risks that lie ahead
As exciting as this growth opportunity seems, I have spotted a few risks. First and foremost is the lack of profitability. Seeing an unprofitable tech company these days is not an uncommon sight. After all, developing and marketing technology solutions is an expensive process. But unfortunately, this means the business is dependent on outside funding to keep the lights on.
Looking at the balance sheet, the firm does appear to have enough liquidity to meet its short-term obligations thanks to the capital raised during its IPO. However, I think it’s likely that Darktrace will need to do another round of fundraising in the near future, potentially leading to a dilution effect for shareholders. If this were to occur, then the Darktrace share price could be in for a tumble, especially given its lofty valuation.
Today, the company has a market capitalisation of around £4.67bn. Comparing that to its $354m (£258m) revenue forecast for 2022 places the price-to-sales ratio at a high level of 18. That’s not unusual for a tech stock. But like most tech stocks, such an inflated valuation could lead to significant volatility in the Darktrace share price moving forward.
The bottom line
I must admit that this business and its technology sound incredibly promising, especially given the rising importance of new cybersecurity solutions. However, the valuation simply looks too rich for my tastes. For now, I’ll be keeping it on my watchlist. But should the Darktrace share price take a tumble, I may be tempted to add it to my portfolio.
