Cybersecurity tries to prevent people getting nasty surprises. But shareholders in cybersecurity provider Darktrace (LSE: DARK) have had to deal with some nasty surprises when it comes to the company’s performance on the stock market. The Darktrace share price has tumbled 41% in the past year.
In the past few weeks, though, the shares have gone up 25%.
Could this mark a turnaround that sees Darktrace shares keep soaring? If so, might now be the time to add the company to my portfolio?
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Strong business performance
I like to invest in great businesses trading at an attractive valuation, just like Warren Buffett.
The Darktrace business seems to be performing well. In a trading update last month for the first quarter of its financial year, the company reported that its customer base was 29% larger than at the same point last year. Quarterly revenue grew 37% compared to the same period the prior year.
That is an impressive sales performance and bodes well for ongoing revenue growth at the firm. I expect demand for cybersecurity services to grow over the long term, expanding the size of the market Darktrace targets.
Revenue growth does not necessarily equate to profit growth, however. Darktrace remains a young company. Often, developing firms need to spend heavily to grow their business, hurting profitability. Last year, for example, the company made a profit of just $1.5m on revenues of $415.5m. That is a wafer thin net profit margin of just 0.4%. Still, the profit was an improvement on the large loss made the previous year. Darktrace seems to be moving in the right direction as a business.
Where next for the Darktrace share price?
Since the trading announcement on 12 October, the Darktrace share price has gone up by a quarter. I take that as a sign that investors are excited by the strong evidence of business growth and long-term potential for Darktrace.
That could lead to further upward price movement. But I would be surprised if the shares keep soaring in the near future as they have in recent weeks. They already look overvalued to me. A market capitalisation of £2.5bn means that Darktrace trades on a price-to-earnings ratio of almost 2,000. Even allowing for the prospect of substantial earnings growth in coming years, that looks like an absurdly high valuation to me.
I think Darktrace needs years to grow into its current price, by continuing to increase revenues and profits. But there are risks along the way. A tightening of corporate budgets during these recessionary times could hurt sales growth. Fluctuating exchange rates might eat into the company’s profits.
I’m not buying
I think it is too early to say whether Darktrace is a great business or merely a decent one in an area that is experience surging demand growth generally. I certainly do not think today’s Darktrace share price makes for an attractive valuation.
For those reasons, I have no plans to add the company to my portfolio.
