Sharp declines in stocks are attractive buying opportunities
If I told you about a stock that lost nearly 50% in two months, you might feel bad for its investors. This is the situation Cloudy (NYSE:REPORT) stock is in play. However, investors are not necessarily upset, as many of them still have more profits in hand. NET stock has rebounded over 1000% from the start of 2020 to its peak. Therefore, surrendering some of it is not just normal but necessary price action.
Nothing ever rallies continuously without rest. The alternative would be a house of cards that collapses at the slightest whiff of boredom. Nevertheless, this decline was serious and investors should resist going long blindly. There are opportunities today, but only by taking great care to explore them.
It is tempting to consider only the price action of the last 12 months. From this perspective, it looks like the NET stock is at an extremely low level. But expanding the view to include all of 2020 makes it clear that other downsides can occur.
NET stock has upside potential
I don’t intend to make this a bearish note on NET stock. The company is well positioned for the future. It aims to help secure and facilitate inter-connectivity, which seems like a perfect fit for the new world. According to its website, Cloudflare strives to make the internet safer and without compromise. This should also keep demand strong for its services and NET stock.
I also recognize that the stock has reached a support level that has been crucial since February of last year. It is therefore likely to find buyers hiding just below. NET rose feverishly by $100 per share in July, then revisited it on Monday. The sell-off in the tech sector was quite scary for those watching the price action that day. Therefore, if the stock market holds, the NET stock has a chance to rally to $140 per share.
However, I advise investors against going too long without making a profit. If it loses the century bar, it could carry much lower and even break above the $75 support. The trigger from $100 looks like a bearish head and shoulders pattern. I can give the bulls the benefit of the doubt for now. Therefore, the assumption is that $100 will hold without further panic on Wall Street.
Fundamentals suggest an upward bias
Yesterday, Federal Reserve Chairman Jerome Powell talked about a rate hike, but stocks shrugged off the comments. This is a preliminary sign that investors accept a higher rate cycle. The bears will therefore need some scary new talking points to do more damage to stocks as a whole.
Basically, Cloudflare has a tempting offer. Its financial statements show exceptional and constant growth. Since 2018, it has increased its revenue and gross profit by more than 40% per year. This is quite impressive, so there is no need to hunt for profits yet. These may come later, as for now, revenue growth should be the focus.
Meanwhile, those looking to invest should ignore the fact that it’s expensive. The right metric for assess in a title like this, it’s its price-to-sales (P/S) ratio. So far, Cloudflare is in the stratosphere with a 12-month P/S of 73. That shouldn’t be a deal breaker though, as the metric may normalize. Zoom (NASDAQ:ZM) P/S was above 120 at its peak. It’s down to just 13.5 as the company managed to get sales growth to outpace the stock price.
The conclusion today is that NET declines should be opportunities for new investors. The 50% correction is tempting, but it’s certainly no reason to go all-in. This is all the more important as the markets are still close to all-time highs and are likely to experience further declines. Sentiment on Wall Street is on edge and the bulls have one foot out.
Until new downtrends develop in the S&P500 chart, I wouldn’t assume a correction is imminent. There will be sell areas, and therein lies the risk of these effects on the NET stock. A relatively easy way to handle this is to set smaller trades and set quick stop losses.
At the date of publication, Nicolas Chahine had no position (directly or indirectly) in the securities mentioned in this article. The opinions expressed in this article are those of the author, subject to InvestorPlace.com publishing guidelines.
Nicolas Chahine is the Managing Director of SellSpreads.com.