Of these cornerstones of the modern internet, which one is the better investment overall?
Cloudflare (Net 0.23%) and Verisign (VRSN 1.66%) Both provide important services that keep the Internet up and running: Cloudflare’s Content Delivery Network (CDN) allows websites to load content faster by storing cached copies of data on edge servers that are physically closer to visitors than the origin server, and it also protects websites from bot-based attacks.
VeriSign operates the authoritative domain name registry for the Internet’s most important top-level domains, .com and .net, and is the primary subcontractor for non-profit organizations for the .edu and .jobs domains. It also operates two of the Internet’s 13 root name servers, which power most modern online communications.
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Cloudflare, which went public in 2019, remains a growth stock. Verisign, which went public in 1998, is a mature tech stock. Berkshire HathawayIt’s a major holding of Cloudflare. But over the past 12 months, Cloudflare shares have risen 26%, while VeriSign shares have fallen 23%. Let’s take a look at why growth stocks have outperformed blue-chip stocks by such a large margin and whether they’re still the better buy.
CloudFlare faces macro headwinds in the near term
Cloudflare’s revenue grew 50% in 2020, 52% in 2021, and 49% in 2022. However, revenue is expected to grow just 33% in 2023, with growth of just 27% in 2024. The company blamed the slowdown on macroeconomic headwinds that forced many businesses to cut back on cloud spending, but its dollar-based net customer retention rate remained well above 110%, and it continued to add large customers (spending more than $100,000 annually) over the past year.
Economies of scale across its cloud infrastructure also led to adjusted gross margins expanding from 77.6% in 2020 to 78.3% in 2023. The company will be profitable on a non-GAAP (generally accepted accounting principles) basis in 2022, and non-GAAP earnings per share (EPS) will nearly quadruple in 2023. The company expects earnings growth of 22-24% in 2024.
Cloudflare’s growth rate appears to be stable, but the stock isn’t cheap at 132 times forward adjusted earnings, and with no GAAP earnings, it’s also a tough stock to own as long as interest rates remain high.
Cloudflare’s rally over the past 12 months has been driven by hopes of a rate cut, but it’s still over 60% off its all-time high in November 2021. The company’s growth should stabilize as the macro environment improves, but the high valuation could limit near-term gains, which may be why company insiders have remained net sellers over the past 12 months.
VeriSign faces long-term challenges
From 2020 to 2023, VeriSign’s revenue grew at a steady compound annual growth rate (CAGR) of 6%, and EPS increased at a CAGR of 4%. Analysts expect revenue and earnings to grow 5% and 1%, respectively, this year. These growth rates seem steady, and the stock seems reasonably valued at 22 times forward earnings.
But VeriSign faces two long-term challenges. First, the company has been repeatedly criticized for its monopoly on .com and .net domains. Earlier this year, three advocacy groups — the American Economic Liberties Project, the Revolving Door Project and the Demand Progress Education Fund — called on the National Telecommunications and Information Administration (NTIA) and the Department of Justice (DOJ) to stop the U.S. government from renewing its contract with VeriSign to manage the .com domain.
Verisign fired back in its own filing with the Securities and Exchange Commission (SEC), saying the U.S. Department of Commerce only had the authority to terminate the contract after it expired, rather than auctioning it off to other bidders. Verisign also noted that even if the government were to withdraw from the contract, it would continue to hold rights to the .com domain through a separate registry agreement with the Authority for Assigned Names and Numbers (ICANN).
Second, there’s the bearish view that mobile apps will eventually make individual websites and easy-to-remember addresses less important. If businesses and internet users stop caring about .com addresses, VeriSign’s renewal rates could slowly decline. Perhaps this is why the company’s shares have underperformed many other blue-chip tech stocks, and also why the company’s insiders have been net sellers over the past 12 months.
Better Buy: Cloudflare
Cloudflare’s stock is expensive, but its business is clearly built for the future of the Internet. VeriSign’s stock is cheap because it’s built for the past of the Internet. The market generally favors future growth over past earnings. I don’t like either stock, especially since there are better growth and value stocks in tech. But if I had to choose right now, I’d pick Cloudflare because it’s simply facing cyclical headwinds and VeriSign faces tougher survival challenges.
Leo Sun has no position in any of the stocks mentioned. The Motley Fool owns shares in and recommends Berkshire Hathaway, Cloudflare, and VeriSign. The Motley Fool has a disclosure policy.
