When I last covered Darktrace (LSE: DARK) in late September, I said that I was going to keep the stock on my watchlist, instead of buying it. One concern I had was the valuation (the stock had a price-to-sales ratio of 31 at the time).
In hindsight, that was the right move. Since that article, Darktrace’s share price has fallen from 864p to 590p, meaning that I’ve avoided quite a significant loss.
So why have DARK shares fallen? And is now a good time to buy the stock for my growth portfolio?
Why Darktrace’s share price just crashed
There are two main reasons Darktrace’s share price has plummeted recently. The first is that late last month, Peel Hunt posted a bearish research note on the company. Published on 25 October, its analysts gave Darktrace shares a ‘sell’ rating with a price target of 473p. They cited a disconnect between the valuation and the ultimate revenue opportunity as the reason behind their bearish call.
The second reason the share price has tanked recently is that early investors have been offloading stock. Earlier this week, Vitruvian Partners – the company’s fifth largest shareholder – dumped 11m shares at a price of 580p, raising proceeds of £64m. This move came after the company’s post Initial Public Offering (IPO) 180-day lock-up period ended.
Russ Mould, Investment Director at AJ Bell, said that Vitruvian’s move could spark other Darktrace investors to follow suit. If that happens, it could put further pressure on the share price.
Should I buy Darktrace shares now?
Should I take advantage of this share price weakness and snap up Darktrace stock for my portfolio while it’s under 600p?
Well, the valuation certainly looks far more reasonable now, to my mind. For the year ending 30 June 2022, analysts expect Darktrace to generate sales of $387m. That means the forward-looking price-to-sales ratio is now around 15. That’s still not low. But it’s not outrageous for a high-growth company like Darktrace, which is forecast to generate revenue growth of nearly 40% this year. I’d be comfortable paying that valuation if I was very bullish on the company.
One concern I have here however, is that profitability could still be years away. This financial year, Darktrace is expected to generate a net loss of $25m. Next financial year, analysts forecast a net loss of $17m. Unprofitable companies tend to be higher-risk investments. That’s because it’s much harder to accurately value them. Given the lack of profits, I’m hesitant to buy the stock now.
Another concern is that founder Mike Lynch – who currently owns 16% of the company – may be tempted to sell stock in the near term. Lynch is currently facing extradition to the US on fraud charges. Given that he’s facing a potentially lengthy legal battle, he may choose to cash in on his post-IPO gains now. This could hit the share price in the near term.
Weighing everything up, I’m happy to leave Darktrace shares on my watchlist for now. All things considered, I think there are better cybersecurity stocks I could buy for my portfolio.
Edward Sheldon has no position in any of the shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.
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