Cloudflare stock soars on AI “news.” But can you really buy it now?

cloudflare (Net -5.43%) The stock took a hit following its first-quarter 2023 earnings report, driven primarily by news that content delivery networks and cybersecurity services lowered their outlook for the rest of the year as they faced economic headwinds. Sure, 31% to 32% annual sales growth is never a bad thing, but this is a premium-priced stock. The market had expected growth this year to be close to 40% or even higher.

But in 2023, there appears to be a quick fix for companies facing depressed stock prices. Just mention AI. After several announcements about its efforts in the AI ​​space, Cloudflare stock quickly regained much of the gains lost since the first quarter.

There are many lessons this can teach investors.

Cloudflare takes advantage of the AI ​​hype cycle

Cloudflare first sparked this whole media cycle after last quarter's report by releasing several news items describing its work in generative AI (the type of service offered by OpenAI's ChatGPT).

First, Cloudflare drew attention to the fact that its Internet security suite has tools that AI companies can use to keep their data safe. Given that much of the generative AI work being done today is done in the cloud (data and AI algorithms hosted in remote data centers and accessed remotely over an internet connection), Cloudflare's introduction of Safety tools like those in the AI ​​Startup Toolset.

And second, Cloudflare relies on many generative AI app startups, including Character.ai, Leonardo.ai, Lexica.art, and SiteGPT.ai, to use Cloudflare's R2 storage to manage the large datasets needed for training. announced that they are using. their algorithm. Cloudflare also announced that a number of AI infrastructure startups have partnered to offer Cloudflare's R2 storage as part of its AI training platform.

Suffice it to say, the market got excited about these two press releases after Cloudflare disappointingly revised down its 2023 revenue outlook.

Data by YCharts.

I'm not denying what Cloudflare did. Investors may need a reminder that the business is doing well and long-term growth prospects are intact. Is the market punishing stocks? Just say “AI” and investors will react accordingly. But this series of events shows where we are in the current hype cycle surrounding AI.

Don't buy it just because it says “AI” on it.

The problem I have with the market reaction to Cloudflare's AI news is that this is not new news at all. Two years ago — April 2021 to be exact — Cloudflare announced a partnership with. Nvidia (NVDA -0.17%) In doing so, we will fill our global internet infrastructure network with GPUs and Nvidia software models to enable AI.

Yes, it's Nvidia that this year the market suddenly woke up and decided it was the giant of AI computing.

Importantly, for Cloudflare's early followers and shareholders (myself included), it's already more than hinted that Cloudflare is servicing this nascent generative AI movement with the help of Nvidia chips and software. That's what happened. Cloudflare's series of news items, while exciting, is not a trove of ground-breaking revelations to help you make investment decisions.

Thanks to ChatGPT's early viral success, this is happening everywhere now. In fact, generative AI could be a game-changer for many companies in the coming years. But companies can't achieve financial results by simply evoking the power of the word “AI.” Companies shouldn't simply be rewarded with stock just because they say they're working on AI. Investors chasing these hot stocks are playing a dangerous game.

The real reason to buy stocks

As for Cloudflare stock and whether it's a buy, I think it's a pass for now. I remain very optimistic about the company's long-term outlook, but the decline after Q1 2023 earnings was completely justified. Remember, just a few months ago, management expected full-year 2023 revenue to be up to $1.34 billion. The outlook has now been lowered to approximately $1.28 billion.

Generative AI or not, Cloudflare is dealing with some macroeconomic speed bumps this year. The stock currently trades at nearly 15 times expected 2023 sales, and the business still reports free cash flow that fluctuates from quarter to quarter.

Data by YCharts.

If you like Cloudflare's business, you'll want to wait until some of the AI ​​hype dies down before you bite.and if That's right, don't forget to take a bite. As always, I still think it makes the most sense to buy shares in these companies piecemeal and build up bigger positions over time. This stock is going to be very volatile for years to come.