The Darktrace share price has suffered for a few months now, but a very good trading update yesterday prompted a sharp rise in the shares. There are reasons to think the cybersecurity group’s share price could kick on from here and potentially reward investors with huge growth.
Why was the Darktrace share price falling before?
First of all though before explaining why huge share price growth could come, it’s worth looking at why the shares have been falling. One is beyond the control of management. That is technology stocks and loss-making companies have been out of favour with investors in recent months as valuations became stretched. Not much Darktrace could do about that.
Another is that backers from its float on the UK stock market sold shares – that’s also quite hard for management to stop. It does create a lot of supply of the shares, though, driving down the price.
The other negative is perhaps more concerning and is something any investor should keep in mind if looking at Darktrace. The shares plummeted in October 2021 after a very critical analyst note. The analysts from Peel Hunt said, among other things, that the group was overvalued, had low barriers to entry, underinvested in research and development (R&D), and that some experts thought the products to be gimmicky.
That’s quite a collection of criticisms and hard to independently verify, although the group spent £15.5m on R&D in the six months to the 21 December 2021, which seems significant. I’m letting the results speak for themselves instead. Also, Shadowfall has accused the group of being aggressively promotional. It clearly has its detractors. One might argue though that high profile market leaders often attract criticism.
Why the shares could keep on rising
While a lack of R&D spend for a technology company is a potential risk as the cybersecurity landscape evolves – it’s clear from the trading update that Darktrace is doing well. Having worked briefly in the industry I know it has a strong brand and a lot of customers.
The results showed that customer numbers grew, while annualised recurring revenue (ARR) rose 45.5% to $427m. It also now expects year-on-year revenue growth of between 44.5% and 46.5%, up from 42%-44%.
The group also moved into a net profit position from a loss the previous year. It looks like the direction of travel is the right one when it comes to the group’s financials.
The group invests a lot on sales and marketing, which should help it in the competitive, high growth market is in. If it loses market share though and competitors do eventually create better products, that would hurt both the company’s finances and the Darktrace share price. So it is an investment that needs to be watched closely.
Overall it’s possible Darktrace shares are still overvalued and that it may lose out to competition over time, especially if it’s not investing sufficiently in R&D. Nonetheless, the move towards becoming profitable and the fact for months the shares have fallen heavily mean I think a recovery could be in the offing. I’m tempted to buy Darktrace shares. There could well be significant share price growth ahead if earnings per share grow.
Andy Ross owns no share 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.
