This ad wasn’t very long, for sure, but it caught my eye over the weekend… that headline above is the subject line that was in some of the emails I received from the Motley Fool, all pointing at subscriptions to their flagship Motley Fool Stock Advisor newsletter (first year $59, renews at “then-current price” — list price is currently $199/yr).

They’ve been testing out lots of these shorter email ads of late, with just a couple paragraphs to get you ginned up and a link to subscribe, so we’re not seeing the long teaser pitches from the Fool at the moment… but the pitch is still, “sign up and you get this secret stock pick.” Here are the clues in the email this time around:

“We just got word that an insider at one of our top recommendations recently purchased $1.5 million worth of company stock.
This is after they already purchased over $3 Million in January, bringing their total holdings to $13 Million.

“And they’re not alone in seeing the potential. A Goldman Sachs analyst recently stated that it looks, ‘favorable for long-term investors.'”

And the Fool’s own assessment of the stock:

“Our own analysts — the same team who have consistently beat the S&P by almost 3.5X for 20 years — believe this company can deliver a ‘robust 25% annualized revenue growth rate over the next decade… paving the way for market-beating returns.'”

25% growth for a decade will make almost any stock attractive, at almost any valuation (those “almosts” are carrying a lot of weight in that sentence, I must admit), so let’s see which one this is…

Thinkolator sez our pitch here is for the cybersecurity company Crowdstrike (CRWD).

How do we match the clues, you might ask? Well, the person who now owns about $13 million worth of shares is actually a Director, not an executive — though she is an executive at other companies. That’s Roxanne Austin, who is indeed reported as being 62 years old. And she has been buying shares recently, she bought a total of about 75,000 shares in December and January in several purchases, including buys of both $3 million and $1.5 million in early January which could technically match the tease, with all of those purchases coming in the $99 range… the rest of her 100,000 or so shares (yes, that’s worth around $13 million these days) were grants for her service on the Board in recent years (she’s been serving since 2018). And she was smart enough to sell some shares when the price was ludicrous, too, selling about 10,000 shares at $275 back in October of 2021, near the peak of the mania.

Interestingly enough, Roxanne Austin’s three purchases in December/January were almost the only examples of a CRWD executive or insider purchasing shares in the open market. Those folks earn a lot of shares as compensation, and they sell a ton of shares on a pretty regular basis, but they essentially never buy the stock. The only examples of insider purchases in Yahoo’s summary of the SEC filings were a purchase of two shares by executive Henry Shawn at $229, about a year ago, which looks strange just because he also sold well over 100,000 shares that month (today he owns about 199,000 shares), so it might have been a little bookkeeping adjustment… and a purchase of 81 shares by Ameer Gandhi last June, but Gandhi is a partner at Accel Venture and could be a minor share adjustment by the funds he manages.

The gold standard for “insider buying” as an indicator of likely share price performance is having three or more insiders buying, with C-suite officers being better indicators than board members — so on that front, Roxanne Austin’s pretty big buy is less encouraging, since she’s not an officer and nobody joined her (Crowdstrike has a crowded C-suite — there are an incredible 11 Chief X Officers… many of them are selling, none are buying), but perhaps it’s a big enough “outlier” that it should signal something optimistic.

To be fair, there has not been a ton of “real” insider selling at CRWD, either — there has been persistent selling for all of the time that they’ve been public, but it’s not like the employees are all dumping all of the shares they’re given each quarter, in a lot of cases they’re just selling a bit more than enough shares to cover their taxes, (stock grants are taxable income, so they have to sell some to cover the withholding taxes). Research has not generally identified any patterns to stock selling by insiders, as far as I know — insider selling, on average, is not reliably a negative indicator… but insider buying, if done by a few insiders at public market prices, is a positive indicator — on average, a pattern of insider buying means the stock will likely beat the market the next 18 months or so. One Board member? Well, it’s better than nothing, I guess.

We know intuitively that insiders buying is better than insiders selling, of course, but selling is more complicated — they sell for a lot of different reasons, especially now that companies offer such generous stock grants to executives and to their early employees (especially at fairly young, venture-funded companies like Crowdstrike), but they really only buy for one reason (well, two: Because they think it will go up… or because they want other investors to see the purchase and think that they think it will go up). Buying by executives and employees at young companies really goes against the grain, frankly, you almost never see it, the culture of tech and biotech is to give huge stock awards, not for employees to “buy in” to company ownership.

Of course, that Board Member also paid only ~$99 a share for her latest buys a few months ago… and the stock is at $137 today, so the story has changed a little. Like a lot of tech stocks, CRWD recovered quite a bit in the first quarter. The price is obviously still way off the highs, it almost hit $300 in late 2021, but it’s a little pricier now than when that insider buying hit.

Is the stock worth owning? It’s obviously in a high-demand and high-growth sector, cybersecurity is only getting more important… though it’s also a competitive sector, and one where I don’t have a real intuitive grasp of the competitive dynamics (CrowdStrike has multiple products, like most firms, and I don’t know why customers might choose CrowdStrike over Palo Alto Networks, Fortinet, Cisco, Microsoft, FireEye, SentinelOne, etc.). Their revenue growth has been absolutely blistering since they came public in 2019 — they were growing at nearly 100% a year back then, and that has slowed down pretty gradually, but they’re still growing, last quarter, at 48%. That’s a remarkable growth number, and growth like that can cure a lot of ills.

One way to assess the competitive position, particularly when you’re dealing with an industry where you don’t know much, is by looking at gross profit dollars (you could use revenue, too, but if you use gross profit you adjust somewhat for companies who might be selling at a loss to get market share) — and on that front, I see Crowdstrike growing faster than most of the other large companies, but they’re not necessarily taking a much larger piece of the pie… and they also face competition from smaller upstarts. If you just look at Fortinet (FTNT) and Palo Alto Networks (PANW), for example, and throw in the much smaller SentinelOne (S), which is more of a direct CrowdStrike competitor, here’s how that gross profit has come in over the past couple years:

2020:
SentinelOne: $54m
Crowdstrike: $645M
Fortinet: $2b
Palo Alto: $2.6b

2022:
SentinelOne: $278m — grew business by $220m, growth rate of 127% a year.
Crowdstrike: $1.64b — grew business by $1b, growth rate of 60% a year.
Fortinet: $3.3b — grew business by $1.3b, growth rate of 28% a year.
Palo Alto: $4.3b — grew business by 1.7b, growth rate of 28% a year.

If those four companies were the whole of the cybersecurity market (which is definitely not the case, they specialize in different segments of cybersecurity, we’re just thinking out loud here… and keeping it simple by only considering a few players), then Crowdstrike would have taken a few percentage points of market share… but Fortinet and Palo Alto may still be winning more sales than Crowdstrike, they’re just coming from a larger market share and a larger size so it’s less impressive on a relative basis. Growing fast doesn’t necessarily mean you’re going to become a dominant player.

They might, and they are competing very well right now — their real focus is on endpoint security, and one of the competitors they like to focus on is Microsoft, with recent investor presentations claiming that users who test the various options choose CRWD over MSFT 80% of the time. So that’s impressive.

So… what does the valuation look like now? The balance sheet is fine, they do have some debt (about $750 million), but that’s easily balanced out by more than $3 billion in cash, and they’re not really burning cash (they are losing money, about $180 million last year, but a good $150 million of the “loss” is non-cash, because they use stock-based compensation to cover about 10% of their operating costs). They don’t seem to have used stock buybacks to cushion the blow of stock-based compensation, so the share count has risen by about 10% in the past few years.

CrowdStrike is one of the most successful “SaaS” stocks of recent years, their business is almost entirely recurring subscription/service revenue for their security modules, so if we use the SaaS metrics that got so popular over the past few years, they have about $2.5 billion in annualized recurring revenue (ARR), and dollar-based net retention of 125%. They are expecting that to slow down considerably this year, as they think they see macro headwinds in their markets, but they still expect to be above 120%, which if they keep it up for a few years would let them double to $5 billion in ARR. They are spending heavily, still, but they’re keeping their customers happy and adding a good chunk of new customers each year. You can almost see why this company was bid up to a crazy valuation of 50X sales in 2021, when all anyone cared about was high ARR growth.

Today, investors are clearly a little more focused on profits, and the business is holding pretty steady right now when it comes to profitability — they’ve generated positive free cash flow since 2021 (partly thanks to that stock-based compensation, again), but have also had a trailing loss of $150-200 million a year for the past couple years on a GAAP basis (meaning, if we assume that paying employees with shares has a cost that’s similar to paying them with money). Because the revenue is still growing quite rapidly, that does mean the loss as a percent of sales is shrinking, so their margins are gradually improving.

They’re already profitable on an adjusted basis, which is still what most analysts and investors watch (even if we shouldn’t), with analysts expecting $2.31 in adjusted earnings per share this year (or a loss of 35 cents using GAAP), but those analysts also believe that Crowdstrike will keep growing at a high rate, even if it’s slower than in the past, growing more than 30% this year and next year, and that this will be enough to get them to GAAP profitability in a couple years… so if you want to use GAAP numbers, CRWD is valued at about 150X 2025 earnings… if not, it’s at 34X 2025 adjusted earnings. Using current adjusted earnings numbers, they earned $1.54 last year and are expected to have $2.31 in adjusted earnings this year, so that would be a current forward PE of about 60. On a cash flow basis, they’re valued right now at about 50X free cash flow.

Those numbers represent a very steep valuation no matter how you calculate it, of course, as is almost always the case with popular growth stocks in high-growth industries, but personally I’d say it’s really just “very expensive,” not “insanely expensive”… at 60X earnings, it is very possible to grow into the valuation, as long as they keep that revenue growing at 25-30% a year and work to build a little bit of cost discipline over time, (that kind of growth rate should make it pretty easy to improve their profit margins and get a little more efficient).

If you use adjust for growth, and use the PEG ratio as your valuation guideline (that’s the PE ratio divided by the expected future growth rate), and are willing to use adjusted numbers, then things improve a little bit. CRWD is likely to have earnings growth somewhere in the 25-40% range (apparently the Fool expects at least 25%, the average five-year growth estimate of analysts in the Yahoo Finance summary is 37%, the estimates for the next few years reflect an expectation of about 30% growth). If you’re willing to go up to a PEG ratio of 2.0, which is generally the max I want to pay for a “growth at a reasonable price” company that I really like, then that would mean you can start to justify buying at a forward PE in the 50-80 range, which makes the current forward PE of 60 look rational. I’d still hesitate, personally, since I don’t like to rely on a PEG ratio for a company that has not been consistently profitable, and the whole cybersecurity sector is priced at such high valuations in general, but the math works out OK.

So… it’s expensive, but arguably justifiable, as long as you really like the company’s competitive positioning and future prospects. I can understand by Roxanne Austin was buying in the $90s — the analyst expectations haven’t changed much, so she was buying at a forward PE of about 43 (and presumably, as a board member, has a good understanding of their competitive advantages and prospects).

If you use a PEG ratio like that, CRWD looks relatively appealing among the other big players in this group, too, thanks to the higher growth rate. If you want proven profitability and growing profit margins, and aren’t interested in paying a premium for future potential growth, then Fortinet might be more interesting — they have actual GAAP profits and have had for years, it’s just that their revenue growth is likely to be about half that of Crowdstrike, more in the 15-20% range, and the stock right now is valued at about 48X 2023 earnings. If you wanted to buy FTNT at a PEG ratio of 2.0, as well, adjusting for the lower growth rate would mean paying something less than 35-40X forward earnings… so on that growth-adjusted metric, FTNT is actually more expensive than CRWD, as long as you use adjusted earnings. Palo Alto Networks (PANW), similarly, is more profitable than CRWD (though not as consistently profitable as FTNT), and is growing slower than CRWD, but is also valued at 50X adjusted 2023 earnings… if they can grow earnings at 25-30% per year, that might be OK, if they grow at 15%, which is where the estimates have them for the next three years, it’s pretty rich. (Incidentally, Fortinet and Palo Alto Networks also have executives who generally sell willy-nilly… though FTNT, like CRWD, has a single Director who’s been buying recently, and I don’t think any insider has bought PANW shares in the open market for at least a few years.)

If you want something more speculative or a little less-followed, then relatively tiny SentinelOne (S), with a market cap of about $5 billion, is growing revenue twice as fast as the $30-billion CrowdStrike (though ARR growth is only a little better, some of the growth is from acquisitions), and has a pretty similar business in cloud-based endpoint protection, with at least some people claiming technical superiority for SentinelOne (I have absolutely no idea on that front)… but they’re still burning cash and have made some pricey acquisitions in the past year or so, and are not likely to be profitable even on an adjusted basis for a couple years, so the risk is much higher. If they get it right, though, and investors fall in love with SentinelOne again, then they could earn a higher valuation multiple and do meaningfully better than the much-larger CRWD (CRWD is valued at about 11X expected 2023 top-line revenue, S at just about 8X… those are still relatively high valuations, historically speaking, but they do look somewhat enticing compared to the 40-60X sales that these kinds of stocks were bid up to in 2021).

Sound like the kind of investment you’d like to make? CrowdStrike actually sounds like a fairly typical Motley Fool pick over the past twenty years — growing market leadership, great investor communications, very strong growth rate, and emerging (adjusted) profitability, but at a very rich current valuation. When a few of those kinds of stocks work out extremely well over a decade, that’s when you get your exceptional 10X long-term returns… you just have to accept that not all of them work out, particularly in sectors like technology where disruption is rapid and dominance is sometimes much more ephemeral than we expect. Much of the Fool’s argument in picking these stocks is that if you buy, say, ten companies that are high-growth leaders, who have trusted management and a real advantage (in the Fool’s opinion), and hold on for 10-20 years (they say “at least five”), you can get one or two 1,000%+ winners that more than make up for the fact that most of the ten will probably do worse than the overall market. Hit some whopper home runs, even if your batting average doesn’t always look good.

That’s the beauty of the math of investing — a terrible stock can only lose 100%, but a great one can gain 10,000%… and it makes sense, and has indeed led Motley Fool Stock Advisor to have exceptional long-term returns… but sometimes it doesn’t work for every individual or subscriber (as we hear from Gumshoe reviewers, from time to time). Especially if you only buy five or ten growth stocks out of the 200 or so that they have in their active recommendations, and it turns out that you didn’t buy one of the relatively few huge winners… or, worse, you buy it but lose patience with it and sell during one of the almost guaranteed 50-80% drops those eventual winners all have.

Every portfolio needs at least a little “growth” in it, but personal preferences and risk tolerance vary greatly…. If you’re not going to try to win the home run derby, you might want to be more careful about keeping your batting average high.

Disclosure: I’m not invested in any of the companies mentioned above, and will not buy any covered stocks for at least three days after publication, per Stock Gumshoe’s trading rules.