The S&P 500 is one of the most important indexes in the financial markets.
While it consists of just the stocks of 500 companies, it represents about 80% of all U.S. equities by market capitalization. To become a member, a company must obtain a market cap above $18 billion, produce a profit in the most recent quarter, and produce a profit in the most recent 12-month period. The stock must also have sufficient liquidity.
Every quarter, a committee selects a few new stocks to join the S&P 500 while deleting other stocks to make room. The goal is to include companies most representative of the large-cap space. This quarter, the committee added cybersecurity leader CrowdStrike(NASDAQ: CRWD) to the index.
CrowdStrike will join the index on June 24 alongside GoDaddy and KKR. Meanwhile, Robert Half, Comerica, and Illumina will be removed from the index to make room.
CrowdStrike is the most recent AI stock to join the all-important S&P 500, which is dominated by AI innovators. Even after climbing 266% since the start of 2023, Wall Street thinks there's still room for the stock to run. Here's what investors need to know.
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Building a competitive advantage with data and AI
Over half of the Fortune 1000 use CrowdStrike's platform to secure their data. CrowdStrike's specialty is endpoint security, which focuses on protecting company devices like computers and smartphones.
This is a naturally growing market, as businesses use more data, and more of that data is transmitted over the internet and stored in the cloud. Global spending on endpoint security is expected to grow at a compound annual growth rate of 13% through 2029. Management sees its total addressable market more than doubling between 2024 and 2028. And CrowdStrike is positioned to take a larger piece of the expanding pie.
There are two reasons for that, both related to its existing position as the current market leader.
First of all, there are significant switching costs when it comes to changing cybersecurity software. Managers don't want to risk cybersecurity breaches just to save a few bucks each month on software expenses. That makes CrowdStrike's services very sticky, as exemplified by its 98% gross-retention rate.
Adding to that, CrowdStrike is successfully implementing a land-and-expand strategy. It's seeing a growing number of customers take five or more of its services. Its cloud, identity, and SIEM (security information and event management) products all grew revenue 90% or more last year. As a result, net-revenue retention is well over 100%, and its average recurring revenue grew 33% last quarter.
The second factor driving CrowdStrike's growth is its investments in artificial intelligence. Artificial intelligence is fueled by data, including feedback. CrowdStrike's platform receives more than a trillion signals every day. As such, it can train its AI to recognize and respond to threats faster than the competition. That gives CrowdStrike something of a network advantage, which results in a virtuous cycle. The more companies using CrowdStrike's solutions the better those solutions perform.
Analysts think CrowdStrike is still a buy
Several Wall Street analysts think CrowdStrike still has room to climb. Forty-seven out of 50 analysts rate the stock a buy or strong buy. Wells Fargo's Andrew Nowinski has the highest price target on the Street and sees shares climbing to $435 thanks to its partnership with Amazon. Amazon agreed to replace a variety of cloud-security products with CrowdStrike's in May.
But after strong price appreciation in recent weeks, investors may want to reconsider the stock at the current price. At its current share price, there's only about 12% upside to Nowinski's price target. And the average on the Street is much lower.
And there's good reason. CrowdStrike currently trades at an enterprise-value-to-sales ratio of more than 27 times. While management expects revenue to keep climbing at a rate above 30% for the next year, that's still quite expensive for the stock. That multiple is up from about 11 times at the start of 2023, although close to its five-year median. The fair value of the stock may lie somewhere in the middle of those multiples.
CrowdStrike is a market leader with clear competitive advantages, and it's exhibiting strong revenue growth. There's a case to be made for the stock at this price, but there may be better alternatives in AI and cybersecurity in today's market.
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John Mackey, former CEO of Whole Foods Market, an Amazon subsidiary, is a member of The Motley Fool's board of directors. Adam Levy has positions in Amazon. The Motley Fool has positions in and recommends Amazon, CrowdStrike, and KKR. The Motley Fool recommends GoDaddy, Illumina, and Robert Half. The Motley Fool has a disclosure policy.
