Cloudflare(NYSE: NET) and VeriSign(NASDAQ: VRSN) both provide crucial services that keep the internet up and running. Cloudflare's content delivery network (CDN) helps websites load their content more quickly by storing cached copies of their data on edge servers that are physically located closer to the visitor than the origin server. It also shields websites from bot-based attacks.
VeriSign operates the authoritative domain name registries for two of the internet's most important top-level domains -- .com and .net -- and is the primary subcontractor for the .edu and .jobs domains for nonprofit organizations. It also operates two of the internet's 13 root name servers, which facilitate most modern online communications.
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Cloudflare, which went public in 2019, is still a growth stock. VeriSign, which went public in 1998, is a mature tech stock and actually one of Berkshire Hathaway's top holdings. But over the past 12 months, Cloudflare's stock rallied 26% as VeriSign's stock declined 23%. Let's see why the growth play outperformed the blue chip stalwart by such a wide margin -- and if it's still the better buy.
Cloudflare faces near-term macro headwinds
Cloudflare's revenue rose 50% in 2020, 52% in 2021, and 49% in 2022. But its revenue only increased 33% in 2023, and it anticipates just 27% growth in 2024. It blamed that slowdown on macro headwinds, which forced many companies to reduce their cloud spending, but it continued to gain large customers (who spend over $100,000 annually) over the past year as its dollar-based net retention rate stayed comfortably above 110%.
Its adjusted gross margins also expanded from 77.6% in 2020 to 78.3% in 2023 as economies of scale kicked in across its cloud infrastructure. It turned profitable on a non-GAAP (generally accepted accounting principles) basis in 2022, and its non-GAAP earnings per share (EPS) nearly quadrupled in 2023. It expects 22% to 24% earnings growth in 2024.
Cloudflare's growth rates look stable, but its stock isn't cheap at 132 times its forward adjusted earnings. Its lack of GAAP profits also makes it a tough stock to own as long as interest rates stay elevated.
Cloudflare's rally over the past 12 months was driven by hopes for lower rates, but it's still more than 60% below its all-time high from November 2021. Its growth should stabilize as the macro environment improves, but its high valuations could limit its near-term gains. That might be why its insiders were still net sellers over the past 12 months.
VeriSign faces longer-term challenges
From 2020 to 2023, VeriSign's revenue grew at a steady compound annual growth rate (CAGR) of 6% as its EPS increased at a CAGR of 4%. Analysts expect its revenue and earnings to grow 5% and 1%, respectively, this year. Those growth rates seem stable, and its stock seems reasonably valued at 22 times forward earnings.
But VeriSign faces two longer-term challenges. First, it's been repeatedly criticized for its monopolization of the .com and .net domains. Earlier this year, three advocacy groups -- American Economic Liberties Project, Revolving Door Project, and Demand Progress Education Fund -- asked the National Telecommunications and Information Administration (NTIA) and the Department of Justice (DOJ) to halt the U.S. government's renewal of VeriSign's contract to oversee the .com domain.
VeriSign fired back with its own filing to the Securities and Exchange Commission (SEC), stating the U.S. Department of Commerce only had the authority to sunset the deal after it expires instead of auctioning it off to other bidders. VeriSign also pointed out that even if the government backed out of the contract, it would continue to hold the rights to the .com domain through a separate Registry Agreement with the Internet Corporation for Assigned Names and Numbers (ICANN).
Second, there's a bearish belief that mobile apps will eventually reduce the importance of individual websites and easy-to-remember addresses. If companies and internet users no longer care about .com addresses, VeriSign's renewal rates could gradually decline. That's probably why its stock is underperforming many other blue chip tech stocks -- and why its insiders have also been net sellers over the past 12 months.
The better buy: Cloudflare
Cloudflare is the pricier stock, but its business is clearly built for the internet of the future. VeriSign's stock is cheaper because it's built for the internet of the past -- and the market generally favors future growth over past returns. I'm not a fan of either stock, especially since there are better growth and value plays across the tech sector. But if I had to pick one right now, I'd stick with Cloudflare because it merely faces cyclical headwinds, while VeriSign faces tougher existential challenges.
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Leo Sun has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Berkshire Hathaway, Cloudflare, and VeriSign. The Motley Fool has a disclosure policy.
