Hook / Thesis (short)
Cloudflare's recent quarter shows the kind of product-led scale investors want to see: durable revenue growth, positive operating cash flow, and a clear trend toward operating profitability. That combination — growth plus improving cash profitability — justifies a rating upgrade to Buy. Recent service outages caused a sharp sentiment-driven pullback; that selloff creates an actionable entry for disciplined traders who respect the execution risks.
Why this matters
Cloudflare sits at the intersection of two multi-year secular trends: the shift of application infrastructure to distributed, edge architectures and the relentless growth of security spend (WAF, DDoS, bot management, SOC-as-a-Service). If the company can convert its technical moat into faster monetization and operating leverage, the equity rerating could be meaningful. Q3 2025 results give us evidence that this conversion is happening.
What the business does (concise)
Cloudflare runs a globally distributed edge platform that combines CDN, DDoS mitigation, a web application firewall, and an edge compute layer called Workers. Customers use Cloudflare to improve performance and secure public-facing applications without managing their own servers. The product also lends itself to usage- and consumption-based monetization — an attractive profile for enterprise upsells and developer adoption.
Recent financials that support the upgrade
- Revenue acceleration: $562.03M in Q3 2025 (period ending 09/30/2025), up sequentially from $512.32M in Q2 and $479.09M in Q1. Q3 versus Q3 a year earlier was +$431M to $562M, roughly a +30.7% year-over-year increase.
- Profitability trajectory: operating loss narrowed to -$37.46M in Q3 2025 from -$67.26M in Q2 2025 — an improvement in operating loss of ~44% sequentially.
- Cash generation: operating cash flow was $167.12M in Q3 2025 while net cash flow was negative due to large investing activity (-$629.52M), which appears to be capacity and infrastructure investment.
- Gross profit and R&D: gross profit was $415.71M, with R&D at $120.96M; the company is still investing in product while starting to show operating-leverage gains.
- Balance sheet / liquidity: current assets are $4.537B vs current liabilities $2.223B (current ratio ~2.0), providing a solid liquidity cushion while the company invests.
Valuation framing
As of 12/28/2025 the share price is trading around $202.39. Using the diluted average shares reported in Q3 2025 (about 349.3M), that implies an approximate market capitalization near $70.7B (this is an approximation using the most recent diluted share count). Annualizing Q3 revenue gives a rough run rate of ~$2.248B (4x Q3), which puts price-to-sales near ~31x on an annualized basis.
That multiple is rich versus typical enterprise software, but Cloudflare is priced for high-growth, differentiated edge + security exposure. The way to reconcile the premium is a path to operating profits and sustained product-led monetization. The recent quarter shows both growth and margin improvement — the market is buying that roadmap, but the stock is still vulnerable to execution slips (see risks).
Catalysts (what can drive the stock higher)
- Continued sequential revenue beats and margin improvement — management showing operating loss trending to breakeven or positive operating income.
- Upsell momentum in security products (WAF, DDoS, managed detection) and higher ARPU from Workers / edge compute adoption.
- Large market growth for DDoS and SOCaaS generating acquisition/expansion tailwinds; independent studies point to accelerating cybersecurity budgets.
- Any clarity on capital deployment that reduces non-core investing cash burn or initiates buybacks would be a positive liquidity/valuation catalyst.
Trade idea - Actionable plan (entry, stop, targets)
Context: recent news-driven outages in November pushed sentiment down and volatility up. That creates an entry window; fundamentals still point to growth and improving profitability.
| Action | Price (USD) | Rationale |
|---|---|---|
| Entry | $190 - $205 | Buy the dip zone; recent print near $202 gives a logical entry band. Use staggered buys if you prefer averaging. |
| Stop | $175 | Hard stop to limit downside — roughly 10-12% below the entry mid-point and below key technical support from earlier trade ranges. |
| Near-term target (3-6 months) | $260 | ~+28% from the entry midpoint; this aligns with reversion toward recent 52-week highs (~$253) if growth/margins remain intact. |
| Stretch target (12 months) | $320 | ~+60% upside if Cloudflare sustains growth, margins improve meaningfully, and sentiment normalizes after outages. |
Position sizing: limit initial exposure to a size that would be tolerable if the stop is hit (e.g., risk no more than 1-2% of portfolio value on this trade). Consider scaling in at the lower end of the entry band to manage execution risk.
Risks and counterarguments
Below are the principal risks that could invalidate the trade thesis. I include a direct counterargument and then the reasons I still prefer a Buy at the entry band.
- Execution risk from outages: There were multiple service disruptions in November that dented investor confidence. A repeat or a severity escalation could trigger larger customer churn or slower enterprise purchases.
- High valuation - The company trades at an estimated price-to-sales near ~31x on an annualized basis. That multiple assumes continued growth and margin progression; anything short of that will pressure the stock.
- Capital intensity / investing cash flow - Q3 investing cash flow was a large outflow (about -$629.5M), pressuring net cash flow. If those investments fail to drive revenue uplift or if capital needs accelerate, margin progress could stall.
- Competitive pressure - Incumbent CDN/security players (traditional CDNs, cloud providers with native edge services) can undercut pricing or bundle capabilities, slowing Cloudflare's monetization.
- Macro / enterprise spend risk - An enterprise IT spend slowdown would hit expansions and new customer additions — high-growth names suffer disproportionately in downturns.
Counterargument: Given the outages and the high P/S multiple, a cautious investor could argue to wait for clearer proof of durable margin improvement or for a deeper pullback to materially lower valuations.
My response: Q3 2025 shows sequential revenue acceleration (Q3 revenue $562.03M vs Q2 $512.32M), operating loss improvement (-$37.46M vs -$67.26M), and strong operating cash flow ($167.12M). Those are the actual early signs of margin inflection investors pay up for. The outages are a meaningful short-term risk, but they have created a disciplined entry where upside is asymmetric if management continues execution.
What would change my mind (downside triggers)
- Repeat major outages leading to measurable customer churn or publicized enterprise contract losses.
- A major quarter with slowing revenue growth (QoQ deceleration) or a reversal back into materially larger operating losses.
- Evidence that large infrastructure investments are not translating into higher ARPU or meaningful product adoption (Workers, security upsells).
Conclusion
Cloudflare is executing the two things I want to see from platform software: user-led adoption turning into revenue growth, and the beginnings of operating leverage. Q3 2025 gives tangible proof on both counts — revenue is accelerating and operating losses are shrinking while operating cash flow is positive. The recent pullback tied to outages is a near-term risk, but it also creates a clear risk/reward entry for disciplined buyers. Upgrade to Buy with the trade plan above and a tight stop to respect the operational uncertainties.
Key dates: most recent quarter ended 09/30/2025 (filing accepted 10/30/2025). Price data current as of 12/28/2025.
Short checklist for traders
- Entry: $190-205 (staggered).
- Stop: $175 (hard stop).
- Take partial profits near $260; re-evaluate for hold toward $320 if momentum and margin story continue.
- Watch: next two quarterly prints for revenue growth consistency and operating-margin progression.