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Down a quarter this week, are Darktrace shares a steal?

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It has been a dramatic week for Darktrace (LSE: DARK). The share price fell by a quarter this week and now trades 48% below its level a year ago.

Does that make them an attractively priced bargain for my portfolio?

No deal

In fact, although Darktrace shares have tumbled this week, they are basically now just back to where they stood last month. That was before the firm revealed that it had received a number of unsolicited, preliminary and conditional proposals from a potential bidder. It was announced this week that that suitor is no longer interested in pursuing the deal, leading to the shares tumbling.

But if a potential bidder decided not to buy Darktrace, should I?

I think the investment case for the company was strengthened by the strong full-year results it published this week. Revenue grew 46% compared to the prior year. Net profit was $1.5m. That may sound slight, but was a welcome turnaround from the $145.8m net loss the firm recorded last year.

Free cash flow also jumped. It nearly quadrupled, coming in at $99.5m for the 12 months. I think that shows some of the long-term cash generation potential the firm has.

These positive trends in Darktrace’s business performance suggest that it has the wind in its sails. I expect further strong growth in years to come.

Are Darktrace shares good value?

Still, does that merit the current valuation attached to Darktrace shares?

After all, even after Darktrace shares declined, the company still commands a market capitalisation of £2.7bn. For a company that made a net profit of around £1.3m in its most recent full year, that implies a price-to-earnings ratio of several thousand! That is incredibly high. Admittedly, the company could see earnings grow sharply in coming years, in which case the ratio may come down to more attractive levels. For now, though, it looks expensive to me.

I think the shares seem costly even if the business does well. They look priced for perfection, but in reality growing companies in fairly new industries can often run into unforeseen challenges.

I also remain unconvinced about the sustainability of Darktrace’s competitive advantage. An installed customer base should be of some help as the company seeks to consolidate its success so far. But I see barriers to entry in the fast-growing cybersecurity space as fairly low. I do not know whether Darktrace will be able to maintain its impressive rates of growth in the long term.

My move

On that basis, I definitely do not see Darktrace shares at their current price as a steal for my portfolio. In fact I think the company may struggle even to maintain its current valuation, especially if customer growth or profits come in below expectations. For now, like the prospective suitor although on a much smaller scale, I will be walking away from the opportunity to put my money into Darktrace.

The post Down a quarter this week, are Darktrace shares a steal? appeared first on The Motley Fool UK.

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C Ruane has no position in any of the shares 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.