Though demand for cybersecurity solutions is on the rise, Palo Alto Networks' (NYSE: PANW) stock price hasn't matched its business results the last couple of quarters. Sales have continued to rise as organizations around the globe migrate to cloud-based operations -- the security of which is a special focus of Palo Alto -- and the company continues to home in on unadjusted profitability. Nevertheless, shares rose too far, too fast in 2018, and a correction was overdue.
After the reset on valuations and Palo Alto's continued double-digit growth, the stock is worth putting on buy lists for the new year.
Accelerating sales and profits
Over a trailing three-year period, Palo Alto's sales and free cash flow (money left over after basic operating expenses and capital expenditures) have both nearly doubled. During the fiscal year ended July 31, 2018, revenue growth began to accelerate due to the company's acquisition of smaller peers. Palo Alto also got a new CEO, Nikesh Arora, a former executive at Google parent Alphabet (NASDAQ: GOOG)(NASDAQ: GOOGL).
Those trends continued during the fiscal 2019 first quarter. Sales growth topped the 29% rate posted during 2018, and unadjusted losses were inching toward black.
Three Months Ending Oct. 31, 2018
Three Months Ending Oct. 31, 2017
Gross profit margin
Earnings (loss) per share
Adjusted earnings per share
YOY = year over year. P.p. = percentage point. Data source: Palo Alto Networks.
Businesses' and organizations' cloud-based operations are growing increasingly complex, as are bad guys' efforts to disrupt them. With digital transformation only increasing around the globe, Palo Alto has a strong tailwind at its back that could bolster growth for years to come.
Nevertheless, some investors may shy away due to the lack of profits -- at least on an unadjusted basis, which includes share-based compensation and one-time expenses related to acquisitions and tax law changes. When accounting for those items and the fast uptick in sales, Palo Alto looks like an attractive investment.
Image source: Getty Images.
Really expensive, but only on the surface
Though Palo Alto is currently running at a loss, its one-year forward price to earnings is 32.8 -- implying Wall Street's expectations that the cybersecurity outfit will soon turn a corner on the bottom line. However, paying for more than 30 years' worth of profits that haven't yet arrived may not be your cup of tea.
Things look a lot better when using price to free cash flow, though. Based on that, Palo Alto is making healthy profits -- $901 million over the last trailing 12-month period, to be exact. That's good for a price-to-free-cash-flow ratio of 20.5.
That looks like a reasonable price for a company that is notching better than 30% and 50% sales and adjusted profit growth, respectively. However, it's still worth noting that Palo Alto's stock will be a volatile one. Misses in top-line growth trajectory can send shares on a gut-wrenching ride, so investors with no patience for that should steer clear. For those who don't mind the ups and downs and have at least a few years to wait, shares look like a good value given how fast the company is expanding.
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Suzanne Frey, an executive at Alphabet, is a member of The Motley Fool's board of directors. Nicholas Rossolillo and his clients own shares of Alphabet (C shares). The Motley Fool owns shares of and recommends Alphabet (A shares), Alphabet (C shares), and Palo Alto Networks. The Motley Fool has a disclosure policy.