As Amazon.com, Inc. (NASDAQ: AMZN) and Microsoft Corporation (NASDAQ: MSFT) investors are well aware, cloud services has been one of the highest-growth tech fields of the past decade and has provided tremendous upside for long-term investors.
On Monday, Wedbush analyst Daniel Ives said cloud security may be the next major growth phase of the cloud business, and Palo Alto Networks Inc (NYSE: PANW) and Zscaler Inc (NASDAQ: ZS) could be the big winners.
In addition to a ramp in cloud security spending in the next two to five years, Ives said he expects larger cloud players to increase their M&A activity as well. With earnings still ahead for Palo Alto and Zscaler in the next couple of weeks, Ives said investors can expect earnings headlines and pressured earnings multiples to trigger volatility among cloud security stocks in the near-term.
However, he said the long-term secular growth trend in cloud security is just getting started.
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Ives said Palo Alto is the wild card in the space given the company’s shift to shorter-duration deals, but he believes the underlying billings and free cash flow growth are trending in the right direction. He said Zscaler is the “best pure play” in cloud security.
“While the valuation is lofty and the stock will continue to grow into its multiple over the coming years in our opinion, we believe seeing the forest through the trees that ZS could double its market opportunity over the next three years from where it sits today, and in the near term, deliver results which justify a stock meaningfully higher as operating margin leverage and further multiple expansion take hold,” he wrote.
Wedbush has an Outperform rating and $275 price target for Palo Alto and an Outperform rating and $90 target for Zscaler shares.
Cloud security will certainly be a major long-term growth market. However, given the rapidly-evolving business, investors can limit risk by buying a basket of four or five of the top names in the space rather than attempting to pick a winner and putting all their eggs in one basket.
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