Do Proofpoint’s Earnings Mean Anything for Cybersecurity?

Proofpoint had strong earnings, but before you buy any cybersecurity stocks, there are other things that must be considered to find value.

May 5, 2014 at 8:30PM

Proofpoint (NASDAQ:PFPT) shares soared after the cloud data protection software provider reported better-than-expected earnings. However, it's worth noting that shares of security stocks have been badly beaten, and had continued to trend lower prior to Proofpoint's report. So, should you buy Proofpoint or peers Palo Alto Networks (NYSE:PANW) and FireEye (NASDAQ:FEYE)?

What did Proofpoint say?
Proofpoint saw gains of nearly 14% following its first-quarter report. The company saw revenue of $42.7 million, beating expectations with growth of 38.8% year-over-year. Moreover, its loss per share of $0.12 was also better than the consensus.

Lastly, the company's guidance was solid, expecting full-year revenue of $179 million and a loss of $0.43 per share, both of which were slightly better than expectations. Essentially, the company beat on all metrics, although the beats were marginal compared to expectations.

High expectations and great volatility
As it appears, Proofpoint's earnings eased some fears that security providers are facing increased competition from larger companies that are building their own security networks. Specifically, Proofpoint's Targeted Attack Protection program, which protects customers against malicious links and emails, saw year-over-year growth of more than 100%. It is this performance that has investors of other cybersecurity stocks excited.

Nonetheless, all security-related companies sell different types of software, including FireEye and Palo Alto. For example, FireEye sells appliances to prevent advanced persistent threats, or APTs, alerting customers, but not actually preventing or eliminating the threat. Palo Alto, on the other hand, operates in the advanced firewall space, combining other services such as intrusion prevention.

With that said, investors know that companies of all sizes have bulked up their security, and as a result, shares of security-related stocks have soared in years past. In the five months prior to March, Palo Alto soared more than 65%, Proofpoint increased 225% in the year prior to March, and FireEye, with its IPO late last year, appreciated by 150% in the initial five months following its debut.

As a whole, this is an industry that has had enormous expectations built in to valuations, and even with large losses since March, these stocks are still expensive. So, are Proofpoint, FireEye, or Palo Alto good buys?

Is there a buying opportunity?
According to Proofpoint's guidance, the stock trades at 6 times guided full-year revenue, with operating margins of negative 20%. FireEye is growing a lot faster, with 152% expected revenue growth this year, in part thanks to an acquisition, and 46% growth is expected in 2015. However, FireEye trades at 9.5 times 2015's expected sales, and has a negative 100% operating margin, meaning $2 is spent for every $1 in earned operating income. Therefore, FireEye is still a big risk.

However, Palo Alto might be a different story. It trades at 10 times trailing 12 month sales, but the company is expected to grow 45% and 34%, respectively, over the next two years. Moreover, the company should be profitable in the process.

In 2012, Palo Alto had seen four consecutive years of operating margin improvements, including profits in 2012, but then took a step back in 2013. However, Palo Alto is expected to earn $0.38 and $0.60 per share during the next two years, respectively, to complement its impressive growth rate. Lastly, the company's upside looks solid beyond 2015, as Palo Alto estimates that its total addressable market will rise from $15.8 billion to $19.5 billion over the next three years, and will continue to grow.

Final thoughts
If you want to invest in the cybersecurity space, you're going to pay for it. But, in the process, it's important to remember that you're not comparing apples to apples, as these companies all offer different services and are priced differently in the market.

With that said, there are dozens of cybersecurity-related companies, and while different, investors can still compare valuations and growth rates to find a good opportunity. In this particular case, Palo Alto operates in a large market, it's attractively priced, profitable, and has a good risk-to-reward ratio, meaning it appears to be the best.

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Brian Nichols has no position in any stocks mentioned. The Motley Fool recommends Palo Alto Networks. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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