Despite its consensus price target of $185 -- 44% higher than Aug. 9's closing price -- Palo Alto Networks (NYSE:PANW) is facing challenges that its once skyrocketing revenue growth can no longer hide. Until Palo Alto recently announced fiscal 2016 Q3 revenue growth of 48%, it had been on a nearly two-year run of 50% or better top-line improvements.
Palo Alto's stellar top-line gains masked the fact that its spending borders on reckless. Last quarter, Palo Alto's operating expenses jumped a mind-boggling 50%, and cost of revenue climbed 44%. Considering guidance for the current quarter calls for 36% to 37% top-line growth, Palo Alto's increasing losses can't be overlooked any longer.
The case for Check Point
One of Palo Alto's primary competitors may seem like an odd choice as a better buy, but Check Point brings something to the table its peer is sorely lacking: a focused management team committed to minimizing overhead even as it continues to grow.
Last quarter was typical of CEO Gil Shwed's long-term strategy of building a sustainable, subscription-based recurring revenue stream while managing spending. Sales improved a "mere" 7%, but thanks to the aforementioned emphasis on expense management, GAAP earnings per share, including one-time items, grew 8% to $0.95. Earnings rose 10% on a non-GAAP basis.
Subscription revenue from Check Point's software blades jumped 21% in Q2 to $93 million and now represents 22% of total sales. Another measure of Check Point's success in building a foundation of recurring revenue was its 14% jump in deferred sales to $892 million. Check Point won't post 30%-plus jumps in revenue each quarter. That's not Shwed's plan. But its profitable, solid fundamentals and predictable slow-but-steady improvement make Check Point a sound choice.
The case for Cisco
Though it may not be the first name that comes to mind in a discussion of data security stocks, Cisco is quietly making a name for itself. In a recent study conducted by NSS Labs, one of the data security industry's leading research firms, Cisco's Firepower 820 solution tested off the charts in both connections per second and effectiveness.
Palo Alto entered two of its solutions for testing, and while it performed admirably, Cisco was at or near the top of the nine products tested in most every category. The better news for Cisco investors is that customers are taking notice. According to CEO Chuck Robbins, last quarter's 3% increase in total revenue to $12 billion was driven in part by a 17% year-over-year improvement in security sales.
Going forward, Cisco should continue to enjoy double-digit gains in data security revenue because of its strategic plans for the fast-growing Internet of Things (IoT) and cloud markets. Making IoT gadgets and cloud hosting is nice, but the real opportunity lies with the data. Security is top of mind for many IT execs, and Cisco is becoming a solution of choice.
The case for IBM
As is the case with Cisco, IBM is in the midst of a transformation away from old-school enterprise hardware to cloud, data analytics, and cognitive computing. Data security is a key component of IBM CEO Ginni Rometty's "strategic imperatives," and it's ahead of its objective of garnering 40% of total sales from its new-ish group by 2018.
Over the trailing 12 months, IBM's strategic imperatives sales were $30.7 billion as of Q2 and now represent an impressive 38% of total revenue. And that figure has increased with each successive quarter, led by IBM's skyrocketing growth in all things cloud-related, including data security.
Like Cisco, IBM doesn't break out security revenue specifically, but Rometty did say sales climbed 18% in Q2, and there's no reason to think that rate will slow anytime soon. As a leader in cloud and data analytics, IBM's security unit is ideally suited to ride the coattails of its strategic-imperatives push. IBM's diverse product lineup and positive momentum also make it a better buy than Palo Alto, both now and in the months and years ahead.
Tim Brugger has no position in any stocks mentioned. The Motley Fool owns shares of and recommends Check Point Software Technologies. The Motley Fool recommends Cisco Systems and 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.