Better Buy: Palo Alto Networks, Inc. vs. Fortinet

Cybersecurity stocks have fallen out of favor recently as investors reacted to slowing sales growth by selling off the major players. Both Palo Alto Networks (PANW 4.19%) and Fortinet (FTNT 1.74%) are well below the all-time highs they set in 2015.

The increased pessimism could be a boon for long-term investors looking for exposure to this promising industry. So, below I'll look at two of the biggest network security appliance vendors to see which one might make the stronger buy right now.

Palo Alto Networks vs. Fortinet

Revenue, sales growth, and profit margins are over the last complete fiscal year. Data sources: Yahoo Finance! and company financial filings.

Sales trends

Both companies are seeing significant growth slowdowns due to unfavorable industry trends, including a move by enterprises to delay IT purchases. The key U.S. market remains highly competitive, meanwhile, and there are economic challenges in other areas of the world, including Latin America and Western Europe.

Palo Alto Networks has so far navigated these headwinds better than its smaller rival. Sales growth was 41% in the most recent quarter, and while that represented a major step back from the prior period's 60% gain, it's still well above Fortinet's 22% improvement.

Palo Alto is also gaining share at a stronger pace than Fortinet. It added 34,000 clients to its customer base over the past 12 months, a period that CEO Mark McLaughlin described as just the beginning of a transformative time for the cybersecurity market. "The security industry is seeing a rapid transformation from legacy hardware and point products to integrated and automated capabilities that seamlessly work together as a platform," he told investors recently. "As the primary innovator driving this paradigm shift, customers are turning to our platform in record numbers to more effectively prevent cyberattacks no matter where their data resides."

Profit picture

On a non-GAAP (adjusted) basis, both companies are about even when it comes to profitability. Product expenses eat up between 25% and 30% of revenue, leaving gross profit margin of just over 70%.

Image source: Getty Images.

Digging deeper on the income statement, investors can see evidence that Fortinet has the edge on earnings. Operating margin has trended down to almost zero, but remains positive compared to Palo Alto's double-digit loss. Meanwhile, only Fortinet can claim consistent bottom-line earnings. The company has generated net income in each of the last five fiscal years. Palo Alto, on the other hand, has endured both an operating and net loss in four of the last five years.

Why buy Palo Alto Networks?

In my view, investors should prioritize strong sales gains over short-term profits because that growth implies market-share gains and progress on creating the type of business scale that will generate significant returns over the coming decade. That preference for growth helps explain why Palo Alto's stock is valued at twice Fortinet's valuation of 4.5 times sales even though it has the weaker profit history.

Consensus estimates call for Fortinet, with help from its surging subscription services segment, to boost revenue by 25% this year before slowing to a 17% pace next year. The comparable numbers for Palo Alto are 33% and 30%. In other words, not only is the latter company growing at a faster pace, but it's also expected to keep that pace relatively steady.

That's a testament to Palo Alto's larger, more diverse product offering, as well as its deeper-entrenched position in the industry. Those advantages lead me to favor buying that stock over Fortinet with an eye toward continued market-share gains ahead.