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Could Palo Alto Networks Be a Millionaire-Maker Stock?

By Nicholas Rossolillo – Apr 12, 2018 at 6:12PM

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It’s been a good year for Palo Alto Networks’ investors. Will the good times keep rolling?

Fueled by increasing need for cybersecurity and a run of better-than-expected financial results, shares of Palo Alto Networks (PANW -1.08%) have rallied 70% in the last year. Cybersecurity is a young but fast-growing industry, and Palo Alto Networks is one of the leading providers of the service. That could equate to further upside for owners of this stock.

Security in the digital age

The digital economy continues to grow and become an increasingly important part of how businesses operate. The number of devices with an internet connection is also booming, a movement referred to as the Internet of Things. That means cyberattacks are also on the rise, and the last thing any business wants is a major headline exposing a data breach or other successful attack.

In light of that, a number of cybersecurity "pure-play" companies have sprung up in the last decade, and Palo Alto Networks has quickly become one of the largest. The company specializes in subscription-based firewall services, but also sells anti-virus products for devices and other threat detection services for businesses. A deepening presence in cloud-based security -- computing that is done off-site at a dedicated data center -- is also being emphasized with the recent purchase of for $300 million. That type of software service is growing in importance for businesses around the world, and Palo Alto Networks is at the forefront of it.

Revenues are expected to be $2.2 billion in the current fiscal year, an annual increase of about 25%. Though the company isn't profitable yet, it does generate positive free cash flow. Price-to-free cash flow is currently at 21.6, making shares a reasonable value considering the strong expected growth.

An artist's rendition of multiple computers all linking up to a cloud.

Image source: Getty Images.

Reasons for caution

Palo Alto Networks is already a big company. Its market cap as of this writing is $17.8 billion, and it sits at the apex of the pure-play cybersecurity stock category along with its other big competitor, Check Point Software Technologies. There are also lots of smaller competitors out there, and that could create some headwinds for Palo Alto's growth.

As mentioned earlier, the company is not profitable. Much of that has to do with share-based compensation. Palo Alto Networks doles out shares to employees as part of their paychecks. That in and of itself isn't bad, but the rate at which the company does so dilutes the ownership of other shareholders. That payout to employees is expected to continue. At last report, the company said there was a weighted average of 91.1 million shares outstanding, but for its fiscal year, it is assuming it will use anywhere from 94 million to 96 million shares to calculate per-share data.

In spite of this, Palo Alto Networks' stock looks like a solid pick, even though the stock's biggest gains may be in the past. With the digital economy continuing to grow, the need to secure it against an attack will also grow. At this stage of the game, it may not create investors massive wealth, but Palo Alto Networks still looks like a good company to own for the long term.

Nicholas Rossolillo has no position in any of the stocks mentioned. The Motley Fool owns shares of and recommends Check Point Software Technologies. The Motley Fool recommends Palo Alto Networks. The Motley Fool has a disclosure policy.

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