Every day, Wall Street analysts upgrade some stocks, downgrade others, and "initiate coverage" on a few more. But do these analysts even know what they're talking about? Today, we're taking one high-profile Wall Street pick and putting it under the microscope...
Cybersecurity company Palo Alto Networks (NYSE:PANW) won a big upgrade today when analysts at R.W. Baird announced they're assuming coverage of the stock and raising their price target to $250 a share. If they're right about that, Palo Alto Networks is worth more than 23% more than it currently costs. But instead of buying it, investors sold off Palo Alto by 1.7% today.
Here's what you need to know.
Upgrading Palo Alto Networks
There aren't a whole lot of details out on this upgrade at present, but what we do know of it, we know thanks to the good folks at TheFly.com, who quote Baird praising Palo Alto Networks' "innovative vision and culture, strong development capabilities and willingness to pivot the business to capture emerging trends."
More than that, Baird argues that in a world seemingly teeming with cybersecurity experts, Palo Alto stock is just one of the long-term plays in cybersecurity that investors should be considering today.
Only "one of," you say?
That's right. Baird may consider Palo Alto a favorite pick, but as it turns out, this banker was fairly busy today picking and panning other stocks in the cybersecurity sector as well. In addition to its Palo Alto upgrade, StreetInsider.com (subscription required) tells us that Baird also picked cybersecurity firms Proofpoint (NASDAQ:PFPT) and Varonis Systems (NASDAQ:VRNS) to outperform, while initiating coverage of Red Hat and downgrading Fortinet -- both at neutral.
Comparing the options
With only three buy-rated stocks to choose from, picking a winner here shouldn't be too difficult, so let's run through a quick valuation exercise, beginning with Palo Alto Networks.
With a $19.3 billion market capitalization and $1.5 billion more cash than debt on its books, Palo Alto stock sells for an enterprise value of just $17.8 billion. Although technically unprofitable from a GAAP point of view, Palo Alto is, however, a free cash flow monster, generating $925 million in cash profits over the past year. This gives the stock an enterprise value-to-free-cash-flow ratio of just 19.2 -- not bad at all for a company that Wall Street analysts generally agree will be growing at 26% or better over the next five years.
Of course, if growth is your thing, Proofpoint could be an even better bet. S&P Global Market Intelligence estimates put this security-as-a-service provider's growth rate at 29% and, with a $5.6 billion market cap and minimal net debt, that means the stock should make for an attractive investment at anything in the range of $200 million in free cash flow or better. Problem is, according to S&P Global data, Proofpoint actually generated only $111 million in FCF over the past 12 months. (It's also unprofitable under GAAP.)
And Varonis? The weakest free cash flow producer of the three cybersecurity names that Baird likes, Varonis generated just $24.5 million in FCF over the past year (and reported GAAP losses of $24 million). Varonis' growth rate -- 20% -- is also the weakest of the three named buys. So while Varonis Systems stock only costs about $1.9 billion in market cap ($1.8 billion net of debt), the low rate of cash production and (relatively) slow growth rate make this arguably the weakest of Baird's three picks in the cybersecurity sphere.
The upshot for investors
After working the numbers, I have to say that I think Baird's first idea is also its best. Cybersecurity is a growth industry, and there's probably plenty of room for multiple companies to operate here (and to profit). For investors looking to profit their portfolios from buying a great company at a great price, though, Palo Alto Networks isn't just "one of" the ideas you should be looking at.
It's clearly the best.
Rich Smith owns shares of Varonis Systems. The Motley Fool owns shares of and recommends Varonis Systems. The Motley Fool recommends Fortinet and Palo Alto Networks. The Motley Fool has a disclosure policy.