Key Points

  • Fortinet is one of the largest cybersecurity pure-play companies by revenue and has consistently grown sales by double-digit percentages for years.
  • The company has transitioned to cloud-based software mostly in-house with little help from acquisitions.
  • Along with growth, this is also one of the most profitable cybersecurity firms around with free cash flow profit margins of over 30% and zero debt.

Our experts issued a rare "Double Down" Buy alert on this one stock... Learn more.


Cybersecurity is a fast-evolving industry. The bad guys are constantly altering their angle and complexity of cyber attack, and security vendors need to stay ahead of the curve lest they be technologically (and financially) left behind. But the lockdown this year has created unique challenges for the digital security industry -- and its customers -- to navigate. Fortinet (NASDAQ:FTNT), in keeping with its stalwart performance over the years, has done particularly well.

Someone offscreen shown working on a computer. An illustrated lock is displayed in the foreground.

Image source: Getty Images.

A graceful transition to the cloud

Fortinet's cybersecurity proficiencies are rooted in an era when throwing up a perimeter around a physical location (like a firewall, a device that acts as a gatekeeper) was the best way to secure data. The cloud and mobility have been changing this (especially in 2020, when work-from-home went mainstream), transforming security from what once looked like a castle to something more like a counterintelligence agency

But Fortinet has been steadily updating its services, and now has a foot in both the past and the future. In fact, CEO Ken Xie pointed out on the last earnings call that Fortinet was the only security vendor recognized as a leader in both software-defined WAN edge infrastructure (for cloud and other networks spanning large areas) and network firewalls (more traditional security, still valid for physical real estate like offices, factories, and data centers).

And though the world of cybersecurity is quickly shifting, Fortinet's legacy products segment (labeled FortiGate products) is still best-in-class, and it grew revenue by 16% year over year in Q3 after a sluggish performance during the economic lockdown. The next-gen services segment (non-FortiGate revenue) grew year-over-year revenue by 27%, driven especially by strong demand from cloud computing operators. Over the trailing 12-month stretch ended September 2020, non-FortiGate revenue was $668 million -- an increase of 27% from a year ago, and good for just over one-quarter of total trailing 12-month revenue. 

These new cybersecurity products are helping sustain Fortinet's double-digit percentage growth rate, and are also making it one of the most profitable security pure-play companies around, a rare combination in this notoriously difficult corner of the tech sector.

Metric

Nine Months Ended
Sept. 30, 2020

Nine Months Ended
Sept. 30, 2019

Change

Revenue

$1.846 billion

$1.545 billion

19%

Gross profit margin

78.2%

76.3%

1.9 pp

Earnings per share

$2.03

$1.22

66%

Free cash flow

$684 million

$573 million

19%

Pp = percentage point. Data source: Fortinet. 

Top-notch profitability paired with a strong balance sheet

So far this year, Fortinet's free cash flow (revenue less cash operating and capital expenses) is at an enviable 37%. This is an important factor to consider when picking cybersecurity stocks. Those with nefarious intent never rest and are always adapting their attacks. Security is therefore always a fast-moving industry. The cloud and mobile endpoints are all the rage at the moment, but mark my words: They won't be the hot topic in security forever. For example, there is growing momentum toward building security directly into applications and the "containers" that move them themselves. As applications grow increasingly large and complex over time, simply securing a network on which data travels won't cut it anymore.

High profit margins thus enable a firm to continuously innovate to remain a relevant choice in protecting customers. And this is why Fortinet has been such an enduring growth story over the years. It has funneled its profits into the right research at the right time, and has been able to adapt its portfolio to match whatever the current need is. And it continues to do so. If app "container security" is the next big thing, Fortinet has a product to meet the demand. And along with its lucrative free cash flow generation, the company also has no debt, and $1.66 billion in cash and short-term investments on hand.

Fortinet shares are off from the all-time highs notched over the summer months, and trades for 23 times trailing 12-month free cash flow after Q3 2020 results. I'm a buyer of this top cybersecurity growth story right now.