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3 Reasons the Future Is Bright for Zscaler Stock

By Trevor Jennewine - Jan 26, 2021 at 11:54AM

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This cybersecurity company could make investors richer as enterprises strengthen their defenses.

According to The Wall Street Journal, hackers recently executed a highly sophisticated cyberattack affecting over 18,000 companies and certain U.S. government agencies. Investigators now believe this attack may have begun years ago, potentially exposing hundreds of thousands of corporate and government networks.

The scope and scale of what has come to be referred to as the SolarWinds hack make Zscaler's (ZS 0.94%) value painstakingly clear. The company's platform provides network security, enabling clients to securely connect to web-based applications and cloud services. And while some cybersecurity firms were actually compromised by the incident, Zscaler was not. In fact, it was one of the first companies to offer response and recovery solutions to those affected.

Here's what investors should know about Zscaler and three reasons why this stock stands to benefit from the increasingly complicated and growing need for cybersecurity.

Woman interacting with security network.

Image source: Getty Images.

1. Network security is critical

The corporate environment is changing. Enterprises are moving to the cloud, accessing software through the internet, and engaging in remote work practices, all of which means one thing: Traditional security solutions built around the perimeter of corporate networks are no longer effective.

Zscaler's platform solves this problem by routing all traffic through its cloud, the Zero Trust Exchange (ZTE), where data is inspected and security policies are enforced. Currently, management puts the company's addressable market at $72 billion -- 150 times the company's top line over the trailing 12 months. But as more enterprises seek cost-effective security solutions, Zscaler's market opportunity should get much larger. In fact, Gartner estimates that by 2024 over 40% of companies will have plans in place to adopt security-as-a-service solutions like Zscaler's -- a massive jump from only 1% in 2018. That fast-paced adoption should be a powerful growth driver for the company.

2. Zscaler is growing quickly

Research firm Gartner recently recognized Zscaler as the leader in the Secure Web Gateway market, indicating it has a more complete vision and better execution than any of its rivals. This marks the 10th consecutive year in which Zscaler has received this honor, and it gives the company a big advantage.

While competitors like Broadcom (AVGO -3.10%) and Cisco (CSCO 0.95%) are much larger, Zscaler is growing more quickly. Over the last three years, Zscaler's revenue rocketed 211%, while Broadcom's sales increased only 35% and Cisco's revenue was flat. Additionally, Zscaler's dollar-based net retention rate has exceeded 100% each year since 2016, indicating that the average customer spends more each year. Going forward, Zscaler's strong market position, reinforced by the high cost of switching security providers, should help the company protect its business and continue to outperform its rivals.

3. Zscaler was built in the cloud

Zscaler provides security as a service through the cloud, which creates benefits for both the company and its clients. For example, clients save money because they don't need costly gateway appliances or IT personnel to support onsite security solutions. What's more, Zscaler has over 150 data centers worldwide and traffic is always routed through the nearest location, which makes Zscaler's platform faster than traditional "hub-and-spoke" solutions where all traffic is routed back to one central data center. Additionally, Zscaler's platform uses machine learning to analyze over 100 billion requests per day, blocking over 100 million threats per day, and each time a new threat is identified, it can be blocked for all clients. Put another way, as Zscaler's customer base expands, all customers benefit.

The company's subscription-based model translates into recurring revenue, which stabilizes the business with a steady inflow of cash. Zscaler's cloud-based distribution model also makes its platform highly scalable, since the cost to support each additional customer is minimal. Moreover, it reduces Zscaler's cost of goods sold, which has kept the company's gross margin above 75% since its IPO. In the future, Zscaler's ability to expand quickly and generate high margins could make the company very profitable.

A final word

Investors should watch Zscaler's customer growth and dollar-based net retention rate, since these metrics indicate how effectively the company is scaling its business. If customer growth slows significantly, or the dollar-based net retention rate dips below 100%, it would be a bad sign for Zscaler. Additionally, investors should keep in mind that Zscaler is not profitable, although the company has achieved a market cap of $26 billion. This could make the stock price volatile.

However, Zscaler has a large market opportunity, and its platform addresses a critical need for effective network security. As more enterprises move to the cloud and workforces become increasingly mobile, Zscaler should continue to grow quickly.

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Stocks Mentioned

Zscaler Stock Quote
$138.17 (0.94%) $1.28
Broadcom Limited Stock Quote
Broadcom Limited
$526.36 (-3.10%) $-16.83
Cisco Systems, Inc. Stock Quote
Cisco Systems, Inc.
$43.35 (0.95%) $0.41

*Average returns of all recommendations since inception. Cost basis and return based on previous market day close.

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