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3 Reasons Zscaler Stock is a Buy

By Trevor Jennewine - Apr 2, 2021 at 7:03AM

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This cybersecurity company could help investors pad their portfolios.

Many enterprises are investing heavily in digital transformation, replacing outdated systems with modern solutions. Those efforts make organizations more agile and efficient, helping them compete in a digital world, but they also create a need for more effective cybersecurity.

That tailwind has translated into strong growth for Zscaler ( ZS 3.31% ) and big gains for shareholders -- the stock is up over 500% in the last three years. But digital transformation efforts are still gaining momentum, and this company still has plenty of room to grow. Here are three reasons Zscaler is a buy.

1. Zscaler has a big market opportunity

Traditionally, companies have protected their data by installing firewalls around the perimeter of the corporate network. However, the world is changing, and enterprises now rely on cloud computing, software-as-a-service, and mobile workforces.

That means many applications aren't located on the corporate network and many employees no longer work inside the corporate perimeter. Those changes have made traditional security measures ineffective. But that's where Zscaler can help.

Digital cybersecurity concept featuring a pad lock surrounded by circuitry.

Image source: Getty Images.

Zscaler has built a secure access service edge (SASE) network, a model in which security is delivered from the cloud instead of on-premise firewalls and appliances. Rather than connecting directly to websites or applications, a client's request is sent through the Zscaler platform, where all data is inspected and business policies are enforced. In this way, Zscaler makes it possible for clients to securely connect to internally and externally managed applications, regardless of device or location.

Currently, management puts the company's addressable market at $72 billion. For reference, Zscaler earned $536 million in revenue over the last 12 months -- less than 1% of its total opportunity.

2. Zscaler is the market leader

Zscaler is the clear leader in the market for secure web gateways, according to research firm Gartner. The company operates the world's largest SASE-based security platform, with 150 global data centers handling more than 150 billion requests per day. That unmatched scale makes Zscaler's solution faster and more effective than its rivals.

Put another way, because SASE networks depend on edge computing, more data centers means less lag time for Zscaler's clients. Additionally, because Zscaler's cloud analyzes billions of data points each day, its AI algorithms are very good at identifying and blocking cyberattacks. In fact, Zscaler outranks all of its rivals in terms of malware detection and advanced threat defense capabilities.

3. Zscaler is growing quickly

Compared to legacy solutions, Zscaler's cloud offers better security and it eliminates the need for costly on-premise appliances. That compelling value proposition has translated into strong financial performance.

Metric

2018

Q2 2021 (TTM)

CAGR

Revenue

$190 million

$536 million

51%

Free Cash Flow

$2.1 million

$80.3 million

330%

Source: Zscaler SEC Filings. CAGR: compound annual growth rate.

Also noteworthy is that Zscaler keeps a high percentage of its customers. In fact, its net retention rate expanded from 117% in 2018 to 127% over the trailing 12 months, meaning the average customer spends more each year. That underscores the value of Zscaler's platform, and it should help the company stay ahead of its rivals.

A final word

Investors should note that Zscaler is not currently profitable on a net income basis, despite being free cash flow positive. Likewise, the stock trades at 43 times sales -- that's a very pricey valuation compared to competitors like Cisco and Broadcom, which trade at 5 and 8 times sales, respectively.

However, Zscaler is growing much more quickly than either of those rivals. Moreover, its best-in-class solution addresses the growing demand for cybersecurity in a digital world. That's why given the massive market opportunity, Zscaler's clear competitive advantage, and its strong financial performance, this stock looks like a good long-term investment.

This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium advisory service. We’re motley! Questioning an investing thesis – even one of our own – helps us all think critically about investing and make decisions that help us become smarter, happier, and richer.

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Stocks Mentioned

Zscaler Stock Quote
Zscaler
ZS
$328.76 (3.31%) $10.55
Broadcom Limited Stock Quote
Broadcom Limited
AVGO
$552.58 (-0.39%) $-2.18
Cisco Systems, Inc. Stock Quote
Cisco Systems, Inc.
CSCO
$56.48 (2.64%) $1.45

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

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