Is It Too Late to Buy Palo Alto Networks Stock?

Following a knockout finish to its 2021 fiscal year (the 12 months ended July 31, 2021), Palo Alto Networks (PANW 4.27%) stock price is up some 92% since the start of 2020. Not bad for the "legacy" cybersecurity firm -- the largest independent security software company as measured by revenue.  

For investors considering the stock, you should know that the boat hasn't been missed. Cybersecurity is more important than ever as the world grows more reliant on digital systems, and the bad guys get increasingly sophisticated in their attacks. In spite of its great run, this technology stock still has a lot of growth potential.

Image source: Getty Images.

Fiscal 2021 in review

Palo Alto Networks finished off its fiscal year with a bang. Revenue was up 28% from a year ago to $1.22 billion, easily surpassing management's previous outlook for as much as $1.18 billion. The gain was primarily driven by software subscription and support sales, up 36% and comprising nearly three-quarters of total revenue (product sales, like Palo Alto's firewall hardware to protect physical assets like data centers and in-office servers, made up the balance).

All told, it was a fantastic year for the company as it continues to benefit from increased demand for its cybersecurity platform in the wake of the pandemic.

Data source: Palo Alto Networks.

A steady stream of high-profile cyberattacks indicates the direction Palo Alto Networks will be headed in the years to come. It isn't just tech companies getting targeted. Just this year, everything from energy infrastructure to manufacturers to sports teams has been hit by cybercrime. Add to the list the recent T-Mobile US attack, which the mobile network operator said led to the information compromise of at least 50 million consumers. It's disagreeable news to hear, but it nonetheless illustrates the current reality. Firms like Palo Alto Networks are integral parts of the world's operational fabric now, and demand for their services will only continue to rise.

For fiscal 2022, Palo Alto Networks said it expects revenue to grow at least another 24% to reach $5.28 billion in annual sales.  

All those acquisitions paying off

If you've been following Palo Alto Networks in recent years -- especially since current CEO Nikesh Arora took the helm in summer 2018 -- you know that the company's path in getting to where it is now has been something of a controversy. Under Arora's purview, nearly a dozen smaller peers and cyber start-ups have been acquired. It's run up quite the bill in doing so, shelling out at least $3 billion the last three years to make said acquisitions.

Data source: Palo Alto Networks.

Arora indicated on the last earnings call that large purchases are finished for now. Was it worthwhile? The price tag may have been large, but Palo Alto Networks was able to afford it. It consistently generates a free cash flow profit margin in excess of 30%, and even after the shopping spree, finished out July 2021 with $3.79 billion in cash and investments offset by convertible debt of $3.23 billion. It isn't the cleanest balance sheet, but considering the high rate of profitability, the cybersecurity leader will replenish its cash in short order.

And though it may have cost shareholders in the short term, the rapid pace of takeovers was necessary as the world is quickly transitioning to cloud computing-based IT infrastructure. A new breed of cybersecurity is needed as a result, and while some legacy firms have invested in organic development to make the transition, money was going to be spent either way to bridge the gap. 

Plus, in the world of intangible assets like software, acquisitions are a much better deal than when trying to merge two or more companies that are physical asset-heavy. Software firms have a great deal of synergy (cross-selling opportunities, efficient infrastructure scaling, sharing of technology and ideas, etc.). Palo Alto Networks's acceleration in revenue and booming free cash flow is an early indication its strategy is only just beginning to pay off. 

So is it too late to climb aboard the Palo Alto Networks train? Hardly. The company is still steadily growing at a fast clip, generating ample profits, and benefiting from an ever-expanding digital economy vulnerable to cyberattack. After the conclusion of fiscal 2021, shares trade for a not-so-reasonable 33 times trailing 12-month free cash flow -- a long-term value for the leader in cybersecurity services.