In the burgeoning cloud infrastructure market, keeping networks secure remains an ongoing challenge. As cybersecurity will continue to be the center of the technological future, investors can't help but find opportunities to buy.
Accordingly, companies focused on cloud security such as Zscaler (ZS -1.44%) and Cloudflare (NET -4.68%) have seen their stocks surge, especially in recent months. However, amid rising stock prices and valuations, only one is likely to emerge as a more reasonable choice for new investors.
The businesses compared
The differences in the companies lie in the focus. Zscaler is exclusively a cloud security company. It has stood out from competitors by establishing a "Zero Trust Exchange." This means that the software assumes everyone is a threat until they prove otherwise, establishing trust only after determining the user's identity and context.
To further enhance security, Zscaler only reveals the existence of specific sites to authorized users. It also uses next-generation firewall protection, or proxy-based architecture, to analyze apps and traffic. This offers a greater degree of protection than traditional firewalls, which sometimes allow secured access before fully investigating a threat.
Furthermore, stockholders could earn further gains over time as Zscaler pursues its next big growth opportunity, as its Zscaler Cloud Protection (ZCP) prevents misconfiguration and protects differing cloud platforms as they work with one another. Its products are so successful that Zscaler has attracted interest from 450 members of the Forbes Global 2000 and numerous government entities.
Cloudflare also takes a "zero trust" approach. Its web application firewall (WAF) helps to protect its more than 25 million clients from bots, distributed denial-of-service (DDoS) attacks, and other network threats. Although Cloudflare uses firewalls, it allows customizing the firewall to address specific threats, protecting a system from bots, anomalies, malicious payloads, and attacks on supply chains.
But, unlike Zscaler, Cloudflare does not limit its offerings to security. Cloudflare also focuses on edge computing services. Edge networks bring internet content and services closer to the end-user, enabling faster response times. The company has established data centers in more than 250 cities worldwide to enable its quick service. Cloudflare will further enhance its connectivity and security advantage by deploying hardware into over 1,000 of the world's most populated office complexes and multi-dwelling units. This proximity could make it the provider of choice in many key locations.
How the two companies compare financially
Zscaler ended its 2021 fiscal year on July 31. During that time, revenue increased by 56% from year-ago levels. However, operating expenses exceeded revenue levels, and interest costs surged by more than tenfold on amortization and issuance costs, leading to losses increasing by 128%. The company also expects a 47% revenue increase in the upcoming quarter.
Cloudflare earned about 44% more revenue than over the previous 12 months, which ended June 30. During that period, losses increased by 6% as operating costs remained ahead of revenue except in the latest quarter and, like Zscaler, the company's amortization and issuance costs surged. Although Cloudflare expressed some concerns about future quarters as the world emerges from the pandemic, the company projected a 45% increase in revenue in the third quarter.
In terms of stock appreciation, Cloudflare has come out the clear winner, rising by almost 200% over the last year, compared with an approximate 95% increase over the same period for Zscaler.
However, the growth has made Cloudflare significantly more expensive. Cloudflare sells for more than 100 times sales, compared with a price-to-sales (P/S) ratio of around 60 for Zscaler. Nonetheless, Zscaler sells for substantially more than Checkpoint Software or Palo Alto Networks, which support sales multiples of eight and 12, respectively.
Zscaler or Cloudflare?
Admittedly, both companies seem to have solid long-term growth prospects. Nonetheless, investors might not want to buy either Zscaler and Cloudflare for now as they support sales multiples that price them for perfection. That valuation could limit near-term upside potential and possibly set up the stocks for a considerable sell-off, especially with online activity expected to slow amid reopenings.
Still, investors should consider leaning toward Zscaler if forced to choose between the two tech stocks. Although both companies focus on growth, Zscaler seems to offer approximately the same revenue growth at a lower multiple. Moreover, if market conditions turn negative, Zscaler stock would probably experience a less dramatic decline than Cloudflare should post-pandemic reopenings slow growth. This makes Zscaler the least risky as the economy moves past COVID-19.