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Here's Why Palo Alto Networks Surged 57% in 2021

By Ryan Downie – Jan 10, 2022 at 8:16PM

Key Points

  • Palo Alto Networks is growing nearly 30% annually.
  • Investors were encouraged by the company's strong official earnings forecast.
  • The stock is fairly expensive but still provides plenty of long-term potential.

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Profit growth and higher valuation drove this cybersecurity stock higher last year.

What happened

Palo Alto Networks (PANW 3.19%) gained 56.7% thanks to strong growth along with rising valuation multiples. It was a great operational year for the company, and it was pushed even higher as investors bought up cybersecurity stocks.

So what

Palo Alto Networks' fiscal year ended in July, and it reported 27% revenue growth along with 36% bookings growth. The company was especially strong in its next-generation security products, indicating that it's gaining traction in key growth categories. That excellent sales expansion also drove improvements on the bottom line. Free cash flow grew to $1.4 billion for the fiscal year, a 30% increase over 2019 and 43% over 2020. This was all achieved alongside new product releases and a significant investment in growth. The company's R&D budget rose 15% while sales and marketing expenditures increased 30%, and free cash flow still rose dramatically.

Child in a suit celebrating and throwing money in the air.

Image source: Getty Images.

This trend continued into the latest quarter. Palo Alto Networks reported a slight acceleration in revenue growth and $550 million in free cash flow. That's encouraging in a highly competitive growth industry.

Shareholders of Palo Alto Networks also benefited from some valuation expansion. The stock started the year with a price-to-sales ratio around 9.6 and a forward price-to-earnings (P/E) ratio around 65. At the end of the year, these ratios were 11.8 and 76.9, respectively.

PANW PS Ratio Chart

PANW PE and Price-to-Sales Ratio data by YCharts

The valuation increase was fueled in part by momentum across the cybersecurity industry. In the first half of the year, the stock closely tracked major cybersecurity ETFs such as the iShares Cybersecurity and Tech ETF (IHAK 2.65%), ETFMG Prime Cyber Security ETF (HACK 2.31%), and the First Trust NASDAQ CEA Cybersecurity ETF (CIBR 2.17%).

PANW Total Return Level Chart

PANW, CIBR, HACK, IHAK Total Return Level data by YCharts

Palo Alto Networks outpaced its peers in the second half of the year based on its forecasts and progress. The company's management forecast 25% revenue growth for fiscal 2023 and nearly $2 billion in free cash flow. After one quarter, that outlook was revised upward for both sales and profits. That momentum set Palo Alto Networks apart from the pack and paved the way to valuation inflation.

Now what

There's little doubt that demand for cybersecurity software and services will continue to swell as digital transformation further shapes the world. The question is which stocks will be the winners and which will be the losers. Palo Alto Networks had a great year in that regard, and investors were rewarded handsomely.

Palo Alto Networks has serious long-term catalysts. It's not the cheapest stock, with a 73 forward P/E ratio. Even adjusting for growth, its price-to-earnings growth ratio is still nearly 3. That shouldn't keep long-term growth investors from buying in, but that could lead to extra volatility in the short term -- especially as interest rates rise.

Ryan Downie owns iShares Trust-iShares Cybersecurity and Tech ETF. The Motley Fool owns and recommends Palo Alto Networks. The Motley Fool has a disclosure policy.

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