What happened
Zscaler (ZS -1.49%) stock rose 60.9% last year because of the company's excellent sales and cash flow. Higher valuation played a minor role, but fundamentals can explain almost all of the returns.
So what
Zscaler provides cloud-based software that helps workers securely access and share data. Remote work became a necessity during the global pandemic.
While many people are returning to the office, distributed workforces have gained a permanent foothold and are going to be the norm for many businesses. That creates demand for cybersecurity companies, and there's lots of opportunity moving forward.
Zscaler reported 56% revenue growth for the fiscal year that ended in July 2021. That growth rate accelerated to 62% in its most recent quarter. Free cash flow nearly tripled in fiscal 2021, growing to 14% of revenue for the full year. That trend also continued in the most recent quarter, as free cash flow nearly doubled to $83 million.
Image source: Getty Images.
Zscaler initially projected 40% revenue growth this year but increased that forecast to 50% following a huge quarterly earnings report. The company is posting huge growth numbers, beating analyst estimates quarter after quarter and revising forecasts upward. That's a recipe for shareholder returns.
The story was complicated by market forces that shifted over the course of 2021. Growth stocks had an overall strong year, but there were hiccups in the fourth quarter. The prospect of Fed tapering and rising interest rates weighed on high-valuation stocks, and things got particularly hairy for "pandemic" stocks that enabled work-from-home, telehealth, and other types of remote interaction. Zscaler is one of those high-valuation stocks that got caught up in the volatility and is currently down around 30% from its 2021 high.
These market forces kept Zscaler's valuation ratios relatively in check. The stock's price-to-sales ratio was 58 at the end of 2021, slightly higher than it was at the beginning of the year. That's still a very expensive valuation, and the company also trades at huge multiples of forward earnings, cash flow, and book value.
ZS PS Ratio data by YCharts.
Now what
Zscaler stock is still pretty speculative at its current valuation, so it's good that investors didn't get carried away last year. It's healthier that the stock's returns were driven by fundamentals and operational excellence.
This promising cybersecurity play is certainly more interesting now that it's 30% below recent highs. If you're interested in investing in Zscaler, be ready to hold it for the long haul.
There are clearly reasons to be excited about the company over the long term, but the stock is likely to deal with volatility along the way. Rate hikes aren't ideal for expensive growth stocks, so don't be shocked if Zscaler endures some steep dips over the next year or two.
