Is Palo Alto Networks Stock a Buy Now?

Palo Alto Networks' (PANW 1.43%) stock price jumped nearly 7% during after-hours trading on Feb. 22 following its second-quarter earnings report.

The cybersecurity company's revenue rose 30% year over year to $1.32 billion, beating analysts' estimates by $40 million, as its billings increased 32% to $1.61 billion. Its adjusted net income grew 20% to $185 million, or $1.74 per share, which also topped analysts' expectations by nine cents.

Those headline numbers were impressive, but should investors still buy Palo Alto's stock as rising interest rates punish higher-growth tech stocks?

Image source: Getty Images.

Robust billings and revenue growth

Palo Alto's year-over-year billings growth, which adds its total revenue to its deferred revenue, accelerated significantly from the first quarter.

Data source: Palo Alto Networks. YOY = Year over year.

For the third quarter, Palo Alto expects its billings to grow 24% to 25% and for its total revenue to increase 25% to 27%.

For the full year, it expects its billings to increase 25% to 26% and its revenue to grow 27% to 29%. That's significantly higher than its previous guidance for 22% to 23% billings growth and 26% to 27% revenue growth.

Palo Alto mainly attributes those robust growth rates to its next-generation security (NGS) services, including Prisma, its suite of cloud-based security services, and Cortex, its artificial intelligence (AI)-powered threat detection platform.

The expansion of those newer businesses -- which was supported by a series of acquisitions -- has reduced Palo Alto's overall dependence on Strata, its core security platform, which runs on on-site firewall appliances. It also widens its moat against cloud-native challengers like CrowdStrike (CRWD 2.30%) and AI-driven hybrid competitors like SentinelOne (S 2.10%).

Palo Alto's annual recurring revenue (ARR) from its NGS services hit $1.43 billion, or 29% of its trailing 12-month revenue, in Q2. We can see that this higher-growth business has become a much bigger piece of the pie over the past two-and-a-half years.

Data source: Palo Alto Networks. TTM = Trailing 12 months.

Easing off the acquisitions and stabilizing its margins

Palo Alto spent nearly $3 billion on acquisitions throughout fiscal 2020 and 2021, but it doesn't plan to make any other big purchases in the near future. Instead, it will focus on integrating those services, stabilizing its margins, and developing new services internally.

Palo Alto remains unprofitable on a generally accepted accounting principles (GAAP) basis, but its non-GAAP operating margin, free cash flow (FCF) margin, and earnings per share (EPS) all continue to improve.

Data source: Palo Alto Networks. YOY = Year-over-year.

On a GAAP basis, Palo Alto's net loss widened from $267 million in 2020 to $499 million in 2021 as it ramped up its acquisitions but narrowed year over year -- from $235 million to $197 million -- in the first half of 2022.

For the full year, Palo Alto expects its adjusted FCF margin to hover between 32% to 33% and for its non-GAAP EPS to grow 18% to 19% -- which is also higher than its previous forecast for 16% to 18% earnings growth.

Is Palo Alto expensive relative to its peers?

Based on the midpoint of Palo Alto's own estimates and a price of $500 per share, its stock trades at nearly 70 times this year's earnings and about nine times this year's sales. Those valuations might initially seem high, but they're reasonable for the high-growth cybersecurity sector.

CrowdStrike trades at 185 times forward earnings and 27 times this year's sales, while SentinelOne -- which isn't profitable on a non-GAAP basis yet -- trades at 50 times this year's sales. CrowdStrike and SentinelOne are both growing faster than Palo Alto, but they're also running their businesses with much lower operating margins.

Therefore, Palo Alto Networks isn't cheap, but it provides a solid balance of growth and value for investors who think CrowdStrike, SentinelOne, and other high-growth cybersecurity stocks are too hot to handle.

It's not too late to buy Palo Alto

Last January, I called Palo Alto Networks my top cybersecurity stock to buy for 2021. The stock has rallied about 30% since I made that call, and I believe it could still have plenty of room to run as new cyberattacks highlight the growing need for cybersecurity services across multiple industries.