Palo Alto Networks Is a Cybersecurity Stock Steal Right Now

Top cybersecurity stock Palo Alto Networks (PANW -1.71%) has been hit with volatility this year. At the moment, it's trading down about 9% so far in 2022, which suggests its handling the volatility better than the S&P 500 and Nasdaq Composite, which are down a respective 16% and 27% for the year.

Accelerating growth and profitability have been key to salvaging this growth stock's price, and the company looks poised to continue delivering the goods. Given its potential, the stock is a fantastic deal right now after the company reported its latest quarterly earnings.

Image source: Getty Images.

Business IT is under siege

It's been rainy days for the market this year as a wall of worry has sent stocks reeling. But businesses themselves are also under duress. Cyberattack activity has been soaring over the last couple of years as the pandemic accelerated the adoption of new digital tools. For example, the number of ransomware attacks (i.e., when an organization's data is held "hostage" until a payment is received) more than doubled globally in 2021, by some estimates.

It's no surprise that demand for services from companies like Palo Alto Networks has been on the rise. The company was in heavy acquisition mode for a few years to bring its services up to speed for the cloud-computing era. Now, Palo Alto is enjoying the results of those efforts.

The third quarter of fiscal 2022 (which ended April 30) demonstrates this. Revenue was up 29% year over year to $1.4 billion. And as an indication of Palo Alto's momentum, remaining performance obligations (RPO; currently invoiced amounts to customers and future service under contract that has not yet been invoiced) increased 40% to $6.9 billion.

In all, the largest cybersecurity software company pure play is having itself a fantastic year as its unadjusted net income gradually starts to converge with free cash flow.

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

What about stock-based compensation?

Palo Alto's growth trajectory is more than respectable, and free cash flow is in incredibly healthy positive territory. However, many investors may still shy away from the stock because of unadjusted net losses (negative $270 million through the first three quarters of the current fiscal year). The difference between the net loss and positive free cash flow is primarily attributable to non-cash expenses like share-based compensation for employees ($821 million so far this fiscal year) and amortization of acquisitions ($94.6 million). Stock compensation is often cited as the top concern.

While $821 million in stock-based compensation is a big number, bear in mind that Palo Alto is a big company, too. Its current market capitalization is over $51 billion as of this writing, so the current pace of annual stock compensation will add about 2% of dilution to existing shareholders this year. Not the end of the world for a fast-growing company; nevertheless, management said that decreasing stock-based compensation as a percentage of revenue is a top priority right now.

Additionally, as a free-cash-flow-positive company, Palo Alto also repurchases shares to help offset stock-based compensation. In the last quarter, it didn't make any repurchases, but it expects to resume that activity as it has about $450 million remaining on its current repurchase authorization, good through the end of calendar year 2022. I expect to see a new authorization announced at some point soon, given the company's strong free cash flow generation.

In all, Palo Alto Network's enduring growth and rising profitability make a great story in the cybersecurity space. Shares trade for 31 times trailing-12-month free cash flow as of this writing. Palo Alto and fellow cybersecurity leader Fortinet remain my top buys in this space for 2022.