What happened

Cybersecurity stocks took a tumble Wednesday morning, and that's kind of strange.

Reporting third-quarter earnings after close of trading last night, CrowdStrike Holdings (CRWD -0.40%) easily topped analyst expectations for both sales and earnings, reporting a $0.40 per share pro forma profit, where the Street predicted only $0.31, and with sales of $580.9 million eclipsing expectations for only $573.8 million. CrowdStrike even guided investors to expect a second earnings beat in the fourth quarter, saying its earnings could top expectations by more than $0.10 per share this quarter.  

CrowdStrike's stock is down regardless, falling 19.5% through 11:10 a.m. ET. What's more, it seems to be pulling industry leader Palo Alto Networks (PANW 2.99%) down 2.3% as well. On the plus side, Fortinet (FTNT 1.07%), which was down as much as 2.2% earlier in the day, has trimmed its losses to just 0.4%.

So what

So what exactly is going on here? If CrowdStrike beat earnings in Q3 -- and promised to do it again in Q4 -- then why is its stock down? And if CrowdStrike's news was good, what sense does it make for Palo Alto and Fortinet stocks to be falling because of it?

Let's dig into the numbers. CrowdStrike grew its quarterly sales 53% year over year in Q3. Non-GAAP (adjusted) earnings (the aforementioned $0.40 per share) more than doubled year over year. The bad news is that according to generally accepted accounting principles (GAAP), earnings were actually negative $0.24 per share -- about 10% worse than a year ago. (On the plus side, free cash flow for the quarter was $174 million, a quarterly record for CrowdStrike.)  

Still, on balance, that sounds pretty good, and CrowdStrike did say that earnings (albeit pro forma) will be even better in Q4. On the other hand, management noted that its net new annual recurring revenue (ARR) was a bit weaker than expected in Q3, impacting Q4 sales, which are predicted to top out around $628 million -- a few million short of Wall Street's prediction. Management further warned that ARR in Q4 could be as much as 10% below Q3 levels.  

This, it appears, it's the prediction that spooked the stock market this morning, and caused CrowdStrike stock to sell off so hard.

Now what

Why is this a concern? Well, consider that in its entire lifetime as a publicly traded company, CrowdStrike has still never earned a GAAP profit (and isn't expected to start earning profits before 2026, according to estimates collected by S&P Global Market Intelligence). And even valued on free cash flow, by which measure CrowdStrike is already profitable ($621 million generated over the past 12 months), CrowdStrike stock sells for a pricey 52-times-FCF valuation. As such, CrowdStrike's valuation seems heavily dependent upon its expected growth rate. It stands to reason that any hint that growth might begin to falter is going to have an outsize effect on the stock's price -- just as we're seeing today.

That being said, at last report analysts were still forecasting strong 40.5% annualized long-term profits growth for CrowdStrike. That's not quite fast enough to make me call an FCF valuation of 52 cheap, but it's getting close. Compared to the alternatives, I certainly think CrowdStrike stock looks more attractively valued than Fortinet at 33.6 times FCF today, with a 23% projected growth rate.

Still and all, if you're looking for the best bargain in cybersecurity stocks today, I think Palo Alto Networks is your best bet. At 29% projected long-term growth, Palo Alto is growing quickly, yet doesn't have nearly so high a bar to clear, as CrowdStrike does, to meet Wall Street expectations, limiting the chance of an earnings miss. And at a valuation of only 21.5 times FCF, Palo Alto Networks is a much cheaper stock than Fortinet or CrowdStrike.

Long story short, CrowdStrike may look like the best target of opportunity after today's near-20% collapse in price. But Palo Alto Networks is still a better value stock for cybersecurity investors.