What happened
Palo Alto Networks (PANW) dropped 17.9% in December over mounting concerns about growth in the cybersecurity industry. The company had no major negative company-specific news during the month. However, investors are gathering a clearer picture of industry dynamics as more companies report quarterly results. These stocks tend to have expensive valuations and are prone to volatility whenever the outlook sours.
So what
Around mid-November, Palo Alto Networks reported its quarterly earnings, which investors generally received positively. Throughout December, investors analyzed earnings reports from several of its notable industry peers, including Zscaler, CrowdStrike, Okta, SentinelOne, and BlackBerry. Cybersecurity remains one of the highest-growth industries in the market, but the trend across these quarterly reports suggests growth is slowing and sales cycles are getting longer.
These stocks have maintained relatively high valuation ratios, despite tumbling throughout the bear market. So any indication of trouble on the horizon will likely cause a sell-off. Investors had hoped Palo Alto Networks and its peers would be relatively insulated from global macroeconomic weakness as the need to handle digital threats and data security remained urgent. Lukewarm management commentary during earnings calls, combined with sweeping layoffs across the tech sector, have cast doubt on the growth narrative.
The impact on Palo Alto Networks stock has been clear. Its price chart looks very similar to that of the Global X Cybersecurity ETF and the Proshares UltraPro QQQ, which is a leveraged exchange-traded fund (ETF) that seeks to triple the Nasdaq's returns.
PANW Total Return Level data by YCharts.
That indicates heavy correlation among the sector's prominent members. Investors are adjusting their assumptions about growth and cash flows across the board, and that's changing the consensus on fair market value for equities. Even though Palo Alto Networks didn't publish anything of note in December, investors can still draw important conclusions about the company's prospects.
Now what
Palo Alto Networks stock is now substantially cheaper relative to its underlying business fundamentals. Its price-to-sales ratio dropped from 9 to 7, its forward price-to-earnings (PE) ratio dropped from 50 to 40, and its price-to-free-cash-flow ratio is under 20. This could be justified if there's an extended period of weak sales growth, but it seems unlikely that December's industry news was significant enough to wipe out nearly 20% of the company's value.
Palo Alto Networks doesn't quite reach the same jaw-dropping growth rates boasted by some of its peers, but it still expanded more than 25% last quarter in a difficult business environment. That's impressive compared to other industries. Long-term growth investors should consider the discounts available in cybersecurity stocks right now.
