The U.S. dollar index peaked in early November 2022 and has since fallen like a rock. Historically, when investors believe that the dollar will remain weak, they will bid up the stock price of technology stocks, which appears to be the case starting this new year.
So far, the Technology Select Sector SPDR Fund, which tracks an index of S&P 500 technology stocks, has risen around 15% in 2023. And with a rising tide lifting all boats, Palo Alto Networks' (PANW 3.01%) shares have risen 17%. However, you should refrain from investing based solely on what happens in foreign exchange markets.
Let's consider some other excellent reasons why Palo Alto Networks should be high on your potential buy list in this uncertain economic environment.
It is still snowballing in a down market
Palo Alto Networks is a cybersecurity company -- an advantage in a terrible economic environment because while the global economy might be going into a recession, cybercrime is in a bull market. Internet magazine Cybersecurity Ventures estimates global cybercrime costs will rise from $3 trillion in 2015 to $10.5 trillion annually by 2025, a compound annual growth rate of 13.4%.
Since few companies can afford many of the costs of intellectual property theft, website spoofing, ransomware, identity theft, Internet-of-Things hacking, or malware, cybersecurity has become an essential service. Consequently, demand for Palo Alto's cybersecurity services remains high even amidst a pandemic, high inflation, rising interest rates, a European war, supply chain woes, and general economic uncertainty.
Image source: Palo Alto Networks.
The company generated 25% revenue growth to reach $1.56 billion in its fiscal 2023's first quarter, which ended in September 2022. That's excellent for the largest IT security company by market capitalization. Additionally, the company's next generation security (NGS) business grew its average recurring revenue (ARR) an astounding 67% year over year to $2 billion. ARR is a fundamental subscription business metric that can help predict future sales. Therefore, a rapidly growing ARR augurs well for the future.
Even better for shareholders, Palo Alto says it is growing at roughly twice its total addressable market rate because multiple changes in the security market are tailwinds for its business. One of the most significant changes is that customers no longer want to buy multiple disparate security functions from different vendors.
Instead, many cybersecurity customers today prefer a vendor that offers a platform of interoperable solutions. So, for example, the days of buying a firewall from one company, antivirus software from another company, and intrusion prevention software from another are over.
The recent economic downturn accelerates this consolidation trend. Many companies, wanting to conserve capital, are consolidating more security functions to fewer vendors in order to cut costs. And Palo Alto gets a lot of that consolidation business because of the high quality of its products.
Today, the company is a leader across seven significant security categories, and information technology experts like Gartner, Forrester Research, Frost & Sullivan, and others rate Palo Alto as having the best solutions.
The one fly in the ointment
Should you decide to invest in this company, you will need to be comfortable with the fact that it is difficult to achieve profitability in the cybersecurity industry. Plus, the potential of rapid technological changes can cause cybersecurity companies to quickly decline into obsolescence if they fail to keep up with change.
For example, despite being in business since 2005, Palo Alto found that its original products providing advanced firewalls and intrusion prevention systems remained stubbornly unprofitable. Then before the company became profitable, technological advancements like cloud computing upended its original business model, delaying profitability further and forcing it to change in 2018 to stay competitive.
PANW Net Income (TTM) data by YCharts
You can see on the above chart that Palo Alto's net income has rarely ventured into profitability for most of its history. However, things are changing.
Growing profits and free cash flow
Palo Alto has finally reached a point in its evolution where it can add revenue at a much greater rate than cost. As a result, its first-quarter fiscal 2023 results produced a net income under generally accepted accounting principles (GAAP) of $20 million, or $0.06 per diluted share, its second straight quarter of profitability.
The company is also a free-cash-flow (FCF) machine, producing $2.4 billion of FCF on a trailing-12-month basis at a robust 42% margin.
PANW Free Cash Flow data by YCharts
Investors love profitable companies with healthy cash flows in a slowing economy, which should limit Palo Alto's downside. And with long-term solid growth tailwinds at its back, it is little wonder savvy investors gravitate to this stock.
