Many growth stocks fell sharply over the past year, dragged down by the looming threat of a recession. But growth has still outperformed the broader market over the past decade. During that time, the S&P 500 Growth index produced a total return of about 248%, topping the 213% total return of the S&P 500.
For risk-tolerant investors, that data makes a strong case for owning at least a few growth stocks, and now is a good time to buy Shopify (SHOP 0.88%) and Zscaler (ZS 1.73%). At their current valuations, both stocks should be able to produce threefold returns over the next five years.
Here's what investors should know.
Shopify: E-commerce
High inflation continued to be a headwind for consumer spending in the holiday quarter, and that led to another round of underwhelming financial results from Shopify. Revenue increased 26% to $1.7 billion and non-GAAP earnings fell 50% to $0.07 per diluted share. But the company is well positioned to regain its momentum when economic conditions improve.
The investment thesis is simple: Shopify is a cornerstone of the growing digital retail industry. The company powered 10% of e-commerce sales in the U.S. last year, second only to Amazon, and it ranks as the leading e-commerce software vendor in terms of market presence and user satisfaction. That success should snowball in the coming years, as Ameco Research estimates that global e-commerce sales will grow at nearly 14% annually through 2030, and Shopify empowers merchants unlike any other solution on the market.
Its software pulls multiple sales channels into a common backend, giving retailers the flexibility to engage buyers across online marketplaces like Amazon and social media like TikTok, as well as brick-and-mortar shops and direct-to-consumer (DTC) websites. Shopify completes the package with an extensive portfolio of value-added services, including solutions for marketing, payments, and financing.
Better yet, the company is executing on an ambitious growth strategy that should keep it on the leading edge of e-commerce for years to come.
One of the most exciting projects is the Shopify Fulfillment Network (SFN), a logistics platform that will simplify freight inbounding and order fulfillment for merchants, enabling them to guarantee two-day delivery to U.S. buyers across multiple sales channels. No other e-commerce software vendor has a comparable offering.
Of course, scaling a system of warehouses will hurt profitability in the near term, but the SFN should make Shopify a more compelling partner for businesses of all sizes in the long run.
Shares currently trade at about 9.9 times sales, a bargain compared to the five-year average of 29.2 times sales.
If Shopify grows revenue at 25% annually over the next five years -- a reasonable estimate given its annualized revenue growth of 53% over the last five years -- its share price could double without any change in its price-to-sales ratio. That's why this growth stock looks like a market-beating investment.
Zscaler: Cybersecurity
Cybersecurity company Zscaler delivered a solid performance in the most recent quarter. Revenue climbed 52% to $388 million and free cash flow soared 114% to $63 million. Additionally, its retention rate remained above 125% for the ninth consecutive quarter, indicating that existing customers are spending more over time, deepening their dependence on Zscaler. Management also raised its full-year guidance.
As a caveat, calculated billings increased just 34% during the quarter, which implies that sales will slow significantly in the coming quarters. Indeed, despite raising full-year guidance, management expects revenue growth of just 38% in the current quarter. But that blemish on an otherwise excellent quarter should give investors no pause. The challenging economic environment has many businesses spending money more cautiously right now, but cybersecurity is ultimately a necessity, and Zscaler should have no problem reaccelerating growth in a more favorable environment.
The investment thesis is straightforward: Zscaler runs the world's largest network security cloud. Its platform, known as a security service edge (SSE), helps businesses protect and connect their employees, applications, and IoT devices by inspecting internet traffic and enforcing zero-trust policies in the cloud rather than corporate data centers. In simple terms, Zscaler eliminates the cost of on-site security appliances, while providing superior protection.
As the largest network security cloud operator, the company processes 280 billion requests each day, logging 300 trillion security signals in the process. Those data points inform its artificial intelligence engine on a scale no other vendor can match, enabling Zscaler to deliver best-in-class security. As proof of its superiority, IT consultancy Gartner has named the company an industry leader for 11 consecutive years.
That should give investors confidence. Zscaler has a very strong position in a market that management values at $72 billion (and growing), yet shares recently traded at 11.7 times sales, a steal compared to the three-year average of 36.6 times sales.
If Zscaler grows revenue at 25% annually over the next five years -- a reasonable estimate given its annualized revenue growth of 54% over the last five years -- its share price could triple without any change in the price-to-sales ratio. That creates a compelling buying opportunity for patient investors.
