Among technology stocks, investors tend to gravitate to hot product stocks such as Apple or artificial intelligence stocks like Nvidia or C3.ai.
However, this often means investors ignore growth stories in segments such as cybersecurity. Although security may lack the visceral appeal of other tech stocks, it plays a critical role in the tech environment. It also offers compelling opportunities in high-growth stocks, particularly with companies like Zscaler (ZS 5.40%).
What is Zscaler?
Zscaler is a cybersecurity company for the cloud. Users often access cloud-based software via mobile in varying locations. This makes establishing a perimeter no longer viable, so software must protect data and resources individually.
Zscaler implements this protection using a "zero trust exchange." This software assumes every user is a security threat. To determine who should have access to a network or its data, Zscaler bases decisions on context. One's identity, context, location, or other factors determine whether one can gain access.
Additionally, Zscaler deploys its software on the edge. Through the Zscaler SASE (secure access service edge), it brings security as close to the user as possible. This eliminates unnecessary backhauling while reducing latency and providing bandwidth that is closer to optimal.
The consumer and investor reaction
Clients continue to take well to Zscaler's products. In the first two quarters of fiscal 2023 (which ended Jan. 31), revenue of $743 million rose 53% from a year ago. Losses also fell to $126 million in the first half of the fiscal year versus a loss of $191 million in the year-ago period.
Despite the rapid growth, investors have not responded well to recent numbers. The growth represents a slight slowing from fiscal 2022, when revenue surged 61% higher year over year. Billings also rose by 36% in the first half of fiscal 2023, well under the 57% of fiscal 2022. Since billings deal with customer sign-ups, that could imply further slowing in revenue.
Consequently, investors punished the stock. It has lost about half of its value over the last year, and it missed the 2023 rally, breaking even year to date.
In the second-quarter 2023 earnings call, CEO Jay Chaudhry said that in a sluggish economy, its customers had become "more deliberate about large purchasing decisions." Nonetheless, with the necessity of cybersecurity, many of these customers will likely purchase the software eventually. Moreover, Zscaler reported a net retention rate of 125%, meaning the average customer of one year or more increased yearly spending on the platform by 25%.
Its price-to-sales (P/S) ratio has also fallen to about 12. While that makes it slightly more expensive than peer Palo Alto Networks, Zscaler sells at its lowest valuation since its 2018 IPO.
Investing in Zscaler
That valuation could indicate that now is the time to buy Zscaler. Indeed, investors have turned on the stock as billings have slowed. Nonetheless, cybersecurity is essential in today's cloud market. Although some clients are not signing deals as readily, the need for a secure cloud should ultimately prompt customers to sign on the dotted line. Investors should consider this factor and the lower sales multiple while the stock is near multi-year lows.