What happened
Shares of Zscaler (ZS 3.87%) fell 10.9% last month after a disappointing quarterly earnings report. The company reported excellent growth that outpaced forecasts, but its outlook concerned investors.
So what
Zscaler reported quarterly financial results on March 2. Its revenue grew 52% over the prior year, topping consensus estimates by more than $20 million. The company's net losses narrowed relative to the prior year, and it produced $63 million in free cash flow, more than double the amount generated a year ago. It even delivered 125% net dollar retention, which indicates high customer satisfaction. That's all good news, but the market seemed unimpressed by Zscaler's forward-looking statements.
Image source: Getty Images.
The cybersecurity leader revised sales guidance upward slightly and significantly increased its adjusted earnings forecasts. That wasn't enough to keep Wall Street happy. The stock dropped nearly 20% in the days following the quarterly report. Even after the upward revision, Zscaler still expects a significant slowdown in the second half of the year. Billings are a key indicator of future revenue, and that number was a bit worrisome. It's taking longer for sales teams to close deals, which is translating to slower growth and lower cash flows.
The economic environment is challenging right now. Zscaler's forward price-to-earnings (P/E) ratio was nearly 90 in early March following an early-year rally. That sort of valuation isn't strange for a high-growth stock, but it doesn't leave much room for error. It didn't take much bad news for the market to pull out of Zscaler.
ZS Price to Free Cash Flow data by YCharts.
The stock was able to claw back some of those losses in the second half of the month as the tech sector displayed momentum, but that wasn't enough to erase Zscaler's prior losses.
Now what
Cybersecurity stocks are one of the most promising segments in the tech sector, and Zscaler is one of the leaders in that market. They provide cloud-based security that protects corporate networks from threats that could jeopardize company, employee, or customer data. It's easy to see why there would be sustainable demand for those services for years to come.
Unfortunately, strong growth isn't enough for Zscaler in the short term. With a forward PE ratio above 50 and a price-to-sales ratio above 11, the stock's performance depends on the company's ability to meet lofty expectations. Zscaler is a compelling long-term investment opportunity, but there's high risk of volatility in the short term.
