Investors' fears of missing out on a growth stock tend to surge following a stock-price rally. That's especially true if a stock's returns have trounced wider markets, as has been the case with Palo Alto Networks (PANW 0.68%) in 2023. Shares have nearly doubled so far this year, compared to a 16% increase in the S&P 500.
The cybersecurity specialist is enjoying strong growth, even though overall enterprise IT spending is slowing. The news is even better around Palo Alto's brightening financial picture.
Have investors gotten ahead of themselves by sending the stock so much higher this year, or are further market-thumping returns on the way? Let's take a closer look.
Safe and secure
The company's late May update contained mostly good news about the business. Enterprises are still prioritizing cybersecurity spending, even as they scale back in other IT niches, and Palo Alto Networks is capitalizing on its strong market-share position.
Sales in fiscal Q3 rose 24% to $1.7 billion. "Our team again executed well in a market that continues to become more challenging," CEO Nikesh Arora said in a press release.
Management is nevertheless finding it easier to generate steady profits in this environment. Net profits landed at $212 million over the last nine months, compared to a $270 million loss in the prior-year period. The company is generating ample cash flow, as well, which points to even stronger annual earnings results on the way.
Looking ahead
Palo Alto Networks raised its sales and earnings outlook for fiscal 2023, and that increase helps explain why the stock has done so well, compared to benchmark indexes like the Nasdaq Composite index. The stock's valuation is elevated to the point where investors might want to be cautious about buying it.
Shares are priced at nearly 13x annual sales, which is the highest premium the stock has achieved in several years. For context, you could own the more diversified and highly profitable Microsoft for about 12x sales.
Palo Alto Networks' more focused cybersecurity portfolio exposes it to the possibility of faster growth. And the last few earnings reports have demonstrated that this growth might hold up well, even during a cyclical downturn in IT spending. Wall Street is clearly excited about Palo Alto Networks' sales and earnings potential once the next expansion phase begins.
MSFT Operating Margin (TTM) data by YCharts.
In the meantime, patient investors might want to watch this stock for now as they wait for a more attractive price. Palo Alto Networks seems poised to improve key financial metrics while winning market share over the next few years. But the stock-price rally has limited shareholders' potential returns from here, especially given the fact that contract negotiations are becoming more challenging these days.
The company will close out its fiscal year in late August in an announcement that will feature management's first official outlook for the 2024 year. Investors who are interested in the cybersecurity space should follow that report and consider buying the stock if Wall Street is disappointed by any cautious comments from the company about short-term demand trends.
