Investors are finding many new reasons to like Palo Alto Networks (PANW -1.22%) right now. The cybersecurity industry is proving to be resilient through the latest downturn in IT spending, and the company is also capitalizing on its newfound profitability.
Risks remain around growth trends, though, and there's a good chance an investor can overpay for this business. With those caution flags in mind, let's take a closer look at whether Palo Alto Networks is an attractive buy candidate today.
The latest results
The bad news for the business is that clients are taking longer to commit to major cybersecurity deals, and they're being pickier about the size of those contracts. In the company's late May earnings report, CEO Nikesh Arora said the market "continues to become more challenging." Those comments echoed the ones by Microsoft and other providers of cloud services.
Yet, Palo Alto Networks is still seeing strong growth with revenue up a blazing 24% in the most recent quarter. Companies are prioritizing cybersecurity spending even in this cost-cutting environment. That's great news for leading providers like Palo Alto, which recently raised its full-year growth goal to target about 25% sales gains in 2023.
Margins are improving
Profitability isn't particularly impressive right now. The company broke into consistently positive earnings only last year, after all. Its operating margin is hovering around 2% of sales, too, while Microsoft consistently turns over 40% of its sales into profits.
MSFT operating margin (TTM) data by YCharts; TTM = trailing 12 months.
Still, investors are excited about the prospects for Palo Alto to push that core profit metric higher over the next few years. Chief Financial Officer Dipak Golechha said in May that the company is committed to achieving profitable growth. Management backed up those claims by raising forecasts for cash flow and operating profit margin for the year. Continued wins along these lines could easily help the stock earn its current valuation premium.
The stock price
There's no denying that Palo Alto Networks is an expensive stock. Shares are currently priced at 13 times annual sales, which is higher than investors have seen since well before the pandemic. Microsoft is trading for 12 times sales, for context, even though the company is much more profitable and owns a dominant market position across several growth niches in the software-as-a-service space.
You could still see excellent returns from owning Palo Alto over the next several years, if the company can extend its current positive sales and profit margin momentum. Most Wall Street pros are expecting this to happen in 2023 and beyond. On average, they predict sales will rise 25% as earnings improve to $4.27 per share from $2.52 last year.
The stock might remain volatile as investors judge whether Palo Alto Networks can hit these ambitious figures. But the company seems on track to win more customers, deepen its relationship with existing clients, and push further toward double-digit operating profit margins.
Assuming it continues along at that general pace, shareholders should be happy to have this software specialist in their portfolios.
