Investors have a very positive view of Palo Alto Networks' (PANW -0.86%) business right now. Shares have easily beaten the market's rally so far in 2023, rising almost 80% through mid-July.
Bulls are excited about the prospects for the cybersecurity specialist, given that the industry is becoming central to enterprise spending as more business shifts to the cloud. Palo Alto's improving finances have investors seeing green, too.
But there's a compelling bearish case to make for this stock, too, and it's worth reviewing if you're considering buying shares right now. With that in mind, let's take a closer look at the main reasons for -- and against -- Palo Alto Networks' stock.
The bear case: Too far, too fast
Bears will focus their complaints on Palo Alto Networks' surging stock valuation, which doesn't seem to connect well with its latest growth results. Sure, the company modestly boosted its 2023 outlook after posting solid sales trends in the fiscal third quarter. But growth has decelerated for four consecutive quarters, slowing to 24% this past quarter from 29% a year ago. Management is projecting further slowing ahead, with fourth-quarter revenue rising by between 17% and 19% to roughly $3.2 billion.
Customers are becoming more selective in their IT spending as well, and they aren't as eager as they had been to sign up for large software-as-a-service commitments. "The market is tough, and definitely more challenging than when we started the year," CEO Nikesh Arora told investors in late May. It's hard to square those weakening trends with the fact that Palo Alto Networks' stock has soared to a valuation of 13 times sales. You could own Microsoft, a more diverse and profitable business, at a cheaper valuation today.
The bull case: Long-term growth is likely
In contrast, bulls love Palo Alto Networks' strong market share in a niche that could see explosive growth over the next decade. It's an artificial intelligence (AI)-focused cybersecurity specialist, after all, and commands a great position in that arena. That success is obvious from the fact that its contract sizes are expanding even as it adds more customers. That base of clients is increasingly tilting toward huge enterprises, too.
PANW Operating Margin (TTM) data by YCharts.
Clients are signing up for additional services over time, too, which is proof that its "land and expand" model is a viable growth strategy. It's not hard to see how this business could post many years of market-beating sales growth as long as it maintains its innovation lead in the AI-fueled cybersecurity space.
The winning position
Risk-averse investors will prefer to stay away from this stock for now, though, as the valuation is steep. Palo Alto Networks doesn't have a long track record of positive annual earnings, either, having just posted its first year of profitability last year while projecting another one ahead in 2023.
But if you're more of a growth stock investor, there's lots to like about this stock today. Palo Alto Networks is winning share even at a time when IT budgets are shrinking overall. Its cash flow and earnings trends are pointing in the right direction, and its portfolio of services will likely meet strong demand over the next several years. The bulls will be right to have pushed its valuation higher in 2023 if Palo Alto Networks simply maintains its current momentum in the years to come.
