Is It Too Late to Buy Fortinet Stock?

Fortinet's (FTNT 0.23%) stock plunged 25% on Aug. 4, after the company posted a mixed second-quarter earnings report. The cybersecurity company's revenue rose 25% year over year to $1.29 billion, narrowly missing analysts' estimates by $10 million, but its adjusted earnings grew 58% to $0.38 per share and cleared the consensus forecast by $0.04.

Fortinet's headline numbers looked healthy, but an unexpected reduction to its full-year revenue forecast rattled the bulls and sparked a broad sell-off across the cybersecurity sector. Does that grim warning suggest it's too late to buy Fortinet?

Image source: Getty Images.

What does Fortinet do?

More than two decades ago, Fortinet launched FortiGate, a "next-gen" firewall that provided more network device filtering capabilities than traditional firewalls did. That firewall became the foundation of its "Security Fabric," a comprehensive security platform that provides end-to-end security tools for on-premise, cloud-based, and Internet of Things (IoT) devices through a mix of appliances, on-site software, and cloud services.

Fortinet differentiates itself from its competitors with customized ASIC chips built for its own hardware and FortiOS operating system. It claims these proprietary chips give it a significant advantage against other cybersecurity appliance providers that use off-the-shelf x86 CPUs, programmable chips, and Arm-based chips. It believes the convergence of the cybersecurity, networking, and hybrid cloud markets will drive the market's long-term demand for its services.

Fortinet's growth rates support that bullish long-term outlook. Between 2012 and 2022, its revenue rose at a compound annual growth rate (CAGR) of 24% while its adjusted net income grew at a CAGR of 27%. It currently serves more than 680,000 customers globally, including most of the Fortune 500, so it's often considered a bellwether of the cybersecurity sector. That's why its reduced guidance for the rest of the year caused many other cybersecurity stocks to stumble.

Was Fortinet's outlook that alarming?

As the following table illustrates, Fortinet slightly reduced its revenue and billings estimates for the full year. It blamed that slowdown on the macro headwinds, which forced many companies to rein in the software spending and sign shorter contracts.

Data source: Fortinet.

Fortinet also dampened hopes for a quick recovery by predicting that its billings growth rate would remain in the "high teens" thorough the end of 2024. That dim outlook raises some troubling questions regarding its long-term goal of generating $8 billion in revenue and $10 billion in billings by 2025. To hit those targets, it needs to grow its revenue and billings at a CAGR of 22% and 21%, respectively, from 2022 through 2025.

Fortinet didn't reiterate its 2025 targets during its second-quarter conference call. Instead, CFO Keith Jensen said Fortinet might re-evaluate those goals as it enters its "normal planning cycle for 2024" in the second half of 2023.

But on the bright side, Fortinet raised its adjusted gross margin, adjusted operating margin, and adjusted earnings growth estimates for the full year. It still expects its margins to decine year over year as its revenue growth cools off, but it expects its price increases, lower product costs, and cost-cutting measures to cushion that blow.

Data source: Fortinet. EPS = earnings per share.

That improved outlook suggests it can still achieve its long-term goal of maintaining an adjusted operating margin of "at least 25%" through 2025. It also indicates it still has plenty of pricing power in the crowded cybersecurity market.

But is it too late to buy Fortinet's stock?

At $57, Fortinet trades at about 38 times this year's earnings per share. That makes it seem cheaper than Palo Alto Networks (PANW 0.91%), which is growing at a similar rate but trades at 48 times forward EPS. CrowdStrike (CRWD 2.03%), which is growing faster than Fortinet and Palo Alto, has a much higher forward multiple of 64.

When I look at Fortinet, I mainly see its resilience during previous economic downturns, its impressive proprietary chips, its stable margins, and its ability to generate consistent profits on the basis of generally accepted accounting principles (GAAP). Its stock might stay in the penalty box until its billings growth accelerates again, but I believe this evergreen cybersecurity company is still a great long-term investment.