Are we headed for a recession, a soft landing, or will the U.S. economy keep rolling and push the market to new all-time highs soon? There are plenty of prognosticators offering their answers, but the fact is that no one really knows. And even if they did, the stock market's behavior doesn't always mimic the broader economy. The uncertainty is why investing in companies operating in essential, secular growth industries like artificial intelligence (AI) and cybersecurity is important.
Cybersecurity leader Palo Alto Networks (PANW 0.91%) is a terrific example. Cybersecurity is not a luxury, and the industry is expected to experience substantial growth for the foreseeable future. The companies that leverage AI and machine learning will ultimately be the industry leaders and the best companies for stockholders. Palo Alto is at the top of the heap.
Palo Alto knocks earnings out of the park
Sometimes analysts get it wrong -- really wrong. When Palo Alto announced that it would deliver its fiscal 2023 fourth-quarter earnings on a Friday, some analysts expressed concern that management was trying to mask a bad report by releasing it on that day of the week. The notion is silly since that choice of release date actually put the report under a brighter spotlight. Nevertheless, the stock dropped 11% between the Aug. 2 announcement and the Aug. 18 report.
The real reason for the unusual release timing -- as the CEO emphasized on the earnings call -- was to get Palo Alto's information out ahead of a sales conference that began on Sunday. The stock popped 11% in after-hours trading following the release. This helps illustrate why investors should choose excellent companies for the long run and beware of making trading decisions based on short-term headlines. In actuality, Palo Alto reported total fiscal 2023 sales of $6.9 billion (up 25%) and guided for at least 18% growth in fiscal 2024.
Now that this is clear, let's look at what separates Palo Alto from the competition.
AI-driven technology has investors excited
The company started years ago selling firewall hardware, but today, Palo Alto offers firewalls as a service (no hardware needed) and industry-leading comprehensive security for networks and the cloud. It harnesses the power of AI and machine learning. For instance, Cortex -- the company's autonomous platform -- uses machine learning to prevent, identify, and respond to threats. Palo Alto reports that it now has more than 5,000 Cortex customers, an increase of 28% from a year ago.
It's pushing Cortex further with the release of XSIAM (Extended Security Intelligence and Automation Management) -- a hub of security operations that uses AI and machine learning to provide continuous automated protection that integrates with existing operations. One great thing about XSIAM for investors is that it provides predictable revenue streams from large customers: The average customer contract for XSIAM has a duration of three to five years and a price tag of $1 million annually.
Palo Alto also offers SASE (Secure Access Service Edge) network security and Prisma Cloud, known as the industry's most complete protection for cloud infrastructure and applications.
Is Palo Alto stock a buy?
Palo Alto's cutting-edge offerings give it a large and growing addressable market. Management believes its total market opportunity is already over $100 billion and will grow to more than $200 billion within five years.
Data source: Palo Alto. Chart by author.
The company is making the most of that opportunity. Its annual revenue has more than doubled from $3.4 billion in fiscal 2020 to $6.9 billion in fiscal 2023, and the company is forecasting $8.2 billion in fiscal 2024. But perhaps the best growth indicator is in the company's remaining performance obligation, which measures the amount of revenue it has under contract for future periods. The higher that number, the more sales a company can feel assured of seeing. For Palo Alto, this metric jumped to $10.6 billion in fiscal Q4, well above its fiscal Q3 total of $9.2 billion.
Data source: Palo Alto. Chart by author.
Growth stocks are notoriously difficult to value, and Palo Alto is no exception. The stock currently trades for a price-to-sales ratio of 10.6, which is slightly higher than its historical average. However, that's much lower than other hot AI names like Palantir Technologies at 15 and Snowflake at more than 20. With a long growth trajectory, industry-leading technology, and a rapidly expanding market, that valuation could prove to be well worth paying.
