Palo Alto Networks (PANW 0.91%) shares have delivered outstanding gains of 70% so far in 2023, and a nice chunk of that jump came after the company released its fiscal 2023 fourth-quarter results (for the three months through July) on Aug. 18. Shares of the cybersecurity specialist shot up more than 15% thanks to faster-than-expected growth in earnings and solid guidance that points toward healthy growth ahead.
But with the stock trading at an expensive 11 times sales and 52 times forward earnings following its hot rally this year, does it make sense for investors to buy this richly valued cybersecurity stock in anticipation of more gains? Let's find out.
Built for long-term growth
Palo Alto Networks exited fiscal 2023 with revenue growth of 25% to $6.9 billion. The company also saw a massive spike of 76% in adjusted earnings to $4.44 per share. More importantly, Palo Alto's earnings guidance of $1.16 per share for the first quarter of fiscal 2024 on revenue of $2.05 billion to $2.08 billion was well ahead of Wall Street's estimate of $1.12 per share in earnings on $1.93 billion in revenue.
What's more, the company's full-year billings forecast of $10.95 billion also exceeded the $10.8 billion consensus estimate, which would be an increase of 19% over the prior year. It is also worth noting that Palo Alto's remaining performance obligations (RPO) increased 30% year over year to $10.6 billion, exceeding the growth in its actual revenue. The solid growth in this metric means that Palo Alto's revenue pipeline expanded impressively, as the RPO refers to the total value of future contracts that are yet to be fulfilled.
As such, it won't be surprising to see Palo Alto exceed its fiscal 2024 revenue forecast of $8.15 billion to $8.20 billion, which would translate into revenue growth of 19% to 20% over last year. Even better, Palo Alto believes that it can sustain these robust growth levels over the next three years.
The company projects its revenue and billings to increase at a compound annual growth rate (CAGR) of 17% to 19% through fiscal 2026. Meanwhile, Palo Alto sees its RPO increasing at a CAGR of 25% over the same period, suggesting that it could continue to grow its revenue at a nice clip beyond the next three years as well.
That won't be surprising given the huge addressable revenue opportunity the company is sitting on. The company estimates that the total addressable market (TAM) of its three cybersecurity platforms could expand from $104 billion this year to $163 billion in 2026, a jump of 56%. Based on its 2023 TAM estimate, Palo Alto controls just under 7% of the cybersecurity market. If the company continues to hold on to that share after three years, its annual revenue could increase to $11.4 billion. This is what analysts are anticipating from the company as well.
PANW Revenue Estimates for Next Fiscal Year data by YCharts
Assuming that Palo Alto does hit that mark in three years and maintains its current sales multiple of 11, its market capitalization could increase to $125 billion. That would be 76% higher than the company's current market cap. However, there is a good chance that Palo Alto could clock faster growth thanks to a solid customer base that's spending more money on its offerings.
Why Palo Alto could outpace expectations
Palo Alto Networks is laser-focused on gaining a bigger share of its customers' wallets, which explains why the company has been rapidly introducing new products. In fiscal 2023, Palo Alto released 74 new major products, which was a big jump of 51% as compared to fiscal 2022. The number of annual major product releases by Palo Alto has jumped five times in the past five years, and this has led to a nice jump in the number of modules being used by the company's customers.
For instance, the number of Palo Alto customers using five or more of its cybersecurity modules increased to 400 in 2023 as compared to just 80 in 2021. By 2028, the company expects the number of customers using five or more modules to increase to more than 7,000. That may be achievable given that Palo Alto is now relying on artificial intelligence (AI) to improve its offerings.
The company estimates that the addressable market for AI-driven cybersecurity operations could increase to $90 billion in 2028. Palo Alto doesn't want to miss out on this lucrative opportunity, which is why it plans to integrate AI across its entire portfolio of services to provide real-time threat detection and response to customers. It also plans to use generative AI to make it easier for customers to interact with its platforms.
With the adoption of AI in cybersecurity set to grow at an annual pace of 24% through the end of the decade, Palo Alto is doing the right thing by introducing this technology across its product portfolio as it could drive incremental customer spending. The company exited fiscal 2023 with 110 deals that were more than $10 million in size, a big jump of 64% over the prior year. For comparison, the number of $10 million-plus deals increased 59% in fiscal 2022.
In all, there is a lot of room for Palo Alto Networks to expand its business nicely in the future thanks to a huge TAM, a sticky customer base, and the rollout of new products that could lead to an increase in its customer base as well as higher spending. So, even though Palo Alto stock may seem richly valued now, it could justify its valuation in the long run with healthy growth and stock upside.
