When you look past the popular large-cap technology companies (including those in the FAANG group and the "Magnificent 7"), you see that many tech stocks still trade far below their all-time highs after a brutal sell-off in 2022.
Tough economic conditions forced investors to reduce their growth expectations for the sector as a whole, as elevated inflation and rising interest rates forced consumers and businesses to reevaluate spending. However, some companies still deliver exceptional operating performances despite nursing a beaten-down stock price.
Zscaler (ZS 1.28%) is one of them. It sells a leading portfolio of cybersecurity products, and it's chasing an enormous addressable market of which it has barely scratched the surface. The company just reported its financial results for the fiscal 2023 fourth quarter and full year (ended July 31), and it topped forecasts on both revenue and earnings. With its stock price still 55% below its all-time high, here's why it's a buy right now.
Cybersecurity software is a growing necessity in the corporate world
Cloud computing is the technology that empowers businesses to operate online. Using a centralized data center, a company can store its valuable information, run its digital sales channels, and connect its teams without having to invest in its own expensive hardware infrastructure.
However, it comes with a downside. Since the company's valuable data is always online, it's exposed to around-the-clock cyber attacks. Research firm McKinsey & Company estimates the proliferation of the digital economy will result in $10.5 trillion worth of damage caused by those cyber attacks each year from 2025.
Zscaler is on a mission to plug the vulnerabilities created by the digital sphere. Its Zero Trust technology is designed for organizations relying on cloud networks, especially those with large remote workforces. See, it's easy to identify an employee when they're in the office. However, when they're logging onto the company's network from home, it's impossible to know if it's really them or if their credentials (username and password) have been stolen.
Zero Trust eliminates that threat in two ways. First, it treats all login attempts as hostile; when an employee signs in, Zscaler analyzes not only their credentials, but also their location and the device they're using to make sure it's really them. Second, rather than connecting the employee to the company's entire cloud network, it only connects them to the online application they need to complete their job. The rest of the network is effectively invisible to them, so if a malicious actor does gain access, they can't compromise other assets.
These steps are crucial to minimizing losses if and when a successful breach does occur. At the moment, Zscaler's software is preventing over 9 billion security incidents every single day on behalf of its 7,700 customers. That includes 32% of the world's largest 2,000 public companies, as identified by Forbes.
Zscaler topped its fiscal 2023 Q4 and full-year forecasts
Like most companies in the software industry, Zscaler is experiencing a slowdown in revenue growth amid the challenging economic conditions. However, in the fiscal 2023 fourth quarter, its $455 million in revenue topped the company's forecast and represented a 43% year-over-year increase.
Its revenue grew at a faster rate than CrowdStrike's, which increased by 37% year over year in the recent quarter, and Palo Alto Networks', which grew by 26%. Those two companies are leaders in the cybersecurity industry, which makes Zscaler's results all the more impressive.
The company is also making progress at the bottom line. It shrank its net loss by 68% to just $30 million compared to the same quarter last year, so it's gradually inching toward profitability. On a non-GAAP (adjusted) basis -- which strips out one-off and noncash expenses like stock-based compensation -- Zscaler actually delivered a net income (profit) of $101 million.
For fiscal 2023, Zscaler's revenue of $1.6 billion marked a 48% increase compared to fiscal 2022. That was also above the company's prior guidance.
Its full-year non-GAAP net income also came in above expectations, surging by 174% to $278 million. It's because Zscaler only grew its operating costs by 26%, which was a much slower pace than its revenue growth. Plus, it only increased its stock-based compensation expense by a modest 6%, which helped significantly boost its non-GAAP profitability.
Why Zscaler stock is a buy on the dip
Earlier, I touched on the potential damage cyber attacks could cause in the coming years, according to McKinsey & Company. The corporate sector spent about $168 billion on protection in 2022, but McKinsey says that number should be closer to $2 trillion, so there's an enormous gap that needs filling. That's an opportunity for cybersecurity providers like Zscaler.
The company places its addressable opportunity at $72 billion, which might be conservative in light of McKinsey's figures. But in any case, with just $2 billion in annual recurring revenue going forward, Zscaler has a major runway for growth ahead.
Professional investors on Wall Street are convinced of the company's future potential. The Wall Street Journal tracks 41 analysts covering Zscaler stock, and 27 of them have given it the highest possible buy rating. One analyst is in the overweight (bullish) camp, while 13 recommend holding. Not a single analyst recommends selling.
With Zsaler stock still trading down 55% from its all-time high, investors might regret not taking the opportunity to buy now when they look back on this moment in a few years.
