If you've been paying any attention to the investing scene lately, you've probably had your fill of discussions about artificial intelligence (AI) and AI stocks. Let's be honest: Many companies (and commentators) are really stretching the definition of AI so it fits a company they care about. In all fairness, it's just good business during a hype cycle.
But one industry that doesn't need to fake its connection to AI is cybersecurity.
Companies like Palo Alto Networks (PANW 0.91%) and CrowdStrike (CRWD 2.03%) were developing AI and machine learning and incorporating it into their businesses well before the technology elevated itself into the mainstream consciousness. The reason is simple: Human intervention in cybersecurity incidents is often too slow to be effective. Cybersecurity software these days must be able to operate autonomously and know how to adjust to previous threats in order to better address future threats. This is the essence of AI.
CrowdStrike is a terrific company (one of my favorites), and I have written about it recently. But despite having 2.5 times more revenue over the trailing 12 months than CrowdStrike, Palo Alto Networks doesn't get the same love.
It should, and here's why.
An incredible transformation
Five years ago, Palo Alto Networks was primarily a next-gen firewall business that sold hardware and subscriptions. However, the company's visionary CEO, Nikesh Arora, recognized the need to move into the cloud and address future cybersecurity needs. He also realized that recurring revenue through software-as-a-service (SaaS) offerings was essential to the business.
The company now offers a suite of comprehensive cloud-based solutions. For example, its latest product, Cortex XSIAM, uses AI to improve security operations, detect and manage threats, and automate many processes. Other products include Prisma Cloud, which provides security for cloud-native applications. More and more businesses run software programs in the cloud nowadays, and the shift is permanent.
Recurring revenue explodes
Palo Alto Networks' innovation has driven revenue growth from $3.4 billion in fiscal 2020 to $6.9 billion in fiscal 2023. The best part is that the vast majority of this revenue is now recurring, as shown below.
Data source: Palo Alto Networks. Chart by author.
Recurring revenue models are vastly superior and provide consistent yearly sales rather than one-off hardware or licensing sales that can be lumpy. Microsoft pioneered this model when it moved from licensing software like Microsoft Word to selling it as an annual subscription -- resulting in tremendous success.
Is Palo Alto Networks stock a good buy?
Signs point to a prosperous future for the company. Its remaining performance obligation (RPO) ballooned to $10.6 billion last quarter from $8.2 billion a year ago. This means the company has 1.5 times last year's revenue already under contract for future periods. This is encouraging since RPO is a leading indicator of growth.
Palo Alto Networks is also popular with major enterprises. The number of deals that call for more than $20 million in annual revenue grew by 43% year over year last quarter. Palo Alto Networks also sees its total addressable market doubling over the next five years from $100 billion to well over $200 billion. This means that sales can double by maintaining its current market share.
Cybersecurity is also a desirable industry in case of a recession or economic slowdown. Companies can cut costs on advertising or labor but cannot afford to cut back on cybersecurity. The costs of breaches, malware, and ransomware are too great.
Of course, no investment is risk-free. Palo Alto Networks has a lot of competition, including Microsoft and CrowdStrike. The valuation could also turn investors off as Palo Alto Networks trades at 12 times sales. However, this is lower than many other popular AI-powered SaaS companies, as shown below.
SNOW PS Ratio data by YCharts
Every tech company seems to be scrambling to let investors know it is into AI, but Palo Alto Networks was in this arena before the hype. The company deserves more time in the spotlight, and the stock should get serious consideration from tech investors.
