The tech-laden Nasdaq Composite index delivered solid gains of 32% so far in 2023 thanks to favorable factors such as cooling inflation, robust economic growth, the receding chances of a recession, and the proliferation of artificial intelligence (AI), which has given several technology stocks a big shot in the arm this year.
The Nasdaq could keep running higher along with the broader stock market. That wouldn't be surprising, as there are chances that the Federal Reserve could start cutting the federal funds rate beginning in the second quarter of 2024. It is worth noting that the Nasdaq was clobbered badly in 2022 and crashed 34% as the Fed raised interest rates to control inflation, but the situation seems to have changed for the better.
That's why now would be a good time for investors to buy shares of Zscaler (ZS 1.28%), a Nasdaq Composite component that has clocked impressive gains of 47% so far in 2023. Let's look at the reasons why.
Zscaler is growing at a terrific pace
Zscaler released fiscal 2023 fourth-quarter results (for the three months ended July 31, 2023), and it grew at a much faster pace than expectations. The cybersecurity specialist's revenue was up 43% year over year to $455 million, exceeding the original guidance, which called for growth between 35% and 36%. The company's adjusted earnings increased at a much faster pace of 156% last quarter to $0.64 per share, exceeding its guidance of $0.49 per share.
For the full year, Zscaler reported a 48% increase in revenue to $1.6 billion. Its non-GAAP earnings jumped to $1.79 per share from $0.69 per share in the year-ago period. Zscaler's terrific growth can be attributed to two factors: an increase in the number of customers the company serves, and a jump in spending by its existing customer base.
Zscaler ended the previous quarter with 7,700 customers, up from 6,700 customers in the prior year period. More importantly, spending by the company's existing customer base grew at a much faster pace. For instance, the number of Zscaler customers with $1 million or more in annual recurring revenue (ARR) for the company increased 37% year over year last quarter to 449. The number of customers who generated at least $100,000 in ARR for the company increased 25% year over year to 2,609.
This explains why the company finished the quarter with a dollar-based net retention rate of 121%. This metric compares the revenue generated by Zscaler's customers in the previous quarter to the revenue generated by those same customers in the year-ago period. So a reading of more than 100% in this metric means that Zscaler's customers either increased their usage of its products or adopted more of its offerings.
It is worth noting that this combination of an improvement in Zscaler's customer base as well as an increase in spending by existing customers allowed the company to double its ARR to more than $2 billion in the space of just seven quarters. Additionally, the company has built a solid revenue pipeline, with its remaining performance obligations (RPO) standing at $3.5 billion at the end of the previous quarter.
The RPO points toward a company's future revenue, as it refers to the value of customer contracts that haven't been fulfilled yet. Zscaler will be able to recognize the revenue from these contracts once it fulfills them. The important thing to note here is that the company's RPO is significantly higher than its fiscal 2024 revenue guidance of $2.06 billion, which would be a 29% increase from fiscal 2023 levels.
In simpler words, Zscaler's revenue pipeline is strong enough to help it achieve its top-line target this fiscal year, though don't be surprised to see it deliver faster growth based on the size of the RPO. Even better, Zscaler is expected to sustain its impressive growth in the long run as well given the cybersecurity niches that it serves.
How much upside can investors expect in the long run?
Zscaler is the leader in the virtual network security market, where it holds 5 percentage points more share than second-placed Akamai. The demand for virtual network security is growing at a steady clip thanks to the growing adoption of zero-trust security, which is a security framework that requires identity verification of each user looking to access resources on a private network.
With the zero-trust security market expected to generate $118 billion in annual revenue in 2032 compared to $25 billion last year, as per Precedence Research, Zscaler is sitting on a massive end-market opportunity. Throw in the fact that the company is building a nice customer base and is witnessing healthy growth in the adoption of its offerings, and it is not surprising to see why it is expected to deliver robust annual earnings growth of 60% for the next five years.
Zscaler's bottom line has been growing at a significantly faster pace than what analysts expect from it right now, so the company seems capable of clocking 60% annual earnings growth in the future. If that's indeed the case, Zscaler's earnings could increase to $18.77 per share in five years based on its fiscal 2023 earnings. Multiplying the projected earnings with the Nasdaq-100's average forward earnings multiple of 27 would translate into a stock price of $506, suggesting that the stock could at least triple in the next five years.
That's why investors looking to buy a cybersecurity stock that could supercharge their portfolios over the long term should consider buying Zscaler before it soars higher.
