Zscaler's (ZS 3.10%) stock sank 7% during after-hours trading following its latest earnings report before reclaiming that lost ground on the following day. For the first quarter of fiscal 2024, which ended on Oct. 31, the cloud-based cybersecurity company's revenue rose 40% year over year to $497 million and exceeded analysts' expectations by $23 million. Its adjusted earnings more than doubled to $0.67 per share and also cleared the consensus forecast by $0.18.

Those headline numbers were impressive, but the temporary drop revealed at least some concerns about its cooling growth and high valuations. Was that brief pullback a buying opportunity or a red flag for Zscaler's future?

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Another quarter of slower top-line growth

Zscaler provides "zero trust" services, which treat absolutely everyone, including a company's top executives, as potential threats. Unlike many larger cybersecurity companies that install their services through on-site appliances, Zscaler only provides cloud-native services, which are stickier and easier to scale as an organization expands.

Zscaler has grown like a weed since its IPO in 2018. From fiscal 2017 to fiscal 2022 (which ended last July), its calculated billings grew at a compound annual growth rate (CAGR) of 57% as its revenue increased at a CAGR of 54%. Its stock hit an all-time high of $368.78 on Nov. 19, 2021, which marked a stunning 2,205% gain from its IPO price.

However, Zscaler's stock has declined about 50% since then as investors fretted over its decelerating billings and revenue growth. Like many of its industry peers, it struggled to gain new customers and lock in higher-value contracts as the macro headwinds drove companies to rein in their software spending.

Metric

Q1 FY2023

Q2 FY2023

Q3 FY2023

Q4 FY2023

Q1 FY2024

Calculated Billings Growth (YOY)

37%

34%

40%

38%

34%

Revenue Growth (YOY)

54%

52%

46%

43%

40%

Data source: Zscaler. YOY = Year-over-year.

Zscaler expects that slowdown to continue with 30% to 31% year-over-year revenue growth in the second quarter. For the full year, it expects its revenue to rise 29% to 30%.

Both of those estimates exceeded analysts' expectations. However, during the conference call, CFO Remo Canessa said the "global macro environment remains challenging" and "customers continue to scrutinize large deals."

On the bright side, CEO Jay Chaudhry noted Zscaler still gained a record number of new logo customers with over $1 million in annual recurring revenue (ARR) throughout the first quarter as the "increased frequency of high-profile breaches" and impending Securities and Exchange Commission (SEC) disclosure requirements for cybersecurity incidents "propelled zero trust security more into focus at the management and the board level."

The company expects its adjusted EPS to rise 54% to 57% year over year in the fiscal second quarter and to grow 37% to 39% for the full year. Both of those bottom-line forecasts also exceeded Wall Street's expectations.

So why aren't investors more bullish on Zscaler?

Zscaler's growth rates still look healthy, but two issues are weighing down its stock: its valuation and concerns about its near-term spending.

With an enterprise value of $27 billion, Zscaler still trades at 73 times forward earnings and 13 times its estimated sales for fiscal 2024. By comparison, its more diversified cloud-native competitor CrowdStrike (CRWD 0.22%) -- which is growing at a comparable rate and also expanding into the zero-trust space -- trades at 58 times forward earnings and 16 times this year's sales. Therefore, Zscaler's premium valuations could limit its upside potential unless its growth accelerates again.

During the fiscal first quarter, its adjusted gross margin held steady year over year at 81%, which suggests it still has plenty of pricing power in its niche market. Its adjusted operating margin expanded from 12% to 18% as it streamlined its spending.

But for the fiscal second quarter, Zscaler expects its adjusted operating margin to dip sequentially (but still rise year over year) to 17%. Jay Chaudhry said for Zscaler to meet the "growing need" for zero-trust services, it would focus on "scaling our go-to-market and R&D organizations" to strengthen the "foundation for the long-term growth of our business."

Those hints of higher spending overshadowed Zscaler's better-than-expected revenue and earnings guidance for the rest of the year. Investors might have been more forgiving if Zscaler were profitable on a generally accepted accounting principles (GAAP) basis, but analysts still expect it to stay unprofitable on a GAAP basis for the foreseeable future.

Is it the right time to buy Zscaler?

Zscaler's stock might need to take a breather for its business to catch up with its valuations, but it's still a rock-solid cybersecurity stock. If you can tune out the near-term noise about its cooler billings growth, high valuations, and elevated spending, I believe it's still a good time to accumulate more shares of this volatile hypergrowth stock as a long-term play.