Overlooked growth stocks could be the biggest gainers during the current bull market. Many high-profile companies have enjoyed surging valuations as they recovered from the 2022 market correction. Some promising businesses have lagged their peers, and one cybersecurity stock in particular has attractive upside potential.
An under-the-radar cybersecurity stock
SentinelOne (S +1.57%) provides endpoint protection software and services to business customers. Its products are used to monitor and eliminate malicious software threats to devices and servers that are connected to an organization's network. The number of cyberattacks is increasing over time, and endpoints are one of the most common entry points to enterprise networks.
It's easy to see why there's serious demand for endpoint security services and that demand is great news for SentinelOne, but taking advantage of that demand is another story. This portion of the cybersecurity industry is highly competitive, with large and capable providers including CrowdStrike, Microsoft, Palo Alto Networks, and Fortinet. The crowded space creates a lot of mouths to feed, even if there's a large and rapidly expanding pie to divide among the crowd.
SentinelOne is trying to differentiate itself by leaning fully into artificial intelligence (AI). Its platform boasts automated monitoring and remediation capabilities. That should improve the efficacy of its threat detection, and it also reduces the burden on human employees to manage those processes. It's a shrewd move to stand out in the crowd, though it would be naive to doubt competitors' AI capabilities -- building automation into the platform will hardly be a unique value proposition. Still, SentinelOne finds itself getting high marks from Gartner and its customers. The company's clearly built a high-quality product.
NYSE: S
Key Data Points
SentinelOne is also aiming to create a competitive advantage by forming distribution partnerships with managed security service providers (MSSPs). MSSPs allow companies to outsource cybersecurity functions, which tends to be valuable for smaller-scale businesses or companies in relatively low-tech industries that might lack the expertise to handle security in-house.
There are pros and cons associated with a partnership distribution model rather than a direct sales model, but maintaining an MSSP network helps SentinelOne maintain a foothold instead of getting steamrolled by larger competitors with greater resources. Analysts speculate that SentinelOne's economic moat is weaker than the likes of CrowdStrike's or Palo Alto Networks', so it's important to pursue alternative strategies in order to stay afloat.
Strong financial results that you can't ignore
The financial results indicate that these strategic moves have been working. SentinelOne reported 42% year-over-year revenue growth in its most recent quarter, supported by 115% net dollar retention. That net dollar retention figure means that customers that were active one year ago are producing 15% more revenue now than one year ago. This indicates that a very low percentage of customers are discontinuing service, and that they are actively expanding their relationship with SentinelOne. That's evidence of high satisfaction, a strong product, and effective customer service and sales functions. Given the quality of competition, the combination of retention and new customer bookings is encouraging. The company reported a 24% year-over-year jump in the number of total customers at the end of its most recent quarter.
SentinelOne is achieving this revenue growth without proportionate expense growth, which is another important consideration. Its most recent quarterly net loss was $70 million, compared to nearly $100 million last year. The company's cash burn rate is actually much lower than its accounting losses, thanks to roughly $300 million of annual noncash expenses.
SentinelOne's free cash outflows for the most recent quarter were $26 million, down from $65 million the prior year. Clearly the burn is declining, and the company is approaching breakeven. Being able to support operations from internal net cash inflows would remove significant risk for shareholders, and that status is within grasp. SentinelOne has over $1 billion of short-term liquid assets, so the burn rate isn't a cause for concern as the company moves toward positive cash flows.
Discount valuation
SentinelOne stock is down more than 65% from its all-time high from late 2021. Cybersecurity stocks and growth stocks in general suffered a big sell-off throughout 2022. Low interest rates and fiscal stimulus related to the COVID-19 pandemic led to surging valuations for growth stocks. That trend quickly reversed when the Federal Reserve hiked interest rates, which fueled concerns about economic contraction and sent stocks tumbling.
Most of the cybersecurity industry has recovered since then as investors anticipate a boost ahead of the Fed cutting rates again. SentinelOne has lagged most of its peers in this recovery, resulting in a discount valuation. Its price-to-sales ratio is under 15, making it significantly cheaper than CrowdStrike and Palo Alto.
Investors can't ignore the competitive risks or the disadvantages of SentinelOne's smaller scale. However, SentinelOne's recent bookings and customer retention results suggest that it's holding its own in a growing industry. While the risk profile is relatively higher for this stock relative to peers, its valuation creates more opportunity for buyers. This stock should have more upside potential in the current bull market.
