Few stocks have had as good a run as Palo Alto Networks (PANW 0.16%) has had over the past five years. The cybersecurity company's stock has risen by nearly 360%, which prompted management to conduct a 2-for-1 stock split on Dec. 16. While a stock split is mostly cosmetic, and doesn't change anything about the underlying business or its investment thesis, it does make it easier for investors who don't have the ability to buy fractional shares to add a stock to their portfolios.
Generally, companies only split their stocks when they feel their per-share price has become too high for the average investor to buy, and that it's likely to stay elevated. There's really only one way for those conditions to occur: The stock price has gone up due to strong business execution. As a result, looking for investment opportunities among companies that are about to split their stocks or have done so recently is a smart idea because they're usually strong businesses.
So, is Palo Alto Networks a buy after its recent stock split?
Palo Alto is a top player in cybersecurity
Palo Alto Networks operates in the lucrative field of cybersecurity software. While this isn't an easy industry to compete in, it is a great sector to operate in. During downturns or recessions, companies may dial back their spending on nonessential services, but cutting cybersecurity budgets would be a terrible idea given how sophisticated and pervasive cyberthreats have become. As a result, cybersecurity has become a fairly recession-resistant business (although providers may have a difficult time signing new customers during an economic downturn).
Palo Alto operates in both the past and future of cybersecurity. Its legacy business is primarily firewalls, which used to be the main cybersecurity tool that businesses deployed. However, as threats got more advanced, so did the software that protected against them. Now, using artificial intelligence (AI) to detect threats is common.
NASDAQ: PANW
Key Data Points
Palo Alto describes this business segment as its next-generation security segment, and it's doing quite well.
In its fiscal 2024 first quarter, which ended Oct. 31, annual recurring revenue from the next-generation security segment rose 40% year over year to $4.52 billion.
CrowdStrike (CRWD 1.79%), one of its key competitors in this area, only operates in the next-gen space. And considering that in its comparable quarter, Crowdstrike's annual recurring revenue only rose 27% to $4.02 billion, Palo Alto's recent results look quite impressive.
However, that's only the next-generation security part of Palo Alto's business.
Not a cheap stock
Overall, Palo Alto's revenue in fiscal Q1 rose 14% to $2.14 billion, so its legacy business clearly bogged it down. However, the legacy business is profitable, which gives it another advantage over CrowdStrike. Over the past three years, Palo Alto's operating profit margins have steadily risen, indicating that it's becoming more efficient.
PANW Operating Margin (Quarterly) data by YCharts.
However, it's still a long way from optimizing its profits -- many software companies have operating profit margins of 30% or greater.
This is a huge part of the Palo Alto investment thesis, as its stock appears fairly expensive at 57 times forward earnings.
PANW PE Ratio (Forward) data by YCharts.
That said, if it can significantly expand its profit margins over the next few years alongside strong business growth (Wall Street expects revenue growth of 14% in its fiscal 2025 and 16% in its fiscal 2026), then its current price could look attractive in retrospect. However, there are a lot of "ifs" baked into that premise. If Palo Alto doesn't achieve those results, the market may not look favorably on the stock.
Plenty of strong cybersecurity investments are available in the market, and Palo Alto is one of them. However, it will need to execute at a high level to justify its current valuation. If it doesn't, don't be surprised if the stock takes a hit. But if it continues on its current trajectory, there could be more growth in store for Palo Alto's share price in 2025.
