Palo Alto Networks (PANW 2.48%) stock has been in fine form on the stock market in the past three months, clocking healthy gains of 18% as of this writing. That's impressive, considering that investors were not impressed when the company released its fiscal 2025 third-quarter results (for the three months ended April 30) on May 20.
Though the company delivered better-than-expected results and guidance, investors were concerned about its margins. Palo Alto's non-GAAP gross margin of 76% was slightly lower than the 77.2% consensus estimate. However, it appears that investors are now looking past that margin miss and have regained confidence in Palo Alto stock.
Let's see why that has been the case, and check whether the stock is worth buying following its recent rally.
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Palo Alto Networks' growth is likely to accelerate
One of the reasons why investors are probably becoming bullish about Palo Alto is because of the company's fast-improving revenue pipeline. This was evident from the 19% year-over-year growth in Palo Alto's remaining performance obligations (RPO) in the previous quarter to $13.5 billion, which was higher than the 15% increase in its top line.
RPO is the total value of a company's contracts that are yet to be fulfilled at the end of a quarter. So, the faster increase in this metric is an indication that Palo Alto is winning more contracts than it is fulfilling right now. That should ideally lead to an improvement in the company's growth rate going forward. Importantly, Palo Alto expects to finish the current fiscal year with an increase of 19% to 20% in its RPO to just over $15 billion, which would be almost identical to the RPO growth it reported in the previous fiscal year.
A key reason why Palo Alto's revenue pipeline is increasing at a nice clip is because of the fast-improving demand for the company's next-generation security (NGS) offerings. These solutions include the company's Cortex extended security intelligence and automation management (XSIAM) platform, which uses artificial intelligence (AI) and machine learning (ML) to stop cyber threats and respond to security incidents, among other things.
Palo Alto says that the annual recurring revenue (ARR) of its XSIAM platform increased by more than 200% year over year in the previous quarter. That's not surprising. The company claims that this platform allows customers to reduce the median time to resolve security incidents to as low as one minute, compared to the earlier response time of two to three days before using XSIAM. What's more, 60% of XSIAM customers have a median time of less than 10 minutes in resolving security incidents.
The healthy traction of such products explains why Palo Alto's NGS ARR increased by an impressive 34% year over year last quarter to just over $5 billion, significantly outpacing the growth in its revenue and RPO.
Another factor that's helping Palo Alto build up a robust revenue pipeline is its platformization strategy, through which it is bundling its various products and services with the aim of simplifying the approach to cybersecurity. Palo Alto believes that platformization will enable customers to make cyber defenses more efficient by integrating different solutions into a single platform while reducing costs related to the training and management of security analysts. The good part is that this strategy is gaining traction among customers.
The company ended the previous quarter with 1,250 customers on its platformization contracts as compared to 900 in the year-ago period. Palo Alto points out that a fourth of its top 5,000 customers are currently on platformization contracts, indicating that it can score more platformization deals going forward. Importantly, platformization is helping Palo Alto score bigger deals, which should eventually aid its margins and drive stronger bottom-line growth.
This is precisely what analysts are expecting, as we can see in the following chart.
PANW EPS Estimates for Current Fiscal Year data by YCharts.
A potential red flag for investors
However, investors looking to buy the stock right now need to be aware of one problem.
While Palo Alto has been recording healthy double-digit growth and its earnings growth is set to accelerate, the stock's valuation suggests that it may have run ahead of itself. Palo Alto is trading at 117 times trailing earnings and 55 times forward earnings, which makes the stock quite expensive when compared to other cybersecurity companies that are showing a faster pace of growth.
Even if we look beyond the cybersecurity industry, there are other tech stocks that have been consistently delivering stronger growth and are trading at significantly cheaper valuations. As such, there are better bets for investors looking to add a tech stock to their portfolios right now.
Of course, keeping Palo Alto on your watchlist and accumulating it on the dips would be a good idea for the long run. This cybersecurity stock has the potential to justify its valuation by clocking stronger earnings growth rates. But buying it right now may not be the smartest thing to do thanks to its expensive valuation.
