Buying Cybersecurity Inventory Inventory Now?

Researching companies that have recently distributed their stock is a fairly smart investment strategy. It's not that the stocks themselves are special. This is when companies typically split their stock for one reason: the stock price goes up a lot. While some may see this as a red flag, that's a terrible way to look at it. Over the long term, stock prices rise when companies do well, and finding companies that perform well is a key part of investing.

One of the most recent stocks is Palo Alto Networks (NASDAQ: PANW)the company split its stock 2-for-1 on Dec. 16. Palo Alto is also a top company in cybersecurity, a critical area designed to see a lot of growth as we become more reliant on technology.

Palo Alto Networks is a mix of legacy and next-generation security products. It still has its legacy firewall business that it's working to bring to next-gen identity, but it also has powerful next-gen security tools that incorporate AI. One of the main use cases for this type of software is endpoint protection, which protects network access points such as laptops or computers from hackers. Palo Alto named platform for this product line Gartner (NYSE:IT)but it's far from the only competitor.

Without a doubt, the most popular investment option is Crowdstrike (NASDAQ: CRWD)Like Palo Alto, it offers a suite of AI-driven cybersecurity products that go beyond endpoint protection.

However, Palo Alto may be a more attractive investment option in this area.

Palo Alto's next-generation security annual recurring revenue (ARR) increased 40% year over year to $4.5 billion in the first quarter of fiscal 2025 (ending October 31, 2024). With ARR up 27% to $4 billion compared to CrowdStrike, Palo Alto appears to have a crack at one of the top cybersecurity picks.

That doesn't tell the full story for Palo Alto, as its overall revenue growth rate is much slower than next-gen platforms. Total revenue increased 14% year over year to $100 million in 1Q, a clear indication that its Legacy platform is struggling. As a result, investors must consider the balance between struggling legacy platforms and thriving next-gen platforms.

This balance appears to be the same, as management provided investors with guidance that total revenue will grow at a rate of 14% in fiscal 2025 (ending July 31), while next-gen ARR will increase from 31% to 32 % growth rate.

But is that enough to justify the share price?

Since Palo Alto is a profitable business, it's best to evaluate the stock's valuation using earnings-based metrics. Palo Alto had the unusual event of artificially inflating its earnings per share (EPS) over the last 12 months (a one-off tax benefit). Therefore, it is better to use forward earnings to value stocks than using lagging earnings.

From a forward earnings perspective, Palo Alto trades at a pricey 58 times forward earnings.

panw pe ratio (forward) chart
PANW PE ratio (forward) data for YCHARTS.

That's not a cheap stock price for a company that's growing revenue at just 14% year-over-year.

We also compared Palo Alto to CrowdStrike using revenue-based multiples (crowdstrike teeters of Profitable and Unprofitable). Palo Alto trades at 16 times sales compared to CrowdStrike's 24 times.

While both dominate the cybersecurity market, it’s safe to say that cybersecurity is currently very expensive. As a result, it's better to look at a different sector, as Palo Alto stock doesn't have much value, even if it beat management's guidance.

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Keithen Drury holds jobs in Crowdstrike. Motley Fool has a spot and recommends CrowdStrike. The Motley Fool recommends Gartner and Palo Alto Networks. Motley Fools has a disclosure policy.

Buying Cybersecurity Inventory Inventory Now? Originally published by Motley for Dummies