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SUMMARY
Parkev Tatevosian, CFA, analyzes Zscaler's underperformance compared to other cybersecurity stocks and evaluates its current valuation and risk profile. Despite recent negative momentum, he concludes that Zscaler remains a buying opportunity due to its growth and discounted price.
MAIN POINTS
- Zscaler is down 20% year-to-date while other cybersecurity stocks have posted significant gains.
- Zscaler's revenue has grown rapidly since 2017, but its operating profit margin has been volatile and remains negative.
- The company's return on invested capital and operating profitability have stagnated at disappointing levels in recent quarters.
- Zscaler's valuation has dropped from a forward price-to-earnings ratio of 80 to 33, making it appear undervalued based on discounted cash flow analysis.
- Despite negative momentum, Zscaler's risk profile is below average with a beta of 0.92 and a weighted average cost of capital of 9.73%.
- Several high-flying cybersecurity stocks have been downgraded, while Zscaler is still rated as a buy due to its lack of recent momentum and perceived opportunity.
DETAILED ANALYSIS
Zscaler has experienced a notable decline in its stock price, falling 20% year-to-date, in contrast to the strong performance of other cybersecurity companies such as Palo Alto Networks, Fortinet, and Okta. Despite this underperformance, Zscaler has demonstrated impressive revenue growth, expanding from approximately $100 million in 2017 to $3.17 billion in the trailing twelve months. This rapid increase highlights the company’s ability to capture market share in the expanding cybersecurity sector, which has benefited from heightened demand due to the proliferation of artificial intelligence and associated security risks.
However, Zscaler’s profitability metrics have been less encouraging. The operating profit margin has fluctuated significantly, reaching -4% in 2019, dropping below -30% in 2022, and recently stabilizing at around -5%. This lack of consistent improvement stands in contrast to some industry peers who have managed to steadily enhance their profitability.
The company’s return on invested capital has also remained negative and flat, with a recent figure of -2.07%, indicating ongoing challenges in generating returns from its investments. These persistent weaknesses in profitability have contributed to investor reluctance to pay premium valuations for the stock.
Zscaler’s forward price-to-earnings ratio has compressed from a high of 80 in early 2024 to 33, positioning the stock near its lowest historical valuation levels. Discounted cash flow analysis suggests a fair value of $219 per share, while the market price is currently $179, indicating potential undervaluation. The stock’s risk profile is moderate, with a beta of 0.92 and a weighted average cost of capital of 9.73%, which is average for the cybersecurity industry.
While several cybersecurity stocks that have surged in value have been downgraded, Zscaler is still considered a buy due to its growth prospects and discounted valuation, despite the lack of recent positive momentum.
LINKS
- YouTube channel membership for exclusive perks and early access to videos.
- Special offer for The Motley Fool Stock Advisor.
- Parkev Tatevosian's book on evaluating publicly traded companies.
- Fiscal.ai investment research platform with a viewer discount.
- Webull investing platform with bonus shares offer.
- Free monthly newsletter on Substack.