Palo Alto Networks (PANW 0.80%) is one of the more popular cybersecurity stocks out there at the moment. The stock is trading up nearly 70% over the past year, so investors might be wondering if all its future growth is already priced in and it's too late to get on board.
To ease those concerns, know that there are still plenty of reasons to love this stock. These five, in particular, provide ample proof that you might want to buy this stock like there's no tomorrow.
1. Palo Alto has impressive demand growth drivers
Cybersecurity threats are a widespread issue that is becoming more prevalent. A 2022 report from Gartner, claimed that supply chain attacks are expected to affect nearly 50% of organizations globally in some form by 2025. Very few industries are immune to this problem. The number of data breaches is increasing around 20% annually, while Internet of Things malware attack volume is rising over 35% per year. The cost of cybercrime is expected to surpass $20 trillion by 2027, nearly quadrupling over five years.
These are serious concerns for consumers and businesses of all sizes. Since cybercrime is an expensive challenge that's not going away, demand for cybersecurity products has a clear set of growth drivers. Analysts expect the cybersecurity industry to grow 10%-12% annually over the medium term. This outpaces many sectors of the economy, creating an excellent growth environment for whichever vendors achieve competitive success.
Image source: Getty Images.
2. Palo Alto offers a quality product which gives its stock a wide economic moat
Palo Alto Networks' product suite provides a competitive advantage to maximize those industry demand drivers. The company maintains a broad portfolio of solutions that cover network security, cloud security, and security operations. High-profile industry analysts and product ratings outlets recognize Palo Alto as an industry leader in numerous areas. Brand strength and reputation are meaningful to customers.
There's also a competitive edge for incumbents in the cybersecurity space. Palo Alto collects a large volume of valuable data as one of the industry leaders. AI is likely to play a role in threat detection and monitoring in the future, and competitors with the best data sets have an advantage in training their AI solutions.
Palo Alto derives a wide economic moat from that size and scale. It is expensive and cumbersome for customers to switch to competitive solutions. Customers are often satisfied with a single, high-reputation vendor that can address many of their cybersecurity needs. It's not always efficient for chief security officers or chief technology officers to deal with multiple vendors rather than a single, trustworthy service provider.
3. Palo Alto is generating consistent growth
Palo Alto's financial results illustrate the strengths covered above. The company has delivered consistent revenue growth, and its free cash flow expanded even faster.
The company's top-line growth rate is slowing due to macroeconomic factors. Its large customer base and broad product portfolio also reduce the number of unpenetrated potential markets. Nonetheless, Palo Alto Networks management forecasts roughly 20% expansion moving forward, which is a respectable rate. The company recently became profitable on a GAAP basis, so its bottom line is growing much more quickly than its sales.
4. Palo Alto maintains efficient operations
Palo Alto's growth is accompanied by impressive operational efficiency. The company's gross margin recently bounced back to 74% after sliding lower for several years. That helped to propel it into a profitable range. Its 40% free-cash-flow margin and return on invested capital (ROIC) are both impressive.
PANW Gross Profit Margin and ROIC data by YCharts
These metrics suggest that Palo Alto efficiently uses its financial resources to generate profits. High-growth companies often burn cash or maintain low profit margins as they invest in product quality or marketing. Palo Alto's margin profile and efficiency metrics indicate that the company can capitalize on demand without spending too much or bending on price.
5. Palo Alto has a reasonable valuation
Palo Alto's forward P/E ratio is just under 50, and its price-to-cash-flow ratio is 45. Neither of those valuation ratios is particularly cheap, but they are both reasonable compared to the company's forecasted growth rate. If Palo Alto can deliver on its 20% revenue growth forecast and achieve a slightly faster pace on cash flow expansion, then its PEG ratio is between 2 and 2.5, depending on your methodology.
That valuation is expensive enough to result in short-term volatility, but this isn't expensive enough to compromise long-term returns. If Palo Alto realizes its potential over the next five to 10 years, then the stock can deliver big gains for shareholders.
