The S&P 500 is the most widely recognized stock market index in the U.S., consisting of the 500 largest companies in the country. Given the extensive reach of its member companies, it's considered by many to be the most reliable gauge of overall stock market performance. To be included in the S&P 500, a company must meet the following prerequisites:
Be based in the U.S.
Have a market cap of at least $18 billion
Be highly liquid
A minimum of 50% of its outstanding shares must be available for trading
Must be profitable on a generally accepted accounting principles (GAAP) basis in its most recent quarter
In aggregate, must be profitable over the preceding four quarters
Palo Alto Networks(NASDAQ: PANW) has been a member of the S&P 500 since June 2023, but the cybersecurity specialist recently announced a 2-for-1 forward stock split. This is typically the purview of a company with years of strong operating and financial results, and Palo Alto fits the bill. Since its initial public offering (IPO) in mid-2012, Palo Alto shares have soared 2,080% as the company has been a key player in the evolving cybersecurity market. Those results aren't relegated to the distant past either. Over the past five years, Palo Alto stock has surged 368% (as of this writing).
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Despite its impressive gains, many on Wall Street believe there's a long runway ahead. Let's look at what's driving Palo Alto's current success and what the future holds.
Image source: Getty Images.
From humble beginnings
Palo Alto has long been known for its disruptive innovations in the cybersecurity field. However, it's the company's more recent history that should be of interest to investors. In an effort to dissuade customers from using a patchwork of one-off solutions, Palo Alto made a bold move earlier this year that shook the industry in what amounted to a major strategy shift.
One of the biggest roadblocks customers face in adopting a single security platform is their use of multiple providers with an assortment of contractual end dates -- which sometimes prevents them from switching to a unified vendor. To overcome those challenges, Palo Alto offered customers free services in order to consolidate their services to one of its security platforms.
Management noted that the lifetime value of customers who used two of its platforms was more than 5 times that of those on a single platform, a figure that jumps to 40 times larger for customers on three platforms. By offering to "pay" for customers to make the switch and taking a short-term financial hit, Palo Alto is laying the foundation for a much more profitable future. While investors were initially skeptical, the company's growth has rebounded quicker than investors expected.
For its fiscal 2025 first quarter (ended Oct. 31), the company generated revenue of $2.1 billion, up 14% year over year, while its earnings per share (EPS) of $0.99 soared 77%. If that wasn't enough to grab shareholders' attention, the annual recurring revenue (ARR) from its next-generation security (NGS) services -- its high-growth businesses -- grew 40% to $4.5 billion. This illustrates that management's controversial strategy is bearing fruit.
Because of the robust results, management increased its forecast. For the full fiscal year, Palo Alto is guiding for year-over-year revenue growth of 14% to $9.15 billion. This would result in adjusted EPS of about $6.34, an increase of 11%, and NGS ARR of $5.55 billion, an increase of about 32%.
Analysts are still bullish on Palo Alto
Wall Street is infamous for its wide range of opinions, so it's worth noting that the majority of analysts who cover Palo Alto agree there's still upside ahead. Of the 54 analysts who offered an opinion thus far in November, 76% maintain a buy or strong buy rating, and none recommend selling. Furthermore, an average price target of roughly $409 represents potential upside of 6% compared to Monday's closing price. Those price targets have begun to drift higher in the wake of Palo Alto's better-than-expected financial results.
However, Evercore ISI analyst Peter Levine is already more bullish than his Wall Street colleagues, maintaining an outperform (buy) rating and a Street-high price target of $455. That suggests potential gains for investors of 18% compared to Monday's closing price. The analyst notes the company is closing larger deals and cites channel checks that "sounded notably more positive, with a strong emphasis on solid execution across the board," Levine wrote in a note to clients.
The one stumbling block facing investors is the stock's frothy valuation. Palo Alto Networks is currently selling for 50 times earnings and 17 times sales, which seems ridiculously expensive. However, its price/earnings-to-growth (PEG) ratio, which accounts for its accelerating growth, comes in at 0.14, when any number less than 1 is the standard for an undervalued stock.
It's also important to remember that Palo Alto Networks has outperformed the broader market by a wide margin over the past five years, generating gains of 369%, roughly 4 times the return of the S&P 500.
When viewed through that lens, I'd argue Palo Alto Networks is a buy.
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