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Is Zscaler Stock a Buy at the Current Valuation?

Cybersecurity threats are everywhere, and they aren't going away. One report estimates that the total cost of cybercrime to the global economy is at least 1 trillion dollars annually. With this in mind, companies need to increase their cybersecurity budgets and utilize the latest technology. The future of cybersecurity is in the cloud, and this is where Zscaler (NASDAQ: ZS) comes in.

Zscaler stock was flying high in 2021, along with most of the growth sector, until it became clear that inflation is more than transitory and that interest rate hikes are coming sooner than expected. The stock has since fallen considerably and trades at more than 20% off its 52-week high.

ZS data by YCharts

Innovative technology

Zscaler provides cloud-based security and is a leader in the Zero Trust Model. Zero Trust is essential in a world where many workers are logged in remotely, ransomware is rampant, and companies operate on hybrid cloud environments. Zscaler was named Gartner's only leader in Secure Web Gateways in 2020, and the company has 275 patents issued or pending. The company's software handles billions of daily incidents and serves a tremendous total addressable market of $72 billion.

Image source: Getty Images

Tremendous growth

Zscaler is growing revenue at an incredible clip. Total revenue reached $673 million in fiscal 2021 and continued to accelerate into the first quarter of fiscal 2022. Fiscal 2021 revenue was 56% higher than fiscal 2020, while Q1 2022 came in 62% higher than the prior-year period.

Data Source: Zscaler. Chart by author.

The accelerating growth rate is highly encouraging and suggests that growth is sustainable. In addition, Zscaler receives about half of its revenue internationally. This is in stark contrast to a company like CrowdStrike (NASDAQ: CRWD) which received 73% of its total revenue from the U.S. for the quarter ended Oct. 31, 2021. Well-rounded sources of revenue spell less risk and more opportunities for growth.

One of the reasons software-as-a-service (SaaS) companies are popular with investors is because of their tremendous gross margins, which point to a company's ability to scale to profitability. Zscaler is no exception. The company posted an 81% non-GAAP gross margin and a 78% GAAP gross margin for fiscal 2021. The company is not yet GAAP profitable, however, as it spends the majority of its revenue on sales and marketing. Cash flow was also encouraging in fiscal 2021 as Zscaler posted over $200 million in cash from operations, up from just $79 million in fiscal 2020.

The valuation remains high

Zscaler's valuation has come down considerably in recent weeks yet remains relatively high. Comparing Zscaler to other high-growth SaaS companies like CrowdStrike and Cloudflare (NYSE: NET) shows that the entire sector is highly valued by investors yet retreating quickly.

ZS PS Ratio (Forward) data by YCharts

Zscaler's forward price-to-sales (P/S) ratio of 38 is greater than CrowdStrike's but slightly less than that of up-and-coming content delivery network (CDN) specialist Cloudflare. One of the reasons that growth stocks are under selling pressure is the fear of faster-than-expected interest rate hikes. With inflation nearing 7%, the U.S. Federal Reserve will likely need to act soon by raising rates.

Opportunity ahead

Cybersecurity is top of mind for business leaders around the world. The evolution of remote work has created an urgent need for Zero Trust solutions, and Zscaler has the technology to meet the needs of modern enterprises. The company is undergoing a period of tremendous, accelerating growth. Gross margins and cash flows indicate excellent ability to scale to profitability in the future. The macroeconomic conditions have caused a re rating in the growth sector, which does not appear to be finished just yet. With this in mind, Zscaler should be on investors' watch lists for now.

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Bradley Guichard owns Cloudflare, Inc., CrowdStrike Holdings, Inc., and Zscaler. The Motley Fool owns and recommends Cloudflare, Inc., CrowdStrike Holdings, Inc., and Zscaler. The Motley Fool recommends Gartner. The Motley Fool has a disclosure policy.


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