Zscaler(NASDAQ: ZS) investors may want to forget about 2024. The cybersecurity specialist’s shares are down more than 10% so far this year on concerns about slowing growth, and the company appears to be heading into 2025 at a disadvantage.
The stock fell nearly 5% on Tuesday after Zscaler reported its first-quarter fiscal 2025 results after the close of trading on Monday. However, a closer look at the company’s results and expectations suggests that investors may have overreacted.
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Let’s take a look at the reasons why Zscaler stock fell following its earnings results, and see if this drop could be a buying opportunity for investors.
For its first fiscal quarter ended Oct. 31, Zscaler reported revenue of $628 million, up 26% from the same period last year. The company’s non-GAAP net income rose an impressive 40% to $0.77 per share. Analyst consensus estimates were for earnings of $0.63 per share on revenue of $606 million.
The company far exceeded these expectations thanks to strong growth in customer spending and an increase in the number of major customers. For example, the number of customers generating annual recurring revenue (ARR) greater than $100,000 increased 17% year over year to 3,165. Meanwhile, the number of customers delivering more than $1 million in ARR increased 25% to 585.
Zscaler’s bookings – the value of contracts customers signed during the quarter – rose 30% year over year, outpacing revenue growth.
Additionally, Zscaler’s focus on adding artificial intelligence (AI)-focused cybersecurity services encouraged the company’s established customers to spend more on its offerings. This is reflected in the company’s dollar-based net retention rate of 114%. This metric compares the money customers spent on a company’s offerings in a given quarter to the amount those same customers spent in the previous year. A score above 100% in this metric means its customers are increasing their spend on its services over time, which bodes well for Zscaler as it points to the tenacity of its cybersecurity platform.
Something else worth noting is that the ARR of Zscaler’s emerging products grew more than twice as fast as that of its core products. This can be attributed to the company’s focus on securing both public and private AI apps, as well as the launch of AI-powered products. Management said during the earnings conference call that products such as its AI-powered virtual assistant, ZDX Copilot, are contributing to an increase in deal size due to increasing customer adoption.
Zscaler calculates that its total addressable market opportunity is a massive $96 billion, suggesting that it could ideally continue to witness improved spending on its products thanks to the advent of new technologies such as AI. All this explains why the company has raised its expectations for the full year. It now expects revenue to grow 21.5% to $2.63 billion in fiscal 2025, up from its previous forecast of 20.5% growth.
Management also raised earnings per share expectations to a range of $2.94 to $2.99, up from the previous range of $2.81 to $2.87. The company’s revenue outlook of $634 million for the current quarter is also slightly higher than Wall Street expectations.
Despite all these positive developments, many investors decided to press the sell button. This may have to do with the valuation of the company.
The fact that Zscaler’s guidance for the current quarter was barely better than analysts’ expectations of $633 million may have led to the post-earnings sell-off. After all, the company’s expectations point to a revenue increase of 21.5%, which would be significantly slower than the 35% growth it reported in the same quarter last year.
Zscaler trades at 14 times sales, which is a premium to the US tech sector’s average sales multiple of 8. In that context, the company’s slowing growth appears to have raised a warning sign for investors. It also trades at an expensive 72 times forward earnings. Considering that Zscaler’s earnings are expected to decline this year from the previous fiscal year’s $3.19 per share, it can be concluded that it is richly valued at the moment.
As such, buying Zscaler after its latest release may not seem like a good idea. However, if the stock continues to fall to a lower valuation, it may be worth considering. After all, the company’s remaining performance obligations increased an impressive 26% year over year to $4.4 billion last quarter. This metric refers to the total value of a company’s contracts that will be fulfilled in the future, improving its revenue pipeline.
There’s no denying that Zscaler is indeed growing at a nice pace, but its valuation is the sticking point. Therefore, investors would do well to add the stock to their watchlists so they can reconsider if it becomes available at a more attractive level.
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Harsh Chauhan has no position in any of the stocks mentioned. The Motley Fool holds and recommends positions in Zscaler. The Motley Fool has a disclosure policy.
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