Fortinet: Great Business Prospects, Risky Valuation

Fortinet, Inc. (FTNT) provides broad, integrated, and automated cybersecurity solutions to a variety of businesses, such as enterprises, communication service providers, and small businesses. The company was founded in 2000 and is headquartered in Sunnyvale, California.

I am bearish on FTNT stock. There is strong profitability, but there are also financial health and valuation concerns. Fortinet outperformed the Nasdaq by a great margin in 2021 but has losses of about 13% year-to-date.

Fortinet Business News

On December 20, 2021, Fortinet was included in the Nasdaq-100 Index.

Ken Xie, Founder, Chairman of the Board, and CEO at Fortinet, stated about this news, “Taking our place on the Nasdaq-100 Index amongst other category-defining companies is another proof point of Fortinet’s successes and future growth opportunities.”

The company posted its Investor Presentation in December 2021, which was full of insights and key facts investors should be aware of to analyze whether FTNT stock is a good investment.

Notable highlights are related to a strong financial and operational performance and key milestones achieved. The firm reported a history of 20 years of strong growth. It is indicative that as of November 30, 2021, the company was among the top 10 performing stocks in S&P 500.

The LTM free cash flow reported was more than $1.2 billion, with a 40% free cash flow margin. The gross margin was higher than 75% as a result of recurring service revenues, and the operating margin was higher than 25%, reflecting both balanced growth and profitability.

It is important to note that Fortinet reported gross margin, operating margin, and free cash flow as non-GAAP financial measures.

Investors with a preference for growth stocks will be pleased to know that Fortinet has delivered strong growth over the past years. It has achieved the ‘Rule of 40’ in nine of the past 12 years since its IPO back in 2009 and expects to achieve ‘Rule of 50’ in 2021.

The ‘rule of 40’ is calculated as revenue growth plus the non-GAAP operating margin. When added together, these two figures should be higher than 40%. Consequently, the ‘rule of 50’ signals better financial performance as the total revenue growth and operating non-GAAP margin should be higher than 50%. This is an impressive statistic reflecting strong and sustained growth.

Fortinet’s products include the FortiGate security platform, a combination of software and hardware to provide security applications, FortiGuard security services which are based on AI and automation to develop enhanced security solutions, and FortiCare technical support services available on a 24/7/365 basis.

Fortinet has more than 550,000 customers globally and has a TAM (total addressable market) of $121 billion as of 2021, which is expected to grow to more than $174 billion by the year 2025. The main sub-markets are Networking and Network Security, Endpoint Security & Security Operations, Identity & IoT/OT Security, and Cloud Security.

The technology company considers its growth drivers to be a security-drive network, vendor consolidation, heightened awareness due to cyberattacks, and increased investments that will support further organic growth.

Valuation and Fundamentals

In 2021, Fortinet added a lot of debt on its balance sheet with a debt/equity ratio of 0.88 as per the latest quarter. Profitability is very strong, with a TTM net margin and ROE of 17.7% and 60.6%, respectively.

The free cash flow trend is also positive and strong both annually and quarterly. In the first nine months of 2021, Fortinet had generated $988.3 million of free cash flow. FTNT stock earnings, in general, are solid.

Turning to valuation, things do not look attractive now. FTNT is relatively overvalued based on its P/E ratio of 94x compared to the U.S. software industry average of 42.8x and expensive based on its PEG ratio of 6.1x. Also, its price/book ratio of 45.7x is high compared to the industry average of 5x.

Wall Street’s Take

Fortinet has a Moderate Buy consensus based on 11 Buys, seven Holds, and one Sell rating assigned in the past three months. The average Fortinet price target of $370.11 represents 18.3% upside potential.

Conclusion

Fortinet is a great growth stock with a remarkable track record and a very large total addressable market. Its fundamentals are strong, but it is richly valued though now after outperforming by far Nasdaq in 2021.

Download the TipRanks mobile app now

To find good ideas for stocks trading at attractive valuations, visit TipRanks’ Best Stocks to Buy, a newly launched tool that unites all of TipRanks’ equity insights.