As Zscaler’s (ZS) earnings day approaches, which is scheduled for September 3rd, I hold a Buy stance on the cybersecurity company, given its consistent track record of exceeding expectations. Furthermore, the San Jose-based firm stands out as one of the highest-quality players in its sector, boasting robust margins and a strong growth trajectory, as spending by AI giants on cybersecurity is expected to continue rising.
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Although valuation remains a point of skepticism that could lead to some short-term volatility, especially after earnings, I believe Zscaler’s Fiscal Q4 results will likely reflect strong demand for its services driven primarily by high cloud adoption rates.
The Bullish Case for Investing in Zscaler Now
The bullish thesis around Zscaler is compelling for several reasons, including its innovative business model, the strong growth prospects of the cybersecurity industry, and its strategic positioning within this sector.
Firstly, Zscaler is a pioneer in Zero Trust architecture, which is crucial for securing cloud environments. Zero Trust operates on the principle of “never trust, always verify,” and Zscaler’s all-in-one approach appeals to enterprises seeking to simplify their security infrastructure and reduce the number of vendors they manage.
Moreover, as enterprises increasingly migrate their workloads and applications to the cloud, the demand for cloud-native security solutions like Zscaler’s is growing. Dan Ives from Wedbush, one of Wall Street’s leading Zscaler bulls, highlights that cybersecurity currently consumes only 3-4% of IT budgets, a figure expected to double in the next two to three years.
The shift towards cloud services by major players such as Microsoft’s (MSFT) Azure, Amazon’s (AMZN) AWS, and Alphabet’s (GOOGL) Google Cloud creates a robust demand for security solutions. Zscaler is well-positioned to benefit from this trend. In its previous quarter (FQ3), Zscaler reported $553 million in revenue, marking a 32% increase year-over-year. The company’s CEO has outlined an ambitious goal to grow annual recurring revenue to $5 billion, up from the current $2.14 billion projection in Fiscal Year 2024.
Market Hurdles and Cybersecurity Competition
However, it’s not all smooth sailing for Zscaler, as it operates in a highly competitive industry. The cybersecurity sector has seen some cooling in stock performance this year. For example, Palo Alto Networks (PANW), a major player in the industry, experienced a sharp decline in its shares due to its aggressive strategy of offering free products in exchange for long-term contracts. This has the potential to impact Zscaler’s ability to secure high-value deals.
Despite these challenges, Zscaler’s Zero Trust Exchange platform continues to perform strongly, with a 30% increase in billings and a notable rise in the number of large customers, including those with $5 million in annual recurring revenue.
Compared to its peers, Zscaler stands out with the highest year-over-year revenue growth and is projected to outpace its competitors in both top and bottom-line growth. This positions Zscaler as a leading player with potentially the best margins in the sector (alongside Fortinet (FTNT)), strengthening the bullish thesis.
Why FQ4 Could Be a Strong Quarter for Zscaler
The clearest indication that bullish sentiment is building ahead of Zscaler’s FQ4 earnings is the consistent upward revision of expectations by Wall Street analysts. The consensus forecast is for EPS of $0.70, reflecting 8% growth, with all 34 analysts covering Zscaler revising their estimates upward in the past three months. For revenues, the consensus is $567.5 million, implying 24% growth, with 31 out of 33 analysts raising their projections.
Optimism is further supported by Zscaler’s track record of beating bottom-line estimates for at least 15 consecutive quarters, a trend likely to be echoed in the upcoming earnings report expected on September 3rd.
However, investors should manage their expectations, as a beat across all metrics isn’t always enough to guarantee a bullish post-earnings reaction. Indeed, other critical factors will be how Zscaler addresses key industry trends, such as cloud adoption rates, the rise of Zero Trust security, advancements in AI and machine learning, cybersecurity investment levels, and regulatory changes.
That said, investors and traders should brace for potential volatility. Option chain data for Zscaler leading up to earnings indicates that a significant move is expected, with the at-the-money straddle for options expiring after earnings suggesting an 11.2% price swing in either direction. This expectation is based on the $197.5 strike price, with call options at $12.50 and put options at $10.05.
High Valuation vs. Growth Potential
The main risk, in my view, that undermines the bullish thesis for Zscaler is its valuation. Zscaler is certainly not a cheap stock, trading at a forward P/E ratio of 66.62x and a forward price-to-sales ratio of 14.11x. While these multiples may appear stretched at first glance, they can be somewhat justified given the company’s 32% revenue growth, progress toward profitability, and its goal of reaching $5 billion in annual recurring revenue.
Is ZS Stock A Buy, According To Analysts?
The Wall Street consensus on ZS is quite bullish. Out of the 31 analysts covering the stock, 25 have a Buy recommendation, while the remaining six recommend a Hold. Despite this optimism, the average price target of $232.04 suggests an upside potential of 16.03% based on the latest share price.
Conclusion – Consistent Track Record Supports Positive Outlook
I hold a Buy stance on Zscaler, especially with its promising Fiscal Q4 prospects. Wall Street’s upward revisions and Zscaler’s consistent track record of beating earnings expectations support a positive outlook. Despite valuation concerns and potential short-term volatility, the company’s strong growth in cloud security and industry-best margins position it well for continued success.
