Better Cyber ​​Security Stock: Fortinet vs. Zscaler

Fortinet (FTNT -0.85%) and Zscaler (ZS -3.37%) are two different ways to invest in the expanding cybersecurity market. Fortinet offers a wide range of endpoint security services for on-premise, cloud-based and Internet of Things (IoT) devices. Zscaler is a smaller, faster-growing provider of cloud-native “zero trust” services that treat everyone, including a company’s top executives, as potential threats.

Over the past 12 months, Fortinet shares are up 26% as Zscaler shares are down 1%. Let’s see why the former outperformed the latter by such a wide margin — and whether it’s still the best buy.

Image source: Getty Images.

Key differences between Fortinet and Zscaler

Fortinet originally developed next-generation firewalls (NGFWs) that upgraded traditional firewalls with more advanced network filtering tools. These firewalls eventually became the foundation of the “Security Fabric,” which brings together more than 50 on-premises and cloud-based services. It now serves over 775,000 customers worldwide.

Fortinet is fundamentally similar to Palo Alto Networks (PANW -2.30%)which also developed NGFWs before launching its other endpoint security services. However, Fortinet differentiates itself from Palo Alto and other industry peers by developing its own custom chips, which it claims can counter threats more effectively than off-the-shelf silicon when paired with its own hardware and software. This strategy also allows Fortinet to tightly control its own supply chain.

Zscaler does not provide on-site appliances, which take up a lot of space, require constant maintenance, and are expensive to scale. Instead, it offers its zero-trust tools as subscription-based cloud-native services that are stickier, easily scalable, and constantly updated online. It also cross-sells additional security modules to its existing customers. It currently serves more than 7,700 clients globally, including nearly a third of the Forbes Global 2000 companies.

Which company is growing faster?

Fortinet went public in 2009. From 2009 to 2019, it grew its revenue at a compound annual growth rate (CAGR) of 24%. From 2019 to 2023, its revenue grew at a CAGR of 25%, from $2.2 billion to $5.3 billion.

Those growth rates have been robust, but its revenue is expected to grow only 9% to 11% to $5.8 billion to $5.9 billion in 2024. That would represent its slowest growth rate since the IPO and would dash initial hopes of generating $8 billion in annual revenue. by 2025. Analysts expect its revenue to grow 10% to $5.9 billion in 2024 and 12% to $6.6 billion in 2025.

Fortinet blames this slowdown on macro headwinds, reduced spending on cybersecurity appliances after a temporary acceleration in 2022 and a cooling upgrade cycle for NGFWs. But the company could also face stiffer competition from Palo Alto, which has consolidated its services into a single “platform” and CrowdStrike (CRWD -3.91%)which brings together all of its endpoint security services in a cloud-native platform.

Fortinet’s growth is cooling, but it’s still increasing its spending on new chips. Analysts expect adjusted EPS to grow 25% in 2024, but grow just 10% in 2025. That growth rate is solid, but its stock isn’t cheap at 33 times forward earnings.

Zscaler went public in 2018. From fiscal 2019 to fiscal 2024 (which ended in July), its revenue grew at a CAGR of 48%. This rapid expansion has been driven by a growing need for trustless services to counter both external and internal cyber threats.

For fiscal 2025, Zscaler expects its revenue to grow 20% to 21% — which would also represent its slowest growth rate since going public. Like Fortinet, Zscaler blames this slowdown on the challenging macro environment. Analysts expect its revenue to grow 21% in fiscal 2024, but accelerate slightly to 23% in 2025. Zscaler’s hyper-growth days may be over, but it’s still expanding faster than many of his colleagues in the industry.

Bottom line, the company expects adjusted earnings to fall 10%-12% in fiscal 2025 as it faces more pricing pressure while ramping up sales, marketing and research and development spending. At $157 a share, its stock still looks pretty expensive at 55 times the midpoint of that gloomy forecast. Analysts had previously expected adjusted EPS to rise 4% in fiscal 2025 and 23% in fiscal 2026 — but are likely to lower those forecasts in response to its latest earnings report.

Buy Better: Fortinet

Fortinet is growing more slowly than Zscaler, but it’s bigger and more diversified, and its stock looks more reasonably valued. Fortinet is also solidly profitable on a generally accepted accounting principles (GAAP) basis, while Zscaler is only profitable on a non-GAAP basis, which excludes all of its stock-based compensation expense.

This is why Fortinet has outperformed Zscaler over the past year, and why it will likely remain the top cybersecurity play for the foreseeable future. Zscaler is not expected, but its declining profits and high valuation will limit its gains in the near term.