Down nearly 30% in 2024: Is Zscaler Stock a Buy?

Zscalerhis (ZS -3.37%) The stock price fell 19% on September 4 after its latest earnings report came out. For the fourth quarter of fiscal 2024, which ended July 31, the cybersecurity company’s revenue rose 30% year over year to $593 million and beat analysts’ expectations by $25 million. Its adjusted earnings per share (EPS) rose 38% to $0.88 and beat the consensus forecast by $0.19.

Those headline numbers looked healthy, but his guidance didn’t impress the bulls. Let’s see if this underdog hypergrowth stock is still worth buying after it’s down nearly 30% this year.

Image source: Getty Images.

Zscaler’s hyper-growth days are coming to an end

Zscaler develops “zero trust” services that treat everyone, including a company’s top executives, as a potential threat. They only offer their tools as cloud-native services that don’t require any on-premises devices. This lightweight approach is typically cheaper, stickier and easier to scale than appliance-powered services as an organization scales.

Zscaler went public in 2018. From fiscal year 2019 to fiscal year 2024, revenue grew at a compound annual rate of 48%. This growth was driven by the rapid expansion of the zero-trust and cloud-native cybersecurity markets. But over the past year, growth in calculated invoices and total revenue has cooled.

Data source: Zscaler. YOY = Year Over Year.

Zscaler’s revenue grew 34% in fiscal 2024, but it expects only 20% to 21% growth in fiscal 2025. This would represent the slowest annual rate of revenue growth since its initial public offering (IPO ). Mainly, this slowdown has been attributed to macro headwinds, which are causing more companies to take a hard look at their software spending.

But it could also face tougher competition from larger, more diversified cybersecurity companies such as CrowdStrike (NASDAQ: CRWD) and Palo Alto Networks (NASDAQ: PANW)which both integrate similar zero-trust tools into their endpoint security platforms. From fiscal 2024 to fiscal 2026, analysts expect Zscaler’s revenue to grow at a CAGR of 21%.

It increases its spending as growth cools

Zscaler has remained unprofitable on a generally accepted accounting principles (GAAP) basis since its IPO. But in fiscal 2024, non-GAAP operating margin expanded 5 percentage points to 20% as non-GAAP EPS grew 78%.

However, non-GAAP EPS is expected to decline 10% to 12% in fiscal 2025 as it expands its sales and marketing teams to pursue new customers. Analysts had previously anticipated a 4% increase.

That steeper-than-expected decline rattled bulls as it coincided with slowing earnings growth and suggested it was losing its pricing power. It also implies that Zscaler is saturating its zero-trust niche and may need to aggressively expand its ecosystem with additional cybersecurity services to continue growing. But that could crush its margins, pitting the company against larger companies like CrowdStrike and Palo Alto.

Pay attention to debt and its dilution

Zscaler had a high debt-to-equity ratio of 2.7 at the end of fiscal 2024. This is roughly triple the debt-to-equity ratio of 0.9 at the end of fiscal 2018. It also increased its share count by 24% in the past. six years.

Even after the latest revenue dip, Zscaler doesn’t look cheap at 57 times this year’s adjusted earnings. CrowdStrike, which is still growing faster even after triggering a disastrous IT outage in July, trades at 70 times forward earnings. Palo Alto, which is growing more slowly than both companies, has a lower forward multiple of 54. Unlike Zscaler, both CrowdStrike and Palo Alto are solidly profitable by GAAP measures.

Is it the right time to buy Zscaler?

Zscaler’s low revenue growth, rising expenses, high leverage, continued dilution and premium valuation all make it a tough stock to recommend. Its members have also sold more than 6 times more shares than they bought in the last 12 months.

Zscaler is still growing, but will face tougher macro and competitive challenges in the next few years. That’s why I wouldn’t touch its stock until its earnings growth stabilizes and its valuations to more sustainable levels.