Zscaler(NASDAQ: ZS) investors may want to forget 2024. Shares of the cybersecurity specialist have dropped more than 10% so far this year due to concerns about its slowing growth, and the company seems set to enter 2025 on the back foot.
The stock fell by nearly 5% on Tuesday after Zscaler released its fiscal 2025 first-quarter results following the close of trading on Monday. However, a close look at the company’s results and guidance suggests that investors may have overreacted.
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Let’s check out the reasons why Zscaler stock fell following its earnings and check if this drop could be a buying opportunity for investors.
For its fiscal Q1, which ended Oct. 31, Zscaler reported revenue of $628 million, an increase of 26% from the same period last year. The company’s non-GAAP net income jumped by an impressive 40% to $0.77 per share. Analysts consensus estimates were for earnings of $0.63 per share on revenue of $606 million.
The company handily beat those estimates thanks to strong growth in customer spending and an increase in the number of large customers. For instance, the number of customers providing annual recurring revenue (ARR) of more than $100,000 increased 17% year over year to 3,165. Meanwhile, the number of customers providing more than $1 million in ARR increased by 25% to 585.
Zscaler’s bookings — the value of contracts signed by customers during the quarter — increased by 30% year over year, outpacing its top-line 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 evident from the company’s dollar-based net retention rate of 114%. This metric compares the money spent by customers on a company’s offerings in a given quarter to the sum those same customers spent in the prior-year period. A reading of more than 100% in this metric means its customers are increasing their spending on its services over time, which bodes well for Zscaler as it points toward the stickiness of its cybersecurity platform.
Another thing worth noting here is that the ARR of Zscaler’s emerging products grew at more than twice the rate 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 on the earnings conference call that products such as its AI-powered virtual assistant, ZDX Copilot, are contributing to an increase in deal sizes due to growing adoption by customers.
Zscaler calculates its total addressable market opportunity stands at a massive $96 billion, suggesting that it ideally could continue to witness improved spending on its products thanks to the advent of new technologies such as AI. All this explains why the company increased its full-year guidance. It now expects revenue to grow by 21.5% in fiscal 2025 to $2.63 billion, up from its earlier guidance for 20.5% growth.
Management also bumped up its earnings per share guidance to a range of $2.94 to $2.99 from the earlier range of $2.81 to $2.87. The company’s revenue outlook of $634 million for the current quarter is also slightly ahead of Wall Street’s expectations.
Despite all these positive developments, many investors decided to hit the sell button. That may have been due to the company’s valuation.
The fact that Zscaler’s outlook for the current quarter was barely ahead of analysts’ expectations of $633 million may have led to the post-earnings sell-off. After all, the company’s guidance points toward a 21.5% increase in revenue, which would be markedly slower than the 35% growth it reported in the same quarter last year.
Zscaler is trading at 14 times sales, which is a premium to the U.S. technology sector’s average sales multiple of 8. In that context, the company’s slowing growth seems to have raised a red flag for investors. It also trades at an expensive 72 times forward earnings. Given that Zscaler’s earnings are set to drop this year from the previous fiscal year’s $3.19 per share, one can conclude that it’s richly valued right now.
As such, buying Zscaler following its latest drop may not seem like a great idea. However, if the stock continues to decline to a cheaper valuation, it may become worth considering. After all, the company’s remaining performance obligations increased by 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, so its revenue pipeline is improving.
There is no denying that Zscaler is indeed growing at a nice pace, but its valuation is the sticking point. That’s why investors would do well to add the stock to their watch lists, for reconsideration 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 has positions in and recommends Zscaler. The Motley Fool has a disclosure policy.
