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Better Cybersecurity Stock: Palo Alto Networks vs. Fortinet

Motley Fool - Tue Oct 4, 8:23AM CDT

Palo Alto Networks(NASDAQ: PANW) and Fortinet(NASDAQ: FTNT) are both promising cybersecurity companies that have consistently bested the market. Over the past five years, Palo Alto's stock rallied about 240% as Fortinet's stock surged more than 580%. By comparison, the Nasdaq Composite rose just over 60% and the S&P 500 by about 40%.

Both companies impressed investors with their robust revenue growth and rising profits. Investors also increasingly viewed the cybersecurity market -- which Fortune Business Insights expects to grow at a compound annual rate of 13.4% between 2022 and 2026 -- as an evergreen industry that could weather the unpredictable macro headwinds.

An IT worker looks at a screen.

Image source: Getty Images.

But should investors still buy either of these cybersecurity stocks as rising interest rates drive investors away from higher-growth tech companies? Let's take a fresh look at their business models, growth rates, and valuations to decide.

The similarities and differences

Palo Alto and Fortinet both created next-gen firewalls by upgrading traditional versions with network device filtering tools. Fortinet launched its first firewall, Fortigate, in 2002. Palo Alto introduced its first next-gen firewall, Strata, in 2007. Both companies capitalized on the growth of those next-gen firewalls to expand their ecosystems with additional services.

Fortinet turned FortiGate into the heart of its "Security Fabric," which provides additional end-to-end protection services for on-premise, cloud-based, and Internet of Things (IoT) devices. Meanwhile, Palo Alto acquired more companies and launched two next-gen platforms: Prisma for cloud-based security services and Cortex for its threat-detection tools powered by artificial intelligence (AI). These complement Strata and widen its moat against newer competitors in the cloud and AI markets.

Today, Fortinet serves over half a million customers worldwide, including most of the Fortune 500. Palo Alto serves more than 85,000 customers, including most of the Fortune 100. Both companies generate a majority of their revenue from subscription-based services, but Palo Alto usually serves larger enterprise customers than Fortinet.

Fortinet is also more geographically diversified than Palo Alto Networks. In their latest fiscal years, Fortinet generated 41% of its revenue in the Americas, while that same region accounted for 69% of Palo Alto's top line.

Which company is growing faster?

Palo Alto and Fortinet have been growing at similar rates. Palo Alto's revenue rose 29% to $5.5 billion in fiscal 2022, which ended in July, as its billings increased 37% to $7.5 billion. It attributed most of that growth to the expansion of its next-gen security services, Prisma and Cortex. Its adjusted earnings per share (EPS) increased 23%.

For fiscal 2023, Palo Alto expects its revenue to rise another 25%, its billings to increase 20% to 21%, and its adjusted EPS to grow 24% to 26%. The company also finally expects to turn firmly profitable on a GAAP (generally accepted accounting principles) basis for the full year. Palo Alto notably closed a 3-for-1 stock split last month.

In 2021, Fortinet's revenue rose 29% to $3.3 billion, billings 35% to $4.2 billion, and its adjusted EPS 19%. Unlike Palo Alto, it's been profitable on a GAAP basis for many years. It attributed a lot of its recent growth to the convergence of the security and networking markets and the fresh threats posed by remote and hybrid work.

For 2022, Fortinet expects its revenue to rise 30% to 32%, its billings by 33% to 35%, and its adjusted EPS by 27% to 33% (after factoring in its 5-for-1 stock split earlier this year).

The valuations and verdict

Neither stock can be considered a screaming bargain yet. Palo Alto still trades at 53 times forward earnings, while Fortinet has a lower forward price-to-earnings ratio of 38.

I like both stocks as long-term plays (I personally own shares of Palo Alto). Still, Fortinet looks like a slightly better investment because it's growing faster, trading at a lower multiple, and is already firmly profitable by GAAP measures. Those strengths could make it a more appealing investment as long as rising interest rates continue to rattle the markets.

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Leo Sun has positions in Palo Alto Networks. The Motley Fool has positions in and recommends Fortinet and Palo Alto Networks. The Motley Fool has a disclosure policy.

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