Good times are here again for Palo Alto Networks Inc (NYSE:PANW) stock. Concerns about execution and the health of the security space as a whole brought Palo Alto Networks stock down over the past few years. But over the last year, PANW stock has gained 65%. At $187, it’s now challenging all-time highs set back in 2015.

The gains make some sense. PANW has an excellent story at the moment. Like so many other tech sectors, security is moving from hardware to cloud-based software. That shift has buoyed issues like Microsoft Corporation (NASDAQ:MSFT) and Red Hat Inc (NYSE:RHT), among many others — and provides a tailwind for Palo Alto Networks stock as well. Demand for security doesn’t seem to be going anywhere, given a number of high-profile data breaches.

But back at the highs, there are some concerns surrounding PANW stock. And in a more nervous market, there’s probably enough here to consider staying away from PANW altogether — or at the least hoping for a much cheaper price.

PANW Stock Projections

The first question is whether the security market is quite as strong as investors might think. In an age of high-profile data breaches like that at Equifax Inc. (NYSE:EFX), one might think security spending was increasing exponentially.

That’s not actually the case. Projections cited by Palo Alto Networks itself in recent presentations suggest the market should grow at about 8% a year. PANW believes it can add to that growth with its Application Framework offering, which could add as much as $5 billion to the company’s addressable market. That app-based ecosystem is a big part of the growth opportunity here, and one that might differentiate Palo Alto from competitors like Fortinet Inc (NASDAQ:FTNT) and FireEye Inc (NASDAQ:FEYE).

That’s a key need here. The security market isn’t quite as differentiated as some bulls believe. Next-generation firewalls are widely available. Palo Alto appears to have an edge for now — but the security business is notably fast-paced, and customer loyalty is relatively thin.

That’s not to suggest that PANW is the next FEYE, which fell nearly 90% between 2014 and 2017. But a cloud-based software story generally is based on “sticky,” long-term, high-margin engagements. The security space doesn’t offer quite that level of loyalty — which means its customers don’t offer quite that level of lifetime value.

Meanwhile, the overall market is growing, but not torridly so. Pricing and competitive pressure will remain intense. FireEye seems to be making progress with its turnaround, and Cisco Systems, Inc. (NASDAQ:CSCO) and Juniper Networks, Inc. (NYSE:JNPR) are trying to do the same.

I get the argument for why SaaS stocks deserve high valuations. I’m skeptical that PANW’s self-described “hybrid cloud” model in the security sector deserves the same kind of enthusiasm.

Insane Issuance of PANW Stock

The biggest issue here, however, is the huge amount of stock-based compensation at Palo Alto Networks. PANW bulls point to attractive price to free cash flow multiples, which likely are in the mid-teens relative to fiscal year 2018 cash flow, and backing out the company’s approximately $12 per share in net cash.

But that free cash flow — and PANW’s non-generally accepted accounting principles earnings — are benefiting tremendously from the company’s issuance of PANW stock to employees. Last August, MarketWatch ranked stocks with a market capitalization of $10 billion based on stock-based compensation as a percentage of revenue. Palo Alto Networks far and away was the worst offender. Stock-based comp equaled over 28% of revenue. Workday Inc (NASDAQ:WDAY) was next at just 23%.

Even Twitter Inc (NYSE:TWTR), whose comp was so out of hand that the company has aggressively pulled it down, performed better on that metric than PANW. TWTR has a larger market cap, and projects $350-$400 million in share-based comp in 2018. Palo Alto Networks, after the second quarter, is on pace for roughly $530 million.

That’s about half of the company’s projected free cash flow. It suggests that shareholders are facing about 3% dilution this year alone. Indeed, Palo Alto Networks is unprofitable on a GAAP basis. Even adjusting for the other one-time factors, like one-time charges and non-cash expense, PANW still wouldn’t have turned a profit in the first half of 2018.

For now, investors and analysts are turning a blind eye. I’m skeptical that will last forever.

PANW Stock Isn’t Cheap

Yet even on the basis of those adjusted figures, PANW looks expensive. The stock trades at 36x FY19 consensus earnings per share, again backing out net cash. Free cash flow numbers are better, but excluding share-based comp, the price to free cash flow ratio too seems to be in the 35x+ range.

Both multiple suggests years of steady, consistent growth. Looking backward, that seems possible. But if the overall industry slows, competition improves, or Palo Alto Networks stumbles again, profit increases could slow dramatically. This is a high-leverage basis: impressive revenue growth the past few years has resulted in significant adjusted margin expansion. (Operating margins rose from 7.2% in FY12 to 20.1% in FY17.)

That expansion won’t come if revenue growth slows down. Something like market-level 8% growth and low double-digit operating income increases aren’t enough at 36x EPS. That doesn’t even include the possibility of the market questioning just how much PANW really needs to dilute its shareholders to drive that growth.

With the stock back at levels that served as resistance earlier this decade, the run in PANW stock may be near an end. Analysts, too, are about the upside, with the average target price on Palo Alto Networks stock suggesting just 5.3% upside.

Again, everything has been going right of late for Palo Alto Networks, and for PANW stock. But that seems about priced in. The risk that something could go wrong does not.

As of this writing, Vince Martin has no positions in any securities mentioned.