Palo Alto Networks Has More Reasons to Sell Than to Buy

  • Palo Alto Networks' (PANW) third-quarter 2022 financial results were strong, but they did not spark a lasting rally because of another net loss.
  • The company has a problem making net profits and its valuation is not cheap.
  • Finances are not very strong as the software company has increased its debt level.
PANW stock - Palo Alto Networks Has More Reasons to Sell Than to Buy

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Palo Alto Networks (NASDAQ:PANW), a software company that provides cybersecurity solutions, challenges the dilemma in stock investing now: whether to invest in growth stocks or in value stocks. The firm reported strong 2022 third quarter (Q3) earnings that caused a short-term bounce from $436 to $527. However, the stock fell back to $475 per share. Does this signal further tough moments for Palo Alto Networks in 2022? I personally think PANW stock now has more clear reasons to sell it rather than buy it.

Ticker Company Price
PANW Palo Alto Networks, Inc. $507.41

Strong Q3 Results

It is not a surprise that after the release of the Q3 2022 financial results reported in May, shares of Palo Alto Networks rallied nearly 21% until Jun. 8. The earnings per share (EPS) GAAP figure of negative 74 cents was a beat by 42 cents. Additionally, revenue of $1.39 billion was a beat by $27.66 million.

The main highlights were a year-over-year increase of 29% in revenue and a 40% year-over-year increase in billings. The most positive news is the fact that Palo Alto Networks raised its guidance for the fiscal year 2022, expecting year-over-over year growth of approximately 29% for revenue in the range of $5.481 billion to $5.501 billion.

After all, revenue is the starting point to evaluate the financial and business performance of this high-growth software company. I am not optimistic even with the upbeat guidance for some key reasons.

Something Is Going Wrong for PANW stock

Looking at the annual revenue growth of Palo Alto Networks, it is easy to be impressed. In 2021, sales growth was 24.87% after a growth of 17.55% in 2020. The company now expects revenue growth of 29% for 2022, as mentioned above. But this only tells part of the financial performance.

The firm began losing money in 2017. Even though Palo Alto Networks generates positive free cash flow, that is not a top reason to get excited and consider the stock a “buy.” We must put all of the fundamental pieces together.

The software firm has a negative operating margin, a high positive gross margin that seems to have peaked at 72.9% back in 2017, and a negative net margin that tends to become worse over time.

In 2020, the net margin was negative 7.83%. In 2021, it grew to negative 11.72%. On a trailing 12-month basis, it stands at negative 7.54%. I do not see much improvement here.

The return on equity ratio, which is an important measurement of profitability, has also become worse and is negative. Is it enough to think of Palo Alto Networks as a high-growth company and neglect its poor profitability? I think not. Unfortunately, valuation is not ideal either.

High Debt-to-Equity Ratio

According to GuruFocus, “Palo Alto Networks’s debt to equity for the quarter that ended in Apr. 2022 was 11.70.

This is too big a number to ignore. It could be much better if the company was profitable, as it would accumulate positive retained earnings and could use them to pay off its debt. Now, the situation is different with net losses in the mix.

The valuation of PANW stock is not cheap. The forward price-to-book figure of 84.89 and a forward price-to-sales figure of 8.62 are not cheap. On the contrary, they signal a pricey stock.

The combined financial metrics show that Palo Alto Networks has more risks than merits right now. Therefore, the stock is not as attractive as you may have thought after reading its latest financial results.

On the date of publication, Stavros Georgiadis, CFA  did not have (either directly or indirectly) any positions in the securities mentioned in this article. The opinions expressed in this article are those of the writer, subject to the InvestorPlace.com Publishing Guidelines.

Stavros Georgiadis is a CFA charter holder, an Equity Research Analyst, and an Economist. He focuses on U.S. stocks and has his own stock market blog at thestockmarketontheinternet.com. He has written in the past various articles for other publications and can be reached on Twitter and on LinkedIn.


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