Cybersecurity company SentinelOne (S 0.09%) went public in the summer of 2021 at one of the steepest valuations on Wall Street. The stock has gradually recalibrated since then and three years later it trades nearly 70% below its peak. However, investors shouldn't assume that a sliding share price always means the underlying business is struggling -- SentinelOne's business is doing better than ever.
The stocks' struggles eased over the past year, and this could be only the beginning of SentinelOne's actual growth journey.
Is SentinelOne the outcast of cybersecurity?
Cybersecurity is a broad and fragmented market where different companies specialize in various types of security. The bottom line across the corporate landscape is that companies need cutting-edge security today to defend against breaches. The average data breach now costs a company close to $5 million in damage, and the companies that provide the best security solutions could be big winners in the coming years. SentinelOne started in endpoint security but has expanded its capabilities to include protection for the cloud, identity, data, and more.
Yet Wall Street apparently disdains this top-tier security company. On an enterprise-value-to-revenue basis, SentinelOne is the cheapest relative to its peers by a wide margin.
S EV to Revenues (Forward) data by YCharts.
This implies that SentinelOne's revenue is worth the least of this group. In other words, for whatever reason (growth rate, profitability, competitive position, etc.), investors aren't willing to pay as much for SentinelOne as they are for its peers. This thinking is misguided and creates a potential investment opportunity.
Why SentinelOne's value lags its peers
Investors favor companies that are profitably growing. So will SentinelOne's business have more revenue in the future, and will it be profitable?
The answer to the first question is straightforward: SentinelOne is growing faster than its peers.
S Revenue (Quarterly YoY Growth) data by YCharts
Some others come close, but investors must consider that SentinelOne is roughly 25% cheaper than the runner-up in the valuation rankings. Given SentinelOne's growth, the valuation gap likely means that Wall Street doesn't see the quality of its revenue as equal to its peers. That's understandable. All these companies are GAAP profitable except SentinelOne.
Yet this could be where the opportunity is.
A reasonable bet for market-beating returns
If the stock's valuation is lower because SentinelOne is not GAAP profitable, then it's reasonable to assume that if it could turn a profit, it would warrant a valuation closer to the rest of its peers. In addition, its top line is already growing faster than 30% annually. If improvements in its financials lead the market to conclude the company merits a dramatically higher valuation, market-beating returns should follow.
The million-dollar question is: How likely is it that SentinelOne will turn a GAAP profit? The answer is that it's only a matter of time.
SentinelOne's gross and operating profit margins have steadily improved as the business has grown.
S Gross Profit Margin data by YCharts.
Additionally, the company generated positive free cash flow in Q1 of this year and roughly broke even in Q2. Management could probably cut some spending and deliver a larger profit if it wanted. However, SentinelOne has $1.1 billion in cash on its books and zero debt, so instead, management is choosing to maximize revenue growth and letting profitability come in its own time. The margin trends make it clear that profitability is on the way, and SentinelOne has the cash to be patient. Investors might be wise to show patience, too. Even if the stock's valuation remains the same, revenue growth alone should drive it higher over time. That said, long-term investors who hold the stock until Wall Street's sentiment toward SentinelOne improves will enjoy the best investment returns.
Here is the bottom line: SentinelOne is a healthy and thriving business. Its stock slid for years due to its lack of profits, but using that logic to justify avoiding it would cause you to miss an eventual comeback story that feels inevitable at this point.
