Palo Alto Networks (PANW 2.02%) has been a great stock for growth investors. Over the past five years, the cybersecurity stock more than quadrupled even as the pandemic, geopolitical conflicts, inflation, and rising interest rates rattled the markets.
From fiscal 2019 to fiscal 2024 (which ended last July), Palo Alto's revenue grew at a compound annual growth rate (CAGR) of 23%. It also turned profitable on a generally accepted accounting principles (GAAP) basis in 2023 and 2024.
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That robust growth was driven by its cloud-based platform Prisma and its AI-powered Cortex threat detection services. The expansion of those two "next gen security" platforms offset the slower growth of its on-site Strata network security services. It was also well insulated from the macro headwinds because large companies generally won't turn off their existing cybersecurity defenses just to save a few dollars.
But from fiscal 2024 to fiscal 2026, analysts expect Palo Alto's revenue to grow at a slower CAGR of 15% as its adjusted earnings per share (EPS) rise at a CAGR of 13%. Its growth is cooling off as its business matures; it struggles to land larger contracts in a challenging market; and it expands its ecosystem with more loss-leading services to widen its moat.
Palo Alto's "platformization" might pay off over the long term, but it already has a market cap of $112 billion and isn't cheap at 53 times its forward adjusted earnings. That premium valuation could limit its upside potential as interest rates stay elevated, so investors should check out other similar cybersecurity companies with lower valuations. One of those stocks is Palo Alto's major competitor Fortinet (FTNT 1.19%).
What does Fortinet do?
At first glance, Fortinet and Palo Alto might seem similar. Both cybersecurity leaders were pioneers in next-gen firewalls (NGFWs) which upgraded traditional firewalls with more network filtering services. They both capitalized on the growing adoption of their NGFWs to build a more diversified ecosystem of endpoint security services, and they both expanded their cloud and AI platforms to keep pace with their smaller competitors.
Fortinet serves more than 805,000 customers worldwide, but it generates less annual revenue than Palo Alto, which only serves about 80,000 customers. That's because Fortinet serves a wider range of smaller customers than Palo Alto.
Another key difference is that Fortinet develops its own application-specific integrated circuits (ASIC) which are optimized for its own first-party software and hardware. Palo Alto and other cybersecurity companies mainly use off-the-shelf chips. Fortinet claims its own custom chips give it a competitive edge against its competitors.
Fortinet weaves together its secure ops, secure access service edge (SASE), and secure networking services across a "Security Fabric" which is designed to profit from the long-term convergence of the cybersecurity, networking, and hybrid cloud markets. Fortinet's expansion of that diversified ecosystem is arguably a more balanced strategy than Palo Alto's heavy dependence on Prisma and Cortex to offset Strata's slower growth.
Why could Fortinet's market cap eclipse Palo Alto's by 2026?
From 2018 to 2023, Fortinet's revenue grew at a CAGR of 24%. It's profitable on a GAAP basis, and its GAAP EPS rose at a CAGR of 31% during those five years.
For 2024, analysts expect its revenue and adjusted EPS to rise 11% and 38%, respectively. Like Palo Alto, Fortinet's business is maturing, and it's struggling to sign bigger contracts in this challenging market. For 2025, they expect its revenue to grow 13% as the macro environment warms up, but they see its adjusted EPS only rising 8% as it ramps up its spending on new chips.
Therefore, Fortinet is growing its sales at a similar rate as Palo Alto, but it only faces a minor near-term earnings slowdown because it's investing in new chips and services. Yet Fortinet's stock only trades at 37 times its forward adjusted earnings, which gives it a lower market cap of $71 billion. If Palo Alto's stock were abruptly revalued at 37 times forward earnings, its market cap would drop more than 30% to $75 billion.
Based on that comparison, Fortinet looks undervalued and Palo Alto Networks seems a bit overvalued. So if Fortinet's growth accelerates at a faster-than-expected clip in 2025 and it allays investors' concerns about its near-term spending, I believe it will command a higher valuation. At the same time, I think Palo Alto's valuations are getting too frothy in this market -- and it could disappoint its investors this year if its platformization strategy merely compresses its margins instead of boosting its revenues.
So while I'm not 100% certain Fortinet's market cap will eclipse Palo Alto's in a year, I believe it has a better shot at surpassing the industry bellwether than many of its peers. It's also a well balanced, reasonably valued play on the growing cybersecurity market regardless of where its stock might end up over the next 12 months.
