Palo Alto Networks Shares Are Climbing Today - Are They Overvalued?

Computer Equipment company Palo Alto Networks stunned Wall Street today as it surged to $252.18, marking a 3.4% change compared to the S&P 500 and the Nasdaq indices, which logged 1.0% and 1.0% respectively.

PANW currently sits within range of its analyst target price of $243.36, which implies that its price may remain stable for the near future.

Surprisingly, analysts give the stock an average rating of buy, which shows that they believe prices could continue to move. Over the last year, Palo Alto Networks shares have outperformed the S&P 500 by 35.0%, with a price change of 48.7%.

Palo Alto Networks, Inc. provides cybersecurity solutions worldwide. The company is a technology company. Valuations in the technology sector are often very high, as investors are willing to overlook gaps in the fundamentals if they believe a company’s innovations can dominate or create new markets.

Palo Alto Networks's trailing 12 month P/E ratio is 382.1, based on its trailing EPS of $0.66. The company has a forward P/E ratio of 50.3 according to its forward EPS of $5.01 -- which is an estimate of what its earnings will look like in the next quarter. The average trailing Price to Earnings (P/E) ratio of US-based technology companies is 27.16 as of first quarter of 2023. In contrast, the S&P 500 average is 15.97. The P/E ratio is the company's share price divided by its earnings per share. In other words, it represents how much investors are willing to spend for each dollar of the company's earnings (revenues minus the cost of goods sold, taxes, and overhead).

Palo Alto Networks's P/E ratio tells us how much investors are willing to pay for each dollar of the company's earnings. The problem with this metric is that it doesn't take into account the expected growth in earnings of the stock. Sometimes elevated P/E ratios can be justified by equally elevated growth expectations.

We can solve this inconsistency by dividing the company's trailing P/E ratio by its five year earnings growth estimate, which in this case gives us a 1.69 Price to Earnings Growth (PEG) ratio. Since the PEG ratio is greater than 1, the company's lofty valuation is not completely justified by its growth levels.

To better understand the strength of Palo Alto Networks's business, we can analyse its operating margins, which are its revenues minus its operating costs. Consistently strong margins backed by a positive trend can signal that a company is on track to deliver returns for its shareholders. Here's the operating margin statistics for the last four years:

Date Reported Total Revenue ($ k) Operating Expenses ($ k) Operating Margins (%) YoY Growth (%)
2022-07-31 5,501,500 3,971,600 -3.43 52.03
2021-07-31 4,256,100 3,285,300 -7.15 -36.19
2020-07-31 3,408,400 2,587,900 -5.25 -180.75
2019-07-31 2,899,600 2,145,300 -1.87 n/a
  • Average operating margins: -4.4 %
  • Average operating margins growth rate: -16.4 %
  • Coefficient of variability (lower numbers indicate less volatility): 51.6 %

Palo Alto Networks's financial viability can also be assessed through a review of its free cash flow trends. Free cash flow refers to its operating cash flows minues its capital expenditures, which are expenses related to the maintenance of fixed assets such as land, infrastructure, and equipment. Over the last four years, the trends have been as follows:

Date Reported Cash Flow from Operations ($ k) Capital expenditures ($ k) Free Cashflow ($ k) YoY Growth (%)
2022-07-31 1,984,700 -192,800 1,791,900 29.19
2021-07-31 1,503,000 -116,000 1,387,000 68.88
2020-07-31 1,035,700 -214,400 821,300 -11.15
2019-07-31 1,055,600 -131,200 924,400 n/a
  • Average free cash flow: $1.23 Billion
  • Average free cash flow growth rate: 18.0 %
  • Coefficient of variability (lower numbers indicating more stability): 36.3 %

Free cash flows represents the amount of money that is available for reinvesting in the business, or paying out to investors in the form of a dividend. With a positive cash flow as of the last fiscal year, PANW is in a position to do either -- which can encourage more investors to place their capital in the company.

Another valuation metric for analyzing a stock is its Price to Book (P/B) Ratio, which consists in its share price divided by its book value per share. The book value refers to the present liquidation value of the company, as if it sold all of its assets and paid off all debts. As of the first quarter of 2023, the average P/B ratio for technology companies is 6.23. In contrast, the average P/B ratio of the S&P 500 is 2.95. Palo Alto Networks's P/B ratio indicates that the market value of the company exceeds its book value by a factor of 62.53, so it's likely that equity investors are over-valuing the company's assets.

As of first quarter of 2023, Palo Alto Networks is likely overvalued because it has an inflated P/E ratio, an elevated P/B ratio, and consistent free cash flow that are on an upwards course. The stock has mixed growth prospects because of its consistently negative margins with a negative growth trend, and an inflated PEG ratio. We hope this analysis will inspire you to do your own research into PANW's fundamental values -- especially their trends over time.

The above analysis is intended for educational purposes only and was performed on the basis of publicly available data. It is not to be construed as a recommendation to buy or sell any security. Any buy, sell, or other recommendations mentioned in the article are direct quotations of consensus recommendations from the analysts covering the stock, and do not represent the opinions of Market Inference or its writers. Past performance, accounting data, and inferences about market position and corporate valuation are not reliable indicators of future price movements. Market Inference does not provide financial advice. Investors should conduct their own review and analysis of any company of interest before making an investment decision.