Better Buy: Palo Alto Networks, Inc. vs. Check Point Software

By Tim Brugger Markets Fool.com

Despite playing in the same sandbox, Palo Alto Networks (NYSE: PANW) and Check Point Software (NASDAQ: CHKP) have taken distinctly different approaches to how they run their respective businesses. In the case of Palo Alto, everything revolves around top-line growth, which had worked wonders for shareholders until recently.

Continue Reading Below

As for Check Point, CEO Gil Shwed has, in some respects, sacrificed high-double-digit quarterly revenue gains and instead opted to grow the business in a slower, more practical manner. The distinctions between the two data security providers make the question of which is the better buy an intriguing one.

Palo Alto's all-encompassing data security reach. Image source: Palo Alto Networks.

The case for Palo Alto Networks

About this time last year, Palo Alto was in the midst of a nearly two-year stretch of generating 50% or better gains in quarterly revenue. The result of Palo Alto's impressive run was a stock price that was flirting with $150 or more per share and quickly became a darling among analysts.

The problem with Palo Alto's skyrocketing growth was twofold. One, it was inevitable that Palo Alto's quarterly sales gains would slow eventually, which leads to the second problem shareholders are facing today. CEO Mark McLaughlin was spending indiscriminately to drive all that growth, which investors didn't seem to mind as long as it kept reporting those incredible revenue gains.

Continue Reading Below

As investors saw last quarter, and are likely to see again when it reports fiscal third-quarter earnings on May 31, Palo Alto is still growing its top line but nowhere near the pace of a year ago. However, spending continues to soar. Last quarter, Palo Alto generated $422.6 million in sales, good for a 26% improvement year over year.

Last quarter was disappointing given its history, but what really hurt Palo Alto's stock was guidance for the current period of 17% to 20% revenue growth. The problem is that as sales are slowing, spending continues to grow. Cost of revenue climbed 20% in the second quarter to $113.2 million, and operating expenses shot up 25% to $363.8 million. Not surprisingly, per-share losses rose to negative $0.67 from last year's $0.66 a share.

Check Point security interface. Image source: Check Point.

The case for Check Point Software

About the same time that Palo Alto stock was flying high and had become an analyst favorite, Check Point was somewhat of an afterthought. With single-digit revenue growth the norm, Check Point stock was meandering. Thing is, what Check Point lacked on the top line it more than made up for where it counts: increasing profits. Investors and analysts, however, didn't seem too interested at the time.

Last quarter was a microcosm of how Shwed has decided to run Check Point's business. Total revenue grew"just" 8% in the first quarter, less than most of its peers. However, earnings per share climbed 15% to $1.06, or 13% after excluding one-time items to $1.20 a share. Check Point's quarter was impressive in and of itself, but it's how it got there that bodes well for the future.

Shwed implemented a subscription-based, recurring-revenue model over a year ago that resulted in its relatively anemic sales growth. However, the slower but more reliable recurring-revenue model is paying off handsomely now. Subscription revenue increased 27% last quarter to $112 million, and continues to make up a larger portion of total sales with each passing quarter.

So which is the better buy, Palo Alto or Check Point? For short-term, risk-tolerant day traders who don't mind wild swings in share price, Palo Alto fits the bill nicely. However, for investors in search of steady, long-term growth, Check Point's expense management and focus on building low-cost recurring revenue as the foundation for the future put it head and shoulders above Palo Alto, not to mention most of its other competitors.

10 stocks we like better than Check Point Software Technologies
When investing geniuses David and Tom Gardner have a stock tip, it can pay to listen. After all, the newsletter they have run for over a decade, Motley Fool Stock Advisor, has tripled the market.*

David and Tom just revealed what they believe are the 10 best stocks for investors to buy right now... and Check Point Software Technologies wasn't one of them! That's right -- they think these 10 stocks are even better buys.

Click here to learn about these picks!

*Stock Advisor returns as of May 1, 2017

Tim Brugger has no position in any stocks mentioned. The Motley Fool owns shares of and recommends Check Point Software Technologies. The Motley Fool recommends Palo Alto Networks. The Motley Fool has a disclosure policy.