3 Reasons Palo Alto Networks Inc. Stock Could Rise

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Any doubts of how the investing community feels about Palo Alto Networks (NYSE: PANW) were laid to rest following last quarter's earnings results. With its stock mired in a slump this year, Palo Alto reported a better-than-expected quarter, which included beating revenue expectations and sharing guidance for the current period that also pleasantly surprised.

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The reaction to Palo Alto's earnings news was swift and positive, as its stock price skyrocketed 17% overnight, driving shares into the black 11% year to date. But has Palo Alto really turned a corner, or did "expansion within our existing customer base and new customer acquisitions in the quarter" simply make for a blowout quarter?

Only time will tell, but there are a few things Palo Alto can do to keep fanning the flames. If it succeeds, shareholders are sure to enjoy a strong 2017.

Keep the checkbook closed

Though Palo Alto's top line and forecast for the current quarter got much of the attention, CEO Mark McLaughlin's progress, albeit minimal, shouldn't be overlooked in reining in overhead in relation to sales costs.

The 25% sales jump to $431.8 million was nice, but the slowing rate of increased sales and marketing-related costs was a sign that McLaughlin is delivering on his promise to lower spending. Though sales expenses hit $226.9 million last quarter, for a 16% year-over-year increase, the growth rate was considerably slower than in past quarters.

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That Palo Alto still spends over half its revenue on sales and marketing, however, remains troublesome. Competitor Check Point Software (NASDAQ: CHKP) is flying high largely because of its stringent spending: Last quarter, its $106.2 million in sales costs represented just 24% of its $435.45 million in sales. If Palo Alto can emulate Check Point in this all-important area, its stock is sure to rise.

Growth where it counts

One of the key drivers of Check Point's relatively nominal sales expenses is its all-out push to grow recurring revenue through subscription software and services. Palo Alto, like Check Point and others in the data-security space, is hoping for much the same thing -- and it's happening.

Of last quarter's total revenue, 62% came from Palo Alto's subscription and support unit. The $267.6 million the division reported for the quarter was good for an impressive 46% year-over-year jump, more than making up for the meager 1.3% gain in product sales to $164.2 million.

The recurring-revenue effort will also make Palo Alto's cost-cutting initiative more effective. It simply costs less to service existing customers than rely on product sales -- and the marketing expenses associated with them -- to drive revenue growth. If Palo Alto can keep the recurring-revenue ball rolling, shareholders will be the better for it.

Surprise, surprise

Continuing to beat revenue expectations, let alone provide better-than-expected guidance, will give Palo Alto stock a boost. Of course, over the long haul, improved fundamentals are needed to give legs to Palo Alto's stock run, but as investors saw last quarter, there's no denying the positive impact of quarterly surprises.

For this quarter, Palo Alto's fourth of fiscal 2017, expectations are for revenue between $481 million and $491 million, equal to a 20% to 23% improvement from a year ago. Excluding one-time items, Palo Alto expects per-share earnings of $0.78 to $0.80, well above last year's $0.50 a share.

Another bright spot for investors is that Palo Alto stock, even after its post-earnings jump, hasn't performed even close to the stock of some of its competitors. Check Point is up 35% year to date. So if Palo Alto can continue making strides where it counts, and beating near-term expectations, the gap in share-price growth with its peers could narrow with each passing quarter.

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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.