Shares of Fortinet (NASDAQ: FTNT) rallied nearly 40% over the past 12 months, easily outperforming the NASDAQ's 30% gain. The cybersecurity company impressed investors with a streak of double-digit sales and earnings growth, and it benefited from surging data breaches sparking interest in security-related stocks.
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But after that big run, Fortinet's stock looks a bit pricey at 93 times trailing earnings. Let's take a closer look at Fortinet to see if the stock can keep outperforming the market this year.
What does Fortinet do?
Fortinet is the fourth-largest network security appliance vendor in the world by annual revenues after Cisco (NASDAQ: CSCO), Palo Alto Networks (NYSE: PANW), and Check Point Software (NASDAQ: CHKP). It's also the market leader in terms of total units sold.
Fortinet's core product is a next-gen firewall called Fortigate, which is tethered to security appliances via its Fortinet Security Fabric. That "fabric" offers end-to-end protection for on-premise, cloud-based, and Internet of Things (IoT) services and devices. The company serves over 330,000 customers, including the "majority" of the Fortune 500.
How fast is Fortinet growing?
Fortinet's revenue rose 18% annually to $374 million last quarter, as its billings climbed 24% to $432 million. Its deferred revenue, a key indicator of forward demand, jumped 30% to $1.22 billion.
Looking ahead, Fortinet's estimated growth rates compare favorably to Palo Alto and Check Point's.
Last quarter, Fortinet founder and CEO Ken Xie declared that "the expanding cloud security market, and the future of securing critical infrastructure and IoT technologies, will enable Fortinet to continue to grow at multiples of the market over the coming years."
Fortinet is also cheaper than Palo Alto and Check Point on an EV/Revenue basis. It currently has an EV/Revenue ratio of 4.5, while Palo Alto and Check Point have higher ratios of 7 and 8.3, respectively.
How profitable is Fortinet?
Fortinet's long-term strategy consists of upselling more products to its existing customers, and using higher-margin subscription-based software revenues to offset the lower margins of its hardware business. That strategy enabled it to significantly expand its gross margin over the past few years.
That margin expansion also enabled Fortinet to stay profitable by both non-GAAP and GAAP metrics. This matters, because Palo Alto is only profitable on a non-GAAP basis, which excludes its high stock-based compensation expenses. Check Point, like Fortinet, is profitable by both measures.
Last quarter, Fortinet's non-GAAP net income rose 57% to $50.5 million, while its GAAP net income more than quadrupled to $26.6 million. Analysts expect that rosy growth to continue, with its non-GAAP earnings rising 40% this year and 17% next year.
By comparison, analysts expect Check Point and Palo Alto's non-GAAP earnings to respectively rise 25% and 11% this year. Based on these expectations, Fortinet's forward P/E of 37 -- which is higher than Check Point's multiple of 18 but matches Palo Alto's multiple -- looks fairly reasonable.
Fortinet's strong market position, solid growth rates, reliable profit growth, reasonable valuations, and lack of debt attracted buyout buzz from IBM, Cisco, Hewlett-Packard Enterprise, and Oracle over the past few years. After all, its enterprise value of $6.5 billion still seems like a small price to pay to establish a leading position in the network security appliance market.
It's unclear if Fortinet will ever be acquired, but I think the same attributes that make it a buyout target make it a sound investment for most investors. Fortinet offers better overall growth than Check Point and stronger profits than Palo Alto, and it isn't weighed down by legacy businesses like Cisco -- which make it a great stock to buy and hold this year.
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Leo Sun has no position in any of the stocks mentioned. The Motley Fool owns shares of and recommends Check Point Software Technologies. The Motley Fool owns shares of Oracle. The Motley Fool recommends Cisco Systems, Fortinet, and Palo Alto Networks. The Motley Fool has a disclosure policy.
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