Better Buy: Palo Alto Networks Inc. vs. FireEye

When Palo Alto Networks (NYSE: PANW) reported earnings last quarter, it delivered -- as usual -- a revenue beat. That, along with strong guidance, helped push its stock up 8% after the announcement on Monday. Another norm for Palo Alto was that its initial gain was quickly cut to 5% as profit takers jumped in.

That contrasts with the story for FireEye (NASDAQ: FEYE), share of which have dipped 15% since it reported solid earnings, but muted guidance Nov. 1. FireEye shareholders are still in the black for the year, but Palo Alto has the momentum. All in all, the question of which is the better buy isn't as cut-and-dried as it seems.

The case for Palo Alto

Investors were pleasantly surprised -- but shouldn't have been -- when Palo Alto reported revenue and EPS (excluding one-time items) above guidance. CEO Mark McLaughlin routinely under-promises and over-delivers, and companies record $505.5 million in revenue and adjusted EPS of $0.74 a share were just the latest examples of that.

The company forecast the next quarter will be strong as well, with sales between $518 million to $528 million, equal to revenue growth of 23% to 25%. In other words, based on the pattern of under-promising, another quarter of 26% to 27% growth should be expected.

In its fiscal 2018 first quarter, the well-paid sales team inked deals with over 2,500 new customers, lifting its total above 45,000. Deferred revenue was another positive metric: It shot up 37% to $1.9 billion. New CFO Kathy Bonnano will stay busy with so many deals done, but not yet included as revenue.

I recognize that Palo Alto is in growth mode, and given its relatively small size -- its market capitalization is $14 billion -- spending now to gain market share in a burgeoning market is logical. That said, at what point will enough be enough?

Palo Alto's operating expenses jumped 21% last quarter to $418.4 million: Cost of revenue also soared 40% to $141.1 million. Spending on sales increased 17% to $258.5 million, equal to 51% of total revenue. The result of that open-checkbook policy was yet another loss, this time of $0.70 a share, 11% worse than the $0.61 a share loss it took a year earlier.

The case for FireEye

It's been a year and half since FireEye named Kevin Mandia CEO, and he knew there were big chores ahead. Expenses were out of control, and FireEye was relying on one-time product sales to drive growth. Mandia's objectives were to drastically cut overhead and shift to cloud-based subscription software sales of its Helix platform to drive recurring revenue.

Despite last quarter's "disappointing" guidance, the FireEye of today is in a dramatically improved position compared to a year ago. FireEye reported revenue of $189.6 million, up 2% and above analyst estimates. With a guidance range of $190 million to $196 million in revenue for the current quarter, the midpoint of the range falls below the consensus analysts estimate of $195.8 million. FireEye's billings expectations for this quarter of $230 million on the high-end also missed the consensus $237.1 million pundits were expecting.

For the recently ended quarter, the adjusted EPS loss of $0.04 was drastically improved compared to last year's loss of $0.18 a share. The improvements to FireEye's bottom line are directly related to its expense management efforts. Though still high, with each passing quarter FireEye is taking giant steps in the right direction.

Cost of revenue eased 1% to $68.2 million, but FireEye slashed operating expenses again. It cut overhead 20% to $183 million, including 20% from its sales and marketing costs to $88.9 million. Again, still awfully high, but nothing like what FireEye was spending a year ago.

The $0.41 a share it lost including all expenses may not impress, but compared to the $0.75 a share in the red it was a year ago, it's become a question of when, not if, FireEye becomes profitable.

The envelope, please

Palo Alto offers investors an opportunity for near-term growth due to its swelling top line and favorable momentum. It's also a Wall Street darling, with 70% of analysts rating it a buy or overweight.

As Palo Alto shareholders have seen so often, though, it likely won't be long before the excitement fades. FireEye, on the other hand, is worth considering for long-term investors in search of growth. And FireEye's recent sell-off limits its downside risk. For those reasons, and due to the incredible progress it has made in such a short period of time, FireEye gets the nod.

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Tim Brugger has no position in any of the stocks mentioned. The Motley Fool recommends FireEye and Palo Alto Networks. The Motley Fool has a disclosure policy.