Why Palo Alto Networks, Inc. Could Be a Gold Mine for Growth Investors

Like others of its ilk, Palo Alto Networks (NYSE: PANW) stock continues to benefit from a market that is growing by leaps and bounds. Securing data is expected to generate an estimated $93 billion this year, and with hacks continuing to affect millions of people around the globe, there's little doubt the opportunity information security represents will only increase.

Though it remains a darling of industry analysts and its stock is up 17% in the past year, Palo Alto needs to fine-tune a few things before it really takes off. Peers including Fortinet (NASDAQ: FTNT) have put Palo Alto's stock performance to shame, rising a stellar 48% over the past 12 months. Even FireEye, which is in the early stages of a major overhaul and continually posts losses, has outperformed Palo Alto.

So what does Palo Alto have to do to be a gold mine for growth investors? The answer to that question is simple, at least in theory.

What's not to love

There were no shortage of positives as Palo Alto kicked off its fiscal 2018 year. The $505.5 million in total revenue Palo Alto reported last quarter was a 27% improvement and set yet another record. The better news is Palo Alto's outstanding results were largely due to its subscription and support revenue.

Like others in the cybersecurity space, Palo Alto is focused on building a relatively reliable foundation of revenue, and subscription and support is a significant step in the right direction. That's why Palo Alto's subscription and support revenue, which soared 36% to $319 million in the first quarter, was so impressive.

Thanks to adding more than 2,500 new customers -- many of them subscription users based on the unit's growth -- Palo Alto's deferred revenue skyrocketed last quarter. The record-setting $1.9 billion in deferred revenue, a good indicator of the company's sales pipeline, was an eye-popping 37% improvement compared to last year.

Another arrow in Palo Alto's quiver was guidance for the current quarter. It expects total revenue of $518 million to $528 million, equal to a 23% to 25% improvement, making it one of the few in its peer group to exceed pundit's guidance expectations.

The roadblock to becoming a gold mine

If Palo Alto is to meet Wall Street's and growth investors' expectations, spending has to get under control. For some perspective, despite its top-line growth Palo Alto's earnings per share actually declined 11% year over year to a loss of $0.70 compared to a negative $0.63 a share. The reason is obvious: Its operating expenses and cost of revenue rose yet again.

The $418.4 million in operating expenses was a 21% jump over the $345.9 million Palo Alto spent in 2017's first quarter. Added to the 40% jump in cost of revenue to $141.4 million, and it's not hard to see why Palo Alto's losses continue to mount regardless of its top-line growth. To its credit, much of the cost of revenue spending increase was to drive subscription revenue, so that may very well pay off down the road.

Palo Alto need look no further than Fortinet as an example of the positive impact cost control can have on the bottom line. Fortinet's total revenue "only" climbed 18% last quarter to $384.22 million. However, thanks to operating expenses and cost of revenue rising just 9% and 10%, respectively, EPS climbed nearly fourfold to $0.15 compared to last year's $0.04 a share.

Spending during a growth phase is to be expected, but for Palo Alto to truly become a gold mine for growth investors, CEO Mark McLaughlin and team have to get a handle on expenses. If, or better still when, Palo Alto keeps its checkbook closed now and again, long-term growth investors will be smiling all the way to the bank.

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