After Earnings, Is Zscaler Stock a Buy, a Sell, or Fairly Valued?

Zscaler ZS released its third-quarter earnings report on Dec. 2. Here’s Morningstar’s take on Zscaler’s earnings and stock.

Key Morningstar Metrics for Zscaler

• Fair Value Estimate: $213.00
• Morningstar Rating: 3 stars
• Economic Moat: Narrow
• Morningstar Uncertainty Rating: High

What We Thought of Zscaler’s Q3 Earnings

• Looking at Zscaler’s headline numbers, it was a strong quarter, with solid topline growth and better-than-expected profitability.
• Billings growth decelerated dramatically to 13% from 27% last quarter, which probably spooked investors and led to the after-market selloff following the firm’s report. We maintain our fair value estimate. We view this deceleration as a temporary result of the sales personnel challenges the company has highlighted over the last couple of quarters.
• Looking at booking growth (30%) and management’s commentary on improving close rates, improving customer engagement, and spending, we think Zscaler is set up for a strong second half of fiscal 2025.

Fair Value Estimate for Zscaler

With its 3-star rating, we believe Zscaler’s stock is fairly valued compared with our long-term fair value estimate of $213 per share, which implies a 2025 enterprise value/sales multiple of 12 times. We forecast Zscaler’s revenue to grow at a 22% compound annual growth rate over the next five years. As enterprises increasingly shift network traffic routing directly to cloud applications, we see massive greenfield opportunities for the firm to take advantage of and grow its business.

Additionally, we think Zscaler’s “land and expand” model will continue to bear fruit. The firm has shown great success in upselling its existing customers by either offering additional modules within a platform or cross-selling its Zscaler Private Access after initially landing with its Zscaler Internet Access offering. Going forward, we project continued up/cross-selling activity for the firm.

Read more about Zscaler’s fair value estimate.

Economic Moat Rating

We assign Zscaler a narrow moat, owing primarily to strong switching costs and a network effort associated with its offerings. We believe the company’s industry-leading zero-trust security solutions will continue to see robust enterprise adoption, allowing it to both retain and expand its footprint within existing organizations, while also allowing the company to land new customers. As a result, we forecast Zscaler to generate excess returns over invested capital over the next decade.

As we look at the broader cybersecurity space, we believe the complexity and intensity of threats are always increasing. Enterprises continue to adopt software-as-a-service solutions, undergo digital transformations, and migrate to the cloud, all while employees continue to work remotely part-time. In turn, we see the number of attack vectors rapidly growing. Similarly, the intensity of digital threats is on the rise, with higher costs for a data breach, including punitive fines.

Read more about Zscaler’s economic moat.

Financial Strength

We view Zscaler’s financial position as healthy. The firm ended fiscal 2024 with around $2.4 billion in cash and liquid investments. While Zscaler does carry debt of around $1.1 billion on its balance sheet, we believe the firm’s cash reserves and ability to generate healthy cash flow from its business will cover its commitments over our explicit forecast.

While the firm has not posted GAAP profitability, Zscaler’s adjusted operating margins have been in the black since 2018 and reached 20% in 2024. We expect Zscaler’s profitability to improve as it increases its operating leverage by toning down some of its research and sales expenditures.

Read more about Zscaler’s financial strength.

Risk and Uncertainty

We assign Zscaler a High Uncertainty Rating due to the ever-shifting cybersecurity space. While the company has positioned itself well to benefit from secular tailwinds, such as a shift to zero-trust security and the convergence of networking and security, the cybersecurity space is known for rapid development. Large incumbents like Zscaler stand to be disrupted by upstarts that could offer better performance in key modules. To stay ahead of the pack, Zscaler has invested a great deal in building out its ZIA and ZPA solutions. However, a shifting demand landscape and newer products that impact Zscaler’s competitive positioning are a risk.

Much like other software firms, Zscaler invests heavily in its sales and research departments. Due to the high spending in these verticals, the firm has yet to achieve GAAP profitability. While we firmly believe in Zscaler’s long-term opportunity, we think that to bask in the light at the end of the tunnel, it will have to execute well in the coming years.

Read more about Zscaler’s risk and uncertainty.

ZS Bulls Say

• Zscaler has strong secular tailwinds, as the convergence of networking and the security market is in its early innings.
• Zscaler has market leadership and high enterprise penetration through its offerings related to secure web gateways and zero-trust network access.
• The consolidation of security vendors should benefit Zscaler, which has a wide array of solutions across an enterprise’s network security stack.

ZS Bears Say

• Large public cloud vendors often offer their own cybersecurity solutions, which could hamper Zscaler’s growth opportunities.
• Zscaler faces competition from vendors like Palo Alto Networks PANW and Fortinet FTNT, which have increasingly invested in the key areas where the firm has market-leading positions.
• There always remains a risk that Zscaler may miss out on the next big technology, allowing competitors to catch up.

This article was compiled by Kayleigh Hall.