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We’re calling up this leader in cybersecurity from the bullpen. We originally added PANW to our “stocks in waiting list,” which we call our Bullpen, last August around $167 per share. Since then, shares of Palo Alto Networks have gained roughly 4{b7c9e2c88beb1a84f22d94ab877a147f4adc4b3519717f3f957a0f34e16918d1} compared to the S&P 500‘s decline of about 1{b7c9e2c88beb1a84f22d94ab877a147f4adc4b3519717f3f957a0f34e16918d1}.

Much like the broader market, PANW went through a nasty decline back in December and has since rallied nicely so far in 2023. But even after this year’s gains, shares are still down from the $180s in late August and the low $200s it reached last April. We think the stock can return to those prior highs in time. 

With earnings on the horizon, we are intentionally starting our PANW position on the smaller side. The company is scheduled to report earnings this coming Tuesday after the closing bell on Wall Street. This buy isn’t a call on the upcoming quarter — but if the stock were to fall for any reason that did not change our positive long-term view, we would greet weakness as an opportunity to bulk up our stake.

We’re starting a position in Palo Alto Networks because of its leadership in cybersecurity. Earlier this week, Goldman Sachs published a research initiation note on cybersecurity companies. The analysts, who rated Palo Alto with a buy, said they expect “secular tailwinds in security to drive budget growth ahead of broader information technology (IT) spending and broader software over the next decade.” Goldman believes security will continue to take share of total IT and software budgets for three reasons:

• Security consistently screens as the first priority for investment in Goldman’s bi-annual survey of chief investment officers.
• Companies need to continue to invest in leading-edge technology to defend against threats.
• The evolving threat landscape has grown increasingly complex as more companies increase digital transformation projects.

Under this favorable backdrop of spending and Palo Alto Networks’ leading multi-platform approach, Goldman believes the company is positioned for “durable growth” of around 20{b7c9e2c88beb1a84f22d94ab877a147f4adc4b3519717f3f957a0f34e16918d1} for the next five years.

“We believe Palo Alto Networks is furthest along in the industry with executing a multi-platform strategy with technology leadership across several product vectors. Today, we view Palo Alto as a portfolio of network, endpoint and cloud products at different stages of product maturity, each leveraging centralized domain expertise in user interface/user experience (UIUX), marketing, security intelligence and machine learning.”

Cybersecurity isn’t completely immune to the weaker macro environment, but it should be one of — if not the — most resilient areas of enterprise spending. On the previous earnings call, management flagged how deals are starting to face more scrutiny and are taking longer to close. But on a more positive note, Palo Alto said it’s experiencing few deal cancelations. We do not think that changes no matter how tough things get in the economy.

If a threat were to arise, causing disruptions to your business, you don’t want to be the one that left the company vulnerable because you cut back spending on cyber.

Palo Alto Networks is also one of a handful of tech companies that has successfully made the pivot towards emphasizing profitability in this evolving macro environment. Management is doing an excellent job accelerating its efforts to drive incremental operating leverage. They have previously committed to 50 to 100 basis points of operating margin expansion and 100 to 150 basis points of adjusted cash flow margin expansion from fiscal 2022 through 2024.

There also could be a special catalyst on the horizon that could reward shareholders. Thanks to management’s push for profitability, Palo Alto Networks has delivered two consecutive quarters of GAAP (generally accepted accounting principles) profitability. If the next two quarters are also profitable, the company will meet all the requirements to be added to the S&P 500 index. We bring this up because a stock tends to jump when it gets included in the index due to the demand that is created by the mutual funds and exchange-traded funds (ETF) that are forced to buy the stock to keep their track to the index

To be clear, just because a company reports GAAP profits for four consecutive quarters it doesn’t guarantee a spot in the S&P 500. We would never recommend buying a stock solely on this basis. We buy stocks for fundamental reasons. However, the addition of Palo Alto to the index would be a nice bonus for shareholders based on the history of other stocks popping in reaction to the news.

We’re initiating our PANW position with a price target of $200 per share, about 15{b7c9e2c88beb1a84f22d94ab877a147f4adc4b3519717f3f957a0f34e16918d1} higher than current levels, representing roughly 49.5-times fiscal year 2024 earnings-per-share consensus estimates. The knock on PANW is obviously that it is an expensive stock on earnings. But if the company continues to handily beat expectations, then the stock will prove to be much a much better value than what it has appeared. Additionally, as the leader in cybersecurity, it’s consistent 20{b7c9e2c88beb1a84f22d94ab877a147f4adc4b3519717f3f957a0f34e16918d1} grow is more defensible than other areas of tech, which are experiencing problems from economic weakness.

(Jim Cramer’s Charitable Trust is long PAWN. See here for a full list of the stocks.)

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