Palo Alto Networks (NASDAQ: PANW) has a ton going for it right now. It enacted a 2-for-1 stock split in December and recently notched a new all-time high after reporting strong Q2 FY 2025 (ending Jan. 31) results.
The stock has looked borderline unstoppable over the past year, and if management's projections hold true, this might continue throughout 2025. However, there's a bit of a premium on the stock, so is it a price worth paying?
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One division in Palo Alto is displaying phenomenal growth
Palo Alto Networks is a cybersecurity company that can best be thought of as two businesses.
Its next-generation business is an incredibly popular option. This artificial intelligence (AI)-powered cybersecurity platform has multiple products and can be used to protect network endpoints and cloud data, and hunt for threats. It is Palo Alto's biggest growth case, but it competes with another worthy cybersecurity competitor: CrowdStrike.
These two are competing in essentially the same market: a companywide cybersecurity platform that easily scales, no matter how many devices are on the network. Furthermore, both companies are trying to consolidate many cybersecurity functions into one platform, a trend Palo Alto calls "platformization."
The growth and potential for this division is so strong that Palo Alto chooses to split it out from its overall results. In Q2, Next-Generation's annual recurring revenue (ARR) rose 37% year over year to $4.8 billion. While we don't have CrowdStrike's Q4 FY 2025 results (which encompass the same quarter as Palo Alto's Q2), CrowdStrike's ARR was $4 billion in Q3, rising 27% year over year. So, it's clear that Palo Alto's comparative business is growing faster and is larger than that of a key competitor, which shows how strong this business segment is for Palo Alto.
Its legacy business, which mostly includes firewalls, isn't doing nearly as well. These customers aren't displaying a ton of growth, which is why Palo Alto's overall revenue only rose 14% year over year to $2.3 billion. However, this mature business unit is likely a substantial driver of profits, boosting Palo Alto's profitability.
PANW Operating Margin (TTM) data by YCharts
This is just the beginning of Palo Alto's margins rising, as many software companies can achieve 30% operating margins when optimized for profitability. However, there is still a massive cybersecurity market for Palo Alto to capture, so prioritizing market share first is smart. But it's something investors must consider before analyzing the stock's valuation.
The stock carries a premium price tag
Because Palo Alto is profitable, many investors will automatically value the stock using its price-to-earnings (P/E) ratio. While I agree that's a smart thing to do, the margin caveat I discussed is also something that investors must weigh.
Right now, Palo Alto's stock trades for 64 times forward earnings, which is a very expensive price tag.
PANW PE Ratio (Forward) data by YCharts
However, Palo Alto still has plenty of room to grow its margins, so investors shouldn't get too wrapped up with this price tag.
If we take a look at Palo Alto's price-to-sales (P/S) ratio, it trades at 17 times sales, which still isn't all that cheap for a software company. For reference, a fully mature software company like Adobe trades for 9.6 times sales.
However, Adobe isn't all that far off from Palo Alto's overall growth rate, especially when management is guiding for 14% revenue growth for FY 2025.
PANW Operating Revenue (Quarterly YoY Growth) data by YCharts
Is Palo Alto worth it?
So, does Palo Alto deserve this premium? I'd say it does, but it's certainly nearing the peak of how much premium should be assigned to the stock. There's a lot of growth baked into Palo Alto's stock price, and investors need to be aware of that before taking a position. But if it can massively grow its margins and continue growing its next-gen cybersecurity business, Palo Alto's stock could be a good one to own moving forward.
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Keithen Drury has positions in Adobe and CrowdStrike. The Motley Fool has positions in and recommends Adobe and CrowdStrike. The Motley Fool recommends Palo Alto Networks. The Motley Fool has a disclosure policy.
The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.
