Why Did Zscaler Stock Crater 20%?

Zscaler stock (NASDAQ: ZS) has declined from around $212 at the beginning of the year to $162 now – a 24% fall over a period when the benchmark S&P index grew 16%. While the stock recovered in August, it nosedived 20% in a single day after the cloud security company published its 2024 preliminary results. In comparison, ZS’s peers Palo Alto Networks (NASDAQ: PANW), Check Point Software (NASDAQ: CHKP), and Fortinet (NASDAQ: FTNT) have all seen their stocks rise 20-30% so far this year and thus comfortably outperforming the market.

The current phase of negativity around the stock follows a period of sustained upward movement for Zscaler stock till February 2024. That said, the stock is trading nearly 45% higher than the levels witnessed at the beginning of 2023 despite the recent sell-off.

Has the bottom been reached?

Some of this rise since early 2023 is justified by the over 40% growth seen in Zscaler’s revenue in each of the years from 2016 to 2023, which, however, did not translate into profits, as the company remained in the red – even at the operating level. Hence, the optimistic valuation of the company was based on its sales and the outlook around growth in the cloud security market. At the price level prevailing at the end of 2023, Zscaler was trading at about 20.7x trailing revenue, which was pricey. The downward trend over the last six months has brought the price down to more sustainable levels. But the key question is, has the bottom been reached? We think not, as Trefis estimates Zscaler’s valuation to be around $155 per share, about 10% below its current market level.

ZS, in its recently published full-year sales for 2024, reported a continuity in its strong annual growth at ~30%. However, at the operating level (GAAP), the company remains in the red. Though, on a positive note, its loss has narrowed down considerably.

At what price level will ZS stock turn attractive?

Overall, the performance of ZS stock with respect to the index has been quite volatile. Returns for the stock were 6% in 2021, -47% in 2022, and 95% in 2023. In comparison, returns for the S&P 500 have been 27% in 2021, -19% in 2022, and 24% in 2023 – indicating that ZS underperformed the S&P in 2021 and 2022. In contrast, the Trefis High Quality (HQ) Portfolio, with a collection of 30 stocks, has outperformed the S&P 500 each year over the same period. 

Why is that? As a group, HQ Portfolio stocks provided better returns with less risk versus the benchmark index; less of a roller-coaster ride as evident in HQ Portfolio performance metrics. Given the current uncertain macroeconomic environment around rate cuts and tense geopolitical conditions, could ZS continue to face a similar situation as it did in 2021 and 2022 and underperform the S&P over the next 12 months – or will it see a strong jump?

Looking ahead, Zscaler expects its revenues to increase by 22%  in Q1 FY2025 . While this expected growth figure is below the levels seen over the years, it remains healthy – especially considering the base effect. In our view, the correction in the stock price this month can be attributed entirely to the revenue slowdown that the company expects. Hence, any improvement in actual growth would be a positive for the stock.

[1] Returns as of 9/5/2024
[2] Cumulative total returns since the end of 2016