Over the past six months, Zscaler has been a great trade, beating the S&P 500 by 22.7%. Its stock price has climbed to $291.35, representing a healthy 38.8% increase. This was partly thanks to its solid quarterly results, and the run-up might have investors contemplating their next move.

Following the strength, is ZS a buy right now? Or is the market overestimating its value? Find out in our full research report, it’s free.

Why Is ZS a Good Business?

Pioneering the "zero trust" approach that has fundamentally changed enterprise network security, Zscaler (NASDAQ: ZS) provides a cloud-based security platform that connects users, devices, and applications securely without traditional network-based security hardware.

1. ARR Surges as Recurring Revenue Flows In

While reported revenue for a software company can include low-margin items like implementation fees, annual recurring revenue (ARR) is a sum of the next 12 months of contracted revenue purely from software subscriptions, or the high-margin, predictable revenue streams that make SaaS businesses so valuable.

Zscaler’s ARR punched in at $3.02 billion in Q2, and over the last four quarters, its year-on-year growth averaged 22.6%. This performance was impressive and shows that customers are willing to take multi-year bets on the company’s technology. Its growth also makes Zscaler a more predictable business, a tailwind for its valuation as investors typically prefer businesses with recurring revenue.

2. Projected Revenue Growth Is Remarkable

Forecasted revenues by Wall Street analysts signal a company’s potential. Predictions may not always be accurate, but accelerating growth typically boosts valuation multiples and stock prices while slowing growth does the opposite, though some deceleration is natural as businesses become larger.

Over the next 12 months, sell-side analysts expect Zscaler’s revenue to rise by 22.6%. While this projection is below its 28.6% annualized growth rate for the past two years, it is healthy and implies the market is forecasting success for its products and services.

3. Excellent Free Cash Flow Margin Boosts Reinvestment Potential

If you’ve followed StockStory for a while, you know we emphasize free cash flow. Why, you ask? We believe that in the end, cash is king, and you can’t use accounting profits to pay the bills.

Zscaler has shown robust cash profitability, driven by its attractive business model and cost-effective customer acquisition strategy that enable it to invest in new products and services rather than sales and marketing. The company’s free cash flow margin averaged 27.2% over the last year, quite impressive for a software business. The divergence from its underwhelming operating margin stems from the add-back of non-cash charges like depreciation and stock-based compensation. GAAP operating profit expenses these line items, but free cash flow does not.

Final Judgment

These are just a few reasons Zscaler is a rock-solid business worth owning, and with its shares topping the market in recent months, the stock trades at 13.9× forward price-to-sales (or $291.35 per share). Is now a good time to initiate a position? See for yourself in our comprehensive research report, it’s free.

Stocks We Like Even More Than Zscaler

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