Palo Alto Networks vs. Fortinet

Palo Alto Networks (NASDAQ: PANW) and Fortinet (NASDAQ: FTNT) are two of the largest cybersecurity companies in the world. Both originally developed next-gen firewalls (NGFWs), which upgraded traditional firewalls with more robust network filtering tools, and they subsequently expanded their ecosystems with additional security services.

Palo Alto Networks now operates three ecosystems: Strata for its NGFW and on-site networking tools, Prisma for its cloud-based services, and Cortex for its AI-driven threat detection tools. Fortinet provides a “Security Fabric” that bundles together its end-to-end security tools for on-premise, cloud-based, and Internet of Things (IoT) devices.

Three cybersecurity professionals working at a workstation.Three cybersecurity professionals working at a workstation.

Image source: Getty Images.

But over the past 12 months, Palo Alto Networks’ stock has rallied about 40% while Fortinet’s stock fell more than 10%. Will that trend continue for the foreseeable future?

The differences between Palo Alto and Fortinet

Palo Alto Networks and Fortinet might initially seem similar, but their business models are different. Palo Alto Networks doesn’t produce its own chips, but Fortinet develops its own application-specific integrated circuit (ASIC) chips that are optimized for its own hardware and software. It claims its chips give it an edge against companies that use off-the-shelf chips.

In all, Palo Alto serves over 80,000 enterprise customers worldwide, while Fortinet serves more than 755,000 customers. However, Palo Alto generates higher annual revenues than Fortinet because it mainly serves larger companies.

Palo Alto Networks consistently relies on the growth of Prisma and Cortex, which it collectively calls its next-gen security (NGS) services, to offset Strata’s slower growth. Fortinet’s growth is more balanced across its secure ops, secure access service edge (SASE), and secure networking solutions services, and it expects the long-term convergence of the cybersecurity, networking, and hybrid cloud markets to drive its growth and tether more companies to its Security Fabric.

Both companies face similar headwinds

Big cybersecurity companies are usually resistant to the macro headwinds because their customers won’t shut off their digital defenses to save a few dollars. But it can still be tough to gain new customers, sign long-term contracts, and raise subscription fees. That’s why Palo Alto and Fortinet struggled with slower growth over the past year.

Palo Alto Networks’ revenue rose 25% in fiscal 2023 (which ended last July), but it only expects 16% growth in fiscal 2024. To cope with that slowdown, it’s consolidating its customers onto a unified platform to curb their dependence on smaller cybersecurity companies for specific services. But that strategy isn’t moving the needle because it’s being driven by free trials and deferred revenue deals.

The company’s adjusted earnings per share (EPS) rose 76% in fiscal 2023, but it only expects 25%-26% growth in fiscal 2024.

Fortinet’s revenue increased 20% in 2023, but it expects just 8%-10% growth in 2024. It mainly blamed that slowdown on the macro headwinds and a cyclical slowdown in its firewall sales, but it could be struggling to keep pace with Palo Alto Networks, the cloud-native leader CrowdStrike, and other major competitors.

Fortinet’s abrupt slowdown is worrisome, because its management previously claimed it could generate $8 billion in revenue by 2025. But to hit that milestone now, the company would need to grow its top line at a compound annual rate of 23% from 2023 to 2025. Fortinet’s adjusted EPS rose 37% in 2023, but it expects just 6%-10% growth in 2024 as it ramps up its spending on its development of new ASIC chips.

Palo Alto Networks trades at 48 times forward earnings, while Fortinet has a lower forward multiple of 34. However, I believe Palo Alto’s stock deserves its higher valuation because it’s growing faster and has a more broadly diversified business.

The better buy: Palo Alto Networks

Palo Alto Networks and Fortinet are both promising plays on the the growing cybersecurity market. However, it doesn’t make sense to buy Fortinet when Palo Alto Networks offers superior growth rates at a slightly higher valuation. So for now, I believe Palo Alto Networks will continue to outperform Fortinet unless its loss-leading platformization strategy flops over the next few quarters.

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Leo Sun has positions in CrowdStrike and Palo Alto Networks. The Motley Fool has positions in and recommends CrowdStrike, Fortinet, and Palo Alto Networks. The Motley Fool has a disclosure policy.

Better Cybersecurity Stock: Palo Alto Networks vs. Fortinet was originally published by The Motley Fool

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