Why has Zscaler climbed 61% in 2021?

What happened

Zscaler (NASDAQ: ZS) shares rose 60.9% last year on the strength of strong sales and the company’s cash flow. A higher valuation played a minor role, but fundamentals can explain almost any return.

So what

Zscaler provides cloud-based software that helps workers access and share data securely. Remote working has become a necessity during the global pandemic.

As many people return to the office, the distributed workforce has gained a permanent foothold and will become the norm for many businesses. This is creating a demand for cybersecurity companies, and there are a lot of opportunities to move forward.

Zscaler reported revenue growth of 56% for the fiscal year ended July 2021. This growth rate accelerated to 62% in its most recent quarter. Free cash flow almost tripled in fiscal 2021, reaching 14% of revenue for the full year. This trend also continued in the last quarter, with free cash flow nearly doubling to $ 83 million.

Image source: Getty Images.

Zscaler initially forecast revenue growth of 40% this year, but increased that forecast to 50% following a huge quarterly earnings report. The company is posting huge growth figures, beating analysts’ estimates quarter after quarter and revising its forecast upwards. It’s a recipe for returns for shareholders.

The story was complicated by market forces which changed during 2021. Growth stocks had an overall strong year, but there were some hiccups in the fourth quarter. The prospect of a Fed interest rate cut and interest rate hike weighed on high valuation stocks, and things got particularly tough for the “pandemic” stocks that allowed the home work, telehealth and other types of remote interaction. Zscaler is one of those high valued stocks that have been caught in volatility and are currently down around 30% from their 2021 high.

These market forces have kept Zscaler’s valuation ratios relatively under control. The stock’s price-to-sell ratio was 58 at the end of 2021, slightly higher than it was at the start of the year. It’s always a very expensive valuation, and the company is also trading at huge multiples of term earnings, cash flow, and book value.ZS PS Report Graph

ZS PS report data by YCharts.

Now what

Zscaler stock is still pretty speculative at its current valuation, so it’s good that investors didn’t get carried away last year. It’s healthier that stock returns have been driven by fundamentals and operational excellence.

This promising cybersecurity game is certainly more interesting now that it is 30% below recent highs. If you want to invest in Zscaler, be prepared to hold it for the long term.

There are clearly reasons to be excited about the business in the long run, but the stock is likely to face volatility along the way. Rate hikes aren’t ideal for expensive growth stocks, so don’t be shocked if Zscaler suffers big declines over the next couple of years.

This article represents the opinion of the author, who may disagree with the “official” recommendation position of a premium Motley Fool consulting service. We are motley! Challenging an investment thesis – even one of our own – helps us all to think critically about investing and make decisions that help us become smarter, happier, and richer.

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