Is This High Growth Stock Breaking Out?
Billionaire Stan Druckenmiller was once asked how he thinks about performance and his answer was quite insightful. Most traders might say something like “I aim to make 15% a year” or some other specific figure, but Stan’s answer was I like to “compare myself to the opportunity set” and beat it, meaning whatever the market is doing he likes to ensure he’s generating higher returns, or alpha.
Against that backdrop, the performance of Zscaler (NASDAQ:ZS) this year has been downright dreadful. The share price has been flat on the year while the market is up an astonishing 28% year-to-date. Or in other words, Zscaler has underperformed the market by that amount and then some, given that it’s marginally under water for the year.
That may all be about to change, however, as a technical chart reveals Zscaler right on the cusp of a potential breakout.
Key Points
- Zscaler’s stock, flat this year against a 28% market gain, is approaching a key $212 resistance level, signaling a possible breakout.
- Recent earnings beat estimates, with 26.4% YoY revenue growth and a 20.8% annual growth forecast.
- With $2.6 billion in liquidity, no debt, and narrowing losses, Zscaler is in a good place to achieve profitability soon.
Is Zscaler Breaking Out Now?
Looking back over the past few years, Zscaler has continually fallen short of a key downtrending resistance line.
Going back all the way to 2021, a cup-and-handle patterns has formed on two occasions. The first took place between 2021 and early 2024, and the second a smaller cup formed during the remainder of the year.
What’s interesting now is that the share price sits right at the key threshold resistance line at $212 per share. A break above that level would trigger a buy signal and perhaps lead to a supercharged rally given that the resistance has held firm for so many years.
What Could Spark a Rally?
ZS earnings were just released and the market greeted the results with disdain, driving the share price lower. But not for long, and that’s where Zscaler becomes interesting as an opportunity because it mirrors the behavior of Datadog post-earnings.
Like Zscaler, Datadog share price was driven substantially lower after management reporting quarterly results but it didn’t last long and soon afterwards the stock went on a monstrous rally as you can see below.
If Zscaler is to rally similarly, something needs to spark it and that might just be in the numbers reported, which were in fact better than forecast. Earnings surprised to the upside with a $0.77 figure versus $0.62 estimated, a 22.75% beat.
So too did revenues come in higher than expected with $627 million versus $605 million estimated, a 3.71% beat. Those figures mirror the upside surprise seen in Datadog too, which beat on the top line by 3.7% and on the bottom line by 15.4%.
When the market figures out that Zscaler is eclipsing expectations perhaps it’s got the fuel to leap higher too but is there anything else under the hood that might spark a rally?
How High Will Zscaler Stock Go?
The highest analyst estimate for how high Zscaler stock will go is $270 per share but the consensus is closer to $224.69, suggesting modest upside of 4%.
While the fundamentals peg fair value slightly higher, the current market conditions are unquestionably bullish with momentum driving some stocks way higher than fair value. A good example of that now is Palantir which is trading close to $80 per share while fair value sits much closer to $39 per share.
In a bullish environment where sentiment is very positive, the odds of a stock rallying beyond fair value is higher than normal. And speaking of sentiment, that is definitely taking a turn for the better with 19 analysts of the 41 who cover the stock upgrading their estimates for the upcoming quarter. That’s hardly a surprise given that the top line is set to grow at an astonishing 20.8% annually over the next five years.
Another strong tailwind in favor of Zscaler is an unbroken streak of 12 quarters in a row of rising year-over-year revenue gains. In fact the most recent quarter’s 26.4% uptick represented the lowest over the past 3 years. Heck for fun we went back 5 years and in every quarter of the past 20, the top line climbed on a YoY basis.
All that good news on the P&L has translated to the balance sheet that now sits with $1.5 billion in cash reserves and $1.1 billion in short-term investments, or in other words about $2.6 billion in liquidity. Better yet, there’s no long-term debt offsetting the fortress asset side of the balance sheet.
Trading at a market cap of $31 billion, Zscaler isn’t cheap on a revenue multiple basis given that $2.29 billion of sales were generated and profitability remains aloof.
But there are signs that the tides may be turning there in favor of shareholders given that net income was -$100 million in each of Q1 and Q2 2022 but has slimmed to just -$12 million last quarter. With revenues forecasted to grow substantially in the coming years, it seems only a matter of time before the bottom line goes into the black and the market starts to react more positively.
Is Zscaler a Buy Now?
For technical traders, this is a precarious time when the price is flirting with resistance but has not yet breached it. Until that happens, the risk of a pullback is high and so the threat of buying the near-term “top” is very real. But for those with an eye on the fundamentals and who can see that the bottom line is likely to turn positive in coming quarters and remain so, arguably there isn’t a better time to buy than now before the market has priced in all the good news that’s on the medium-term horizon.
And if you’re wondering why we can be confident in predicting that when net income goes positive in the next year it’s likely to remain so for most quarters going forward it’s largely due to the extremely high gross margin of 77.5% that has historically not deviated far from that threshold. In other words, revenue gains will quickly accrue to the bottom line and in a substantial way given how high the gross margins are.
