1 Cybersecurity Stock To Buy On The Dip?

Cybersecurity company SentinelOne (NYSE:S) has seen its stock drop by about 12% YTD, following a broader slump among cybersecurity companies.

This dip, contributed to by both high valuations and market disillusionment after Crowdstrike’s disastrous July outage, has wiped out value for some shareholders while potentially creating opportunities for others.

Will SentinelOne bounce back, and is the stock a buy after this year’s selloff?

Key Points

• SentinelOne stock is down 12% YTD due to high valuation metrics and market concerns.
• Q2 showed 33% revenue growth and improving margins, signaling progress toward profitability.
• Despite tough competition, analysts expect a 20% upside.

First, a Look at Valuation

Before examining SentinelOne’s future prospects, let’s get a sense of where the stock is now with regard to price. Shares of the company, currently priced at $24.15, trade at about 10.6x sales and 4.7x book value. For a high-growth tech company, these multiples are far from extreme.

The problem is that SentinelOne has yet to turn a profit and has posted significant losses throughout its entire public history. In the past 12 months alone, the company has lost about $281 million. The rate of loss has been remarkably steady, equally about $70 million each quarter.

While this shows that the company isn’t actively losing ground when it comes to profitability, the steady rate of losses does call into question whether SentinelOne is worth the high price the market still assigns to it.

How Is SentinelOne Performing?

Continued losses notwithstanding, a look at SentinelOne’s most recent earnings report does show significant fundamental improvements for the company.

Specifically, revenue in Q2 rose 33% year-over-year to $198.9 million. Annualized recurring revenue rose by a very similar 32% to $806 million, a substantial improvement on the current trailing 12-month revenue total of $723 million.

A major driver of this revenue gain was SentinelOne’s continued effort to acquire high-value customers. As of the end of Q2, the company had 1,233 customers contributing annualized revenues of $100,000 or more, a 24% gain from the year-ago quarter. This group of large customers accounts for a little over 15% of total ARR.

Though losses have continued at a consistent pace, they have gradually come to account for a smaller proportion of SentinelOne’s revenues.

Net margin at the end of 2023 was -54.7%. As of the end of Q2, that margin had narrowed to -38.9%. While still deeply negative, it’s clear that SentinelOne is making progress in trimming its losses as it scales its revenues up.

Here, it’s also worth noting the increasingly large gap between how quickly revenues and the cost of revenues are rising. For H1 of last year, SentinelOne generated revenues of $282.8 million at a cost of $87.3 million.

This year, the respective numbers are $385.3 million and $100.8 million. H1 revenues grew about 36%, while the cost of generating rose by just 15%. If this trend continues, SentinelOne can likely put itself on a trajectory for eventual GAAP profitability.

It’s also important to consider that high rates of revenue growth are expected to continue. The forward expected revenue growth rate for SentinelOne is 34.6%, a fact that could help the company make further progress in narrowing its losses.

Where Are the Downsides?

One major drawback for S shareholders at this point is the highly competitive nature of the cybersecurity industry today. Though market leader CrowdStrike is still reeling from the effects of its global outage in July, this doesn’t seem to have given SentinelOne much opportunity to pick up customers from the embattled major.

While SentinelOne is certainly achieving solid growth, the company doesn’t seem to have established a firm hold over the market in the way that CrowdStrike has.

SentinelOne also appears to have a bit of a stock-based compensation problem. For the first six months of this fiscal year, the company incurred stock-based compensation expenses of $123.2 million. Indeed, earnings per share were very slightly positive on an adjusted basis in Q2 after factoring this expense out.

Whereas SentinelOne lost $0.22 per share on a GAAP basis, about $0.20 of that loss was accounted for by stock-based compensation.

This habit of compensating employees with an overly generous number of shares has also had a strong diluting effect on the existing base of shareholders.

The number of shares outstanding at the end of Q2, for instance, was 6.8% higher than the number at the end of the year-ago quarter. The ongoing creation of additional shares is a major concern for investors, as SentinelOne could continue issuing new shares at a similar rate going forward.

Will SentinelOne Recover?

SentinelOne stock is expected to recover with the median target price standing at currently $29, roughly a 20% jump from the last closing price. More than two-thirds of analysts also rate the stock as a Buy, suggesting that institutional investors still maintain a favorable view of the company.

Indeed, a rebound already appears to be underway to some degree. Though down significantly in the year to date, S shares have risen by over 18% in the last three months.

Much of this gain likely comes from expectations of lower interest rates, which make growth stocks more attractive. The tailwinds from the generally positive Q2 report also appear to have played a role in helping the stock regain some momentum.

With all of this said, it’s still quite likely that SentinelOne is overvalued. The company’s valuation multiples are fairly high, and the ongoing issuance of new shares creates the possibility for additional dilution of the existing stock base.

Combined with the company’s lack of GAAP profitability and extremely narrow profitability on even a non-GAAP basis, it appears that SentinelOne is a stock that carries a fair number of unknowns at a rather high price tag.

As such, S may be unsuitable for more conservative investors or those who prefer a value investing approach. More risk-tolerant growth investors hoping to capitalize on the growing opportunities in cybersecurity, though, may still find SentinelOne appealing.

Cybersecurity as a global market is expected to grow to half a trillion dollars by 2030, potentially creating extremely long growth runways for the companies that emerge at the top of the market.