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Palo Alto Networks Stock Upgraded: What You Need to Know

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Every day, Wall Street analysts upgrade some stocks, downgrade others, and "initiate coverage" on a few more. But do these analysts even know what they're talking about? Today, we're taking one high-profile Wall Street pick and putting it under the microscope...

In less than a week -- on Monday, Feb. 26, after market close -- Palo Alto Networks (NYSE: PANW) will report its fiscal Q2 2018 earnings for the quarter ended Jan. 31. Analysts are expecting good things, with consensus estimates on Yahoo! Finance predicting 24% growth in sales from fiscal Q2 2017 levels and 25% growth in earnings.

Analysts at Susquehanna Securities are pretty hopeful, too, and upgraded Palo Alto stock to "positive" this morning -- before earnings, but not because of earnings.

Here's what you need to know.

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Image source: Getty Images.

Upgrading Palo Alto stock

In line with other analysts' expectations, Susquehanna is expecting Palo Alto to produce "strong numbers" when it reports next Thursday, the bank explains in a note covered on (requires subscription) this morning. But that's not the reason that Susquehanna is upgrading the stock.

According to Susquehanna, growth rates are stabilizing for Palo Alto's Next Generation FireWall (NGFW) appliance, and "channel checks" look positive for the company's sales. Asking around, Susquehanna analysts have heard mostly "positive industry feedback" from Palo Alto's peers and customers, and believe the company is poised to outperform the market going forward.

Susquehanna posits a $195 price target on the stock, implying as much as 18% upside for new buyers today.

Valuing Palo Alto stock

Adding to the analyst's enthusiasm for Palo Alto Networks stock is the fact that, in Susquehanna's view, Palo Alto stock has reached a "relatively attractive valuation following a long period of underperformance."

Palo Alto stock, you see, has not been a stellar performer for investors lately. Despite rising about 5% over the past 12 months, the stock has lagged the broader S&P 500 by more than 10 percentage points. On the one hand, that's not too surprising. When calculated according to GAAP accounting standards, data from S&P Global Market Intelligence confirm that Palo Alto Networks has lost money consistently ever since 2012. Analysts surveyed by S&P Global further predict that Palo Alto will report GAAP losses this fiscal year, and next year, and the year after that, as well.

That being said, analysts expect the losses to dwindle. But even more important than the GAAP numbers is the fact that Palo Alto is already profitable where it counts: on the cash flow statement. That document shows Palo Alto generating positive cash profits as far back as 2011, and churning out more than $764 million in free cash flow over the past 12 months.

Weighed against the stock's $15 billion market capitalization and its $1 billion net cash position, I value Palo Alto at roughly 18.3 times its $14 billion enterprise value -- a bargain relative to analysts' projected 26% long-term growth rate.

What to expect next week

That's the long-term story. As for what to expect next week (which, again, Susquehanna isn't concerned with, because it thinks the long-term story looks so good), Palo Alto last guided investors to expect fiscal Q2 2018 sales of between $518 million and $528 million, and pro forma profits of $0.78 to $0.80 per share. Wall Street is looking for management to come close to maxing out both those ranges, so any shortfall could still be punished in the short term.

Medium term, Palo Alto guided to about $2.165 billion in sales for this full fiscal year and earnings of roughly $3.38 per share at the midpoint. If management reaffirms or raises those targets, Susquehanna's expected profit from Palo Alto Networks stock could come even earlier than predicted.

We'll find out which way the near-term winds are blowing next week. In the meantime, though, don't forget that the long-term story here still looks attractive: A price of 18 times free cash flow paired with a 26% long-term growth rate. So long as those numbers hold firm, Palo Alto Networks stock should look attractive.

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Rich Smith has no position in any of the stocks mentioned. The Motley Fool recommends Palo Alto Networks. The Motley Fool has a disclosure policy .

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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