Although Zscaler (currently trading at $184.03 per share) has gained 6.9% over the last six months, it has trailed the S&P 500’s 13.1% return during that period. This may have investors wondering how to approach the situation.
Given the relatively weaker price action, is now a good time to buy ZS? Find out in our full research report, it’s free.
Why Is ZS a Good Business?
Pioneering the "zero trust" approach that has fundamentally changed enterprise network security, Zscaler (NASDAQ: ZS) provides a cloud-based security platform that connects users, devices, and applications securely without traditional network-based security hardware.
1. ARR Surges as Recurring Revenue Flows In
While reported revenue for a software company can include low-margin items like implementation fees, annual recurring revenue (ARR) is a sum of the next 12 months of contracted revenue purely from software subscriptions, or the high-margin, predictable revenue streams that make SaaS businesses so valuable.
Zscaler’s ARR punched in at $3.53 billion in Q1, and over the last four quarters, its year-on-year growth averaged 24.4%. This performance was fantastic and shows that customers are willing to take multi-year bets on the company’s technology. Its growth also makes Zscaler a more predictable business, a tailwind for its valuation as investors typically prefer businesses with recurring revenue. 
2. Customer Acquisition Costs Are Recovered in Record Time
The customer acquisition cost (CAC) payback period represents the months required to recover the cost of acquiring a new customer. Essentially, it’s the break-even point for sales and marketing investments. A shorter CAC payback period is ideal, as it implies better returns on investment and business scalability.
Zscaler is quite efficient at acquiring new customers, and its CAC payback period checked in at 35.3 months this quarter. The company’s rapid recovery of its customer acquisition costs indicates it has a strong brand reputation, giving it more resources pursue new product initiatives while maintaining the flexibility to increase its sales and marketing investments. 
3. Excellent Free Cash Flow Margin Boosts Reinvestment Potential
Free cash flow isn’t a prominently featured metric in company financials and earnings releases, but we think it’s telling because it accounts for all operating and capital expenses, making it tough to manipulate. Cash is king.
Zscaler has shown robust cash profitability, driven by its attractive business model and cost-effective customer acquisition strategy that enable it to invest in new products and services rather than sales and marketing. The company’s free cash flow margin averaged 28.1% over the last year, quite impressive for a software business. The divergence from its underwhelming operating margin stems from the add-back of non-cash charges like depreciation and stock-based compensation. GAAP operating profit expenses these line items, but free cash flow does not.
Final Judgment
These are just a few reasons Zscaler is a rock-solid business worth owning. With its shares trailing the market in recent months, the stock trades at 7.9× forward price-to-sales (or $184.03 per share). Is now a good time to buy? See for yourself in our full research report, it’s free.
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