Zscaler: A Heavily Downgraded Stock With Big Upside Potential

Key Points

• Zscaler had a robust quarter and guided for another year of double-digit growth; the price dip is an opportunity. 
• EPS guidance is below consensus due to increased tax expectations but likely cautious; investors should expect outperformance. 
• Analysts are lowering their price targets but remain firm in their conviction this is a consensus Moderate Buy stock with double-digit upside potential. 

Zscaler’s NASDAQ: ZS 2025 guidance disappointed the market and sparked a heavy round of analyst revisions. The bulk of revisions are negative and put the stock on MarketBeat’s list of Most Downgraded names, not a typical position for stocks that are good buys. However, downgrades are relative to where the sentiment was pegged at the start of the cycle and where it ends at the end, which, in this case, is good on both counts. 

The takeaway is that analysts' sentiment is weighing on the share price today, but the sell-off is overblown, and a robust upside lies ahead for this cyber security stock. It may take some time for the market to recover, but a move back above $200 is likely before the end of the fiscal year, a 35% gain for patient investors, and the downside risk is limited. 

MarketBeat.com tracked 20 analyst revisions within the first 24 hours of the release, showing a high conviction in their sentiment. Although 15 or 75% of the targets were reduced, including a new low target, the new low assumes some upside from the critical support levels, and the consensus is a double-digit gain. The critical details are that only a single downgrade was issued to Neutral from Buy, and the consensus remains a Moderate Buy with the potential for a 35% upside at the consensus. 

Zscaler Falls on Tepid, Cautious Guidance; Investors Should Expect Outperformance

Zscaler had a solid quarter in Q3, with revenue rising by 30.3% to $592 million and outpacing the consensus estimate by 440 basis points. The strength was driven by increased adoption of its zero-trust framework and increasing transaction volume across its network. Billings, an indicator of future business, is slowing but still strong at 27%, suggesting another year of double-digit growth.

As strong as revenue growth is, margin improvement is better. The company halved its GAAP operating loss on revenue leverage and cost control, driving a 40% increase in adjusted net income and a 34% increase in earnings per share. Earnings per share outpaced top-line growth and the consensus estimate, surpassed by 2600 basis points or 26% more than expected. 

Guidance is a mixed bag, with revenue forecasts well above the consensus and earnings well below. The critical detail is that the company changed its assumed tax rate to 23% because of its growth and outlook, deeply impacting the expected result. Even so, higher taxes are a good problem because the business is growing and expecting to grow long-term. The forecast for 2025 is for 20% in Q1 and for that pace to be sustained sequentially through year’s end. Investors can expect the company to outpace its consensus because of the trend; it beat guidance and consensus 100% of the time for the last two years.  

Deeply Undervalued, Zscaler Profits and Builds Value for Investors

Zscaler’s profit guide is below forecast but sufficient to sustain the balance sheet and build shareholder value. Cash flow in fiscal 2024 allowed for a 12% cash build, a 17% increase in current assets, and a 30% increase in total assets that more than offset the increased liability. The net result is a 75% increase in shareholder equity, a trend expected to continue in 2025. 

Following the release, the price action in Zscaler is under pressure, but the initial decline was halted at a critical support level, which is still providing support. This level is near $155 and has provided solid support several times, so it is not expected to break now. The risk is that it will break now and open the door to a much larger decline. However, a move lower will deepen the value and likely result in the expected rebound, only starting from a lower price point.