Why Did Zscaler Stock Drop 16% in April?

The cybersecurity stock was another victim of the growth stock sell-off.

The cybersecurity stock was another victim of the growth stock sell-off.

What happened

Shares of Zscaler (ZS -9.18%) declined 16% in April, as the stock was another victim of the market correction. Rising interest rates and an economic slowdown are causing investors to pull capital from riskier assets, and unprofitable growth stocks are feeling that pinch — even if the businesses continue to perform well.

So what

There wasn’t any major news about the cybersecurity stock last month, but shareholders still got slammed. Instead, a clear correlation is visible when Zscaler’s performance is compared to the Vanguard Growth ETF and industry peers such as Cloudflare and Crowdstrike.

VUG Total Return Level Chart

ZS, VUG, CRWD, NET Total Return Level data by YCharts

Zscaler got much cheaper relative to sales and forward earnings. The company reported net losses, which actually grew year over year last quarter, however it’s free cash flow positive. That’s important because it shows that Zscaler doesn’t have to burn cash to achieve its phenomenal growth rate. It also clearly shows that the company’s management is willingly passing up profits, instead prioritizing expansion through spending on hires, marketing, and product development. That’s exactly what usually excites growth investors.

Hooded hacker at a keyboard with a shaded face sitting in front of a map of the world.

Image source: Getty Images

Now what

Despite falling, Zscaler still isn’t cheap. Its 27.9 price-to-sales ratio is almost five times higher than that of Alphabet, which is much more stable and still delivering above-average growth. The stock’s forward P/E ratio is still nearly 200. That’s not the most meaningful metric, because Zscaler clearly doesn’t manage to maximize profits. It still shows that plenty of optimism is priced into the stock despite its recent declines.

That’s not bad for a company that’s growing around 60%, but that sort of valuation still requires a leap of faith from investors. Fewer people are willing to take that sort of leap these days. Economic uncertainty has investors acting fearfully, and higher interest rates are suddenly making lower-risk assets, such as bonds, more attractive.

Zscaler isn’t the type of investment with a lot of momentum right now. It can clearly take a beating without any news to prompt a drop. If the company reports bad results or an uninspiring business outlook on its May 26 quarterly earnings call, it could get even uglier.

None of this really dictates long-term performance, so investors who are bullish about Zscaler’s prospects should be excited about the stock’s swoon. The company is a leader in a high-growth industry with sustainable catalysts for years to come. However, shareholders are likely to experience more volatility over the next few quarters.

Read this article on Motley Fool

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