Author: Julian Lin

After cybersecurity peer Zscaler (ZS) preannounced strong financial results, cybersecurity stocks have rallied hard in just a matter of weeks. SentinelOne (NYSE:S), however, has seen only a modest bump. S remains unprofitable on a non-GAAP basis, but the stock trades at a large discount to cybersecurity peers on a growth-adjusted basis. The company has more than enough net cash to fund its path to profitability, which management reiterated as being in two years. Wall Street remains enamored by endpoint competitor CrowdStrike (CRWD) but is overlooking the equally disruptive positioning of S, likely due to the different cash flow profiles. I continue to view S as one of my top picks in the portfolio.

S Stock Price

Unlike many other tech stocks, S remains close to lows.

This is largely due to the fact that the broader tech rally was triggered mainly due to many tech companies projecting transitions to either GAAP or non-GAAP profitability. S is “only” projecting 2,500 bps of margin expansion, but because it remains unprofitable on a non-GAAP basis, the stock continues to trade at arguably conservative multiples relative to its revenue growth rate.

S Stock Key Metrics

In its most recent quarter, S delivered 92% YOY revenue growth – making it one of the fastest growing names in the tech sector.

For the year, S delivered 106% YOY revenue growth, an incredible feat considering that it had also delivered triple-digit growth in the two years prior.

S has been rapidly improving its operating margins as it is allowing operating leverage to take hold. Non-GAAP operating margins improved by 31% in the quarter.

This past year marked the second year in which the company has been able to improve non-GAAP margins by over 20%. S has increased non-GAAP operating margins by 25% for 6 straight quarters.

S maintained a strong 130% net retention rate in the quarter. I note that due to its smaller product portfolio, S may see more pressure on this metric than that of larger peer CRWD (this is one of the advantages that CRWD has over this smaller rival).

S ended the quarter with $1.2 billion of net cash (26% of the current market cap), which would be enough to fund over 6 years of FY24 run-rate cash flow losses (I have not given any credit to higher interest income).

Looking forward, management has guided for the first quarter to see 75% YOY revenue growth and for the full-year to see 51% revenue growth. Non-GAAP operating margins are expected to improve by as much as 24%. Management noted that the guidance should be viewed as being conservative because they are assuming that macro-related uncertainties to persist for the full year.

On the conference call, management credited their success to their MSSP partners, noting that “businesses are increasingly turning to managed security protection.” Recall that S’s MSSP partnerships make it an appealing option for smaller and medium sized businesses. In the quarter, S also announced a new partnership with Wiz – the leader in cloud security posture management (‘CSPM’). This partnership combines leaders in both CSPM as well as endpoint security, creating an “end-to-end cloud security” offering that should help maintain/accelerate growth for both these firms.

S is interestingly one of the few tech companies not conducting mass layoffs. While management reiterated expectations for non-GAAP profitability in FY25, they also defended their decision to avoid layoffs, stating that they pride themselves in having stronger employee retention than industry average. Management stated the following:

We don’t intend to sacrifice growth or market share. Our investment approach will remain highly selective and focused on key areas of competitive strength. We will remain dynamic and are committed to delivering on our margin improvement regardless of how the broader macro environment unfolds.

Many tech firms have taken advantage of the operating environment to aggressively reduce their long-term cost structures and stand to benefit upon improved economic conditions. S appears to have taken a different approach, instead choosing to continue investing aggressively to capture market share. As a long-term investor, I prefer the latter approach given the large market opportunity, but the former approach may help to drive continued strong returns for another top holding in Meta Platforms (META).

S saw gross margins increase 2 percentage points sequentially to 73.5% in the quarter, and management expects continued improvements as revenue grows and they realize the benefits of increased scale.

Is S Stock A Buy, Sell, or Hold?

As of recent prices, S was trading at just 9.4x forward sales. In contrast, CRWD was recently trading at around 12x sales in spite of having half the growth rate.

Assuming 20% long term net margins, 25% growth, and a 1.5x price to earnings growth ratio (‘PEG ratio’), I could see fair value hovering around 7.5x sales. That would make S a double over the coming years, and I suspect my 25% exit growth rate and 1.5x PEG ratio assumptions to prove too conservative.

Many investors may be thinking that S is a risky stock due to competition from mega-cap tech titan Microsoft (MSFT). Yet as I have stated in other reports, SentinelOne’s main competition comes from legacy vendors like McAfee and Symantec (AVGO). S notes that its ASPs remain stable and it continues to win “in a significant majority of competitive situations.”

Specifically as it relates to MSFT, management noted that they are seeing “more displacements of Microsoft.” Management stated the following:

Let me share an example of a large financial institution that moved away from Microsoft to SentinelOne, a solid platform win where we help the customer consolidate point solutions across endpoint cloud and many other adjacent modules. After an unpleasant experience with technological limitations and high total cost of ownership, the customer realized the huge difference between expectations and outcomes. After years of security gaps and difficult operability, the customer replaced Microsoft with SentinelOne. We were able to deliver broader coverage from a single platform. We see this time and time again.

I have noticed this discrepancy between public perception and reality of Microsoft’s dominance elsewhere in video conferencing as Microsoft Teams proved woefully insufficient relative to Zoom Video (ZM). It appears that MSFT’s dominance is also overstated in cybersecurity – while many investors seem to think that it is simply a matter of money, they are underestimating the difficulty of such an endeavor as well as the fact that MSFT might not be so willing to prioritize innovation over profit margins.

The greatest risk to S stock at this point is that of management execution. It is possible that the path to profitability takes longer than expected – the main catalyst for S to narrow its discount with cybersecurity peers remains improving its profit margins. S does have plenty of net cash to allow for delays in this path, but the stock may prove volatile if consensus estimates for revenue growth prove too optimistic. I continue to view S as one of my top picks in the market today, as it is offering unusually high secular growth at more than reasonable valuations. I reiterate my strong buy rating for the stock.