Fortinet (FTNT, Financial), a technology company that provides cybersecurity and networking solutions, has delivered a stellar performance for its shareholders so far in 2023, with gains of nearly 53% year-to-date, beating the Nasdaq composite's gains around 31%, as of this writing.
There's a lot to like about Fortinet, including the strong competitive advantages of the company and the robust profitability and growth. Unfortunately, this technology stock has one main risk for new investors, and that is its valuation. There is almost no margin of safety according to my estimates, which makes the risk of a possible correction in the second half of 2023 uncomfortably high.
Fortinet has several competitive advantages
Fortinet has several competitive advantages that have helped it establish a strong position in the market. Some of these advantages include high performance and scalability, advanced threat intelligence, a strong partner ecosystem, a continuous focus on innovation, a huge number of customers worldwide and a very high number of patents.
Fortinet had more than 660,000 customers worldwide and 1,285 global patents as of March 31, 2023. The company offers a comprehensive security fabric that integrates a wide range of security products and services. Its portfolio includes solutions for network security, endpoint security, cloud security, application security and more. This integrated approach allows for seamless coordination and communication between different security components, providing enhanced protection and visibility across the entire network.
Fortinet's security solutions are known for their high performance and scalability. It leverages custom hardware and purpose-built security processors to deliver fast and efficient security services without compromising network performance. This makes Fortinet particularly well-suited for organizations with high traffic volumes or complex network architectures.
The company has a dedicated threat intelligence team that constantly monitors the threat landscape and gathers real-time information about emerging threats and vulnerabilities. This intelligence is integrated into security solutions, enabling proactive threat detection and mitigation. Fortinet's extensive threat intelligence helps organizations stay ahead of evolving threats and provides it with actionable insights to strengthen its security posture.
Fortinet has built a strong partner ecosystem that includes value-added resellers, system integrators, managed security service providers and technology partners. This collaborative approach enables Fortinet to extend its reach, deliver integrated solutions and provide comprehensive support to customers worldwide. By leveraging its partner network, Fortinet can effectively deliver its security solutions and provide ongoing customer support.
Overall, Fortinet's competitive advantage lies in its comprehensive security fabric, high performance, advanced threat intelligence, breadth of solutions, strong partner ecosystem and focus on innovation. These factors have contributed to its success and position as a leading cybersecurity company in the market.
Fortinet has excellent profitability and growth
The fundamentals look very strong as Fortinet has a high GuruFocus profitability rank of 9 out of 10 and the highest possible growth rank 10 out of 10. The GF score of 93 out of 100 indicates the highest outperformance potential, based on a historical study by GuruFocus.
Fortinet has an operating margin that is expanding, as its five-year average operating margin growth rate is 21.40% per year. For the quarter that ended in March 2023, the company had an operating margin of 21.57%, a gross margin of 75.62% and a net margin of 19.62%.
Turning to growth, Fortinet performs very well, having a three-year revenue per share growth rate of 30.4% and a three-year EPS without NRI (non-recurring items) growth rate of 40.8%.
The company has a financial strength rank of 7 out of 10 and a debt-to-equity ratio of 86.92, which is considered too high. However, with a cash-debt ratio of 2.91 and an interest coverage ratio of 58.78, I see the high debt-to-equity ratio as not being of concern. The company has had a very strong and positive free cash flow trend in the past five years and a three-year free cash flow per share growth rate of 30.1%.
Fortinet's valuation is the problem
What I am mostly worried about with Fortinet is its valuation. With a GF Value of $75.43, the stock seems to be fairly valued. It has almost no margin of safety between its estimated intrinsic value and its stock price, and this creates a potential downside risk in my opinion as multiples could compress.
The stock trades at a price-earnings ratio of 61.69 with a forward price-earnings ratio of 51.74. I consider the price-to-free-cash-flow ratio of 32.63 to be quite expensive, and the price-book ratio of 3,732.5 is at an abnormally high level. Some may argue that growth stocks tend to trade at premiums because the expectations are high. I believe this is a mistake in investing as ignoring the valuation turns financial analysis into pure gambling. The odds of generating positive returns are not very high.
