Palo Alto Networks May Need a Breather Before Its Next Rally

Cybersecurity has been important for years, but its significance is about to expand thanks to artificial intelligence. Every AI model, chatbot, and physical AI requires digital safeguards to deter hackers. Furthermore, hackers are using AI to penetrate more systems, creating the need for larger cybersecurity budgets.

This core thesis is part of the reason why Palo Alto Networks (NASDAQ: PANW) has surged by almost 80% year-to-date. While the pieces are coming together for sustained revenue growth, the current rally may be a bit overdone.

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Investors can already see the impact of AI

Palo Alto Networks' fiscal 2026 third-quarter results pointed to meaningful revenue acceleration. Total sales increased by 31% year over year, compared to a 15% year-over-year increase in the previous quarter.

Recent acquisitions of CyberArk and Chronosphere contributed to elevated growth rates, but Palo Alto Networks' underlying business still exhibited more growth than usual. Its annual recurring revenue (ARR) from next-generation security was up by 60% year over year. The total ARR reached $8.1 billion, with $1.6 billion of that coming from the acquisitions.

Guidance implied $3.35 billion in fiscal 2026 Q4 revenue, which would be an 11.7% sequential growth rate. Year-over-year growth rates are more attractive, but sequential growth rates factor in the recent acquisitions. Palo Alto Networks also expects to close out the year with up to $8.95 billion in ARR from next-generation security solutions, guidance that offers meaningful revenue visibility.

The valuation is hard to justify

Palo Alto Networks has flipped the switch and is firmly back to being a growth stock. The period of gradually decelerating revenue growth rates appears to be over, but a high valuation still looms over the company.

Every key valuation metric you can consider leaves a bit to be desired. A P/E ratio just above 300 leaves very little room for error, and a PEG ratio that's approaching 6 also indicates the stock is overvalued. The company's price-to-sales ratio has almost doubled over the past few months and currently sits at 24 times sales.

Artificial intelligence is a multiyear tailwind that should propel Palo Alto Networks' revenue and profits. However, a lot of that success has already been priced into the stock at current levels. The cybersecurity stock recently endured a 10% dip, so more investors are noticing the high valuation.

Still, the stock is worth monitoring. Dips are valuable buying opportunities for patient investors. It's hard to question Palo Alto Networks' fundamental growth and its positioning amid a big tailwind, but the valuation needs some work.

Marc Guberti has no position in any of the stocks mentioned. The Motley Fool recommends Palo Alto Networks. The Motley Fool has a disclosure policy.