Zscaler's Margin Expansion and Peer Edge: A Cloud Security Leader's Valuation Play

Zscaler (ZS), a pioneer in cloud-native security, has positioned itself as a key beneficiary of the global shift to Zero Trust architectures and AI-driven cybersecurity. With revenue growth outpacing peers and margins holding up against industry-wide pressures, the company's valuation—though elevated—may still reflect a compelling opportunity for long-term investors. Here's why.

Revenue Growth: A Leader in a Booming Market

Zscaler's Q1 2025 results underscore its dominance in cloud security. Revenue surged 22.6% YoY to $678 million, driven by its Zero Trust Exchange platform, which handles over half a trillion daily transactions. The company's Annual Recurring Revenue (ARR) hit $2.9 billion, growing 23% YoY, with a clear path to surpass $3 billion by year-end. Regional performance was equally strong, particularly in APAC, where revenue rose 28.2% YoY, signaling expanding global reach.

The company's focus on AI is a key differentiator. Its ZDX CoPilot and LLM Proxy offerings, which secure AI models and workflows, generated $75 million in bookings in Q1—a 70% YoY jump. This product momentum aligns with rising demand for GenAI security modules, a trend likely to accelerate as enterprises adopt AI broadly.

Margin Pressures, but Strategic Investments Pay Off

While Zscaler's margins dipped slightly—gross margin fell 1.1 PP YoY to 80.3%, and operating margin dropped 0.4 PP to 21.6%—the declines stem from strategic R&D investments in AI and platform scalability. Compare this to peers like CrowdStrike (CRWD), which operates at a 75% gross margin, or Palo Alto Networks (PANW), which struggles with low teens revenue growth. Zscaler's margins remain healthier, and its Free Cash Flow (FCF) guidance for FY2025 (25.5%-26%) suggests a path to margin recovery as scale benefits kick in.

The CAC payback period, now at 29.4 months, is a concern, but Zscaler's customer retention (114% DBNR) and high-value deals—such as $10M+ ZPA contracts in automotive and finance—mitigate this risk. The company's Zero Trust Branch solution, which cut costs for enterprises deploying remote branches, also highlights operational efficiency gains.

Valuation: A Premium, but Justified?

Zscaler's Price-to-Sales (P/S) ratio of 13.88 is a stark contrast to the software industry median of 2.27, but it's not without rationale. The company's 3-year revenue CAGR of 49.6% and ARR-based guidance framework (introduced for FY2026) signal confidence in long-term growth. Meanwhile, peers like MongoDB (MDB) and SentinelOne (RNS) trade at lower multiples but lack Zscaler's cloud-native advantage and enterprise-scale traction.

While the P/S multiple is high, EV/Revenue metrics further contextualize the valuation. Zscaler's EV of ~$34 billion (assuming a $210 stock price and $3 billion in cash) versus FY2025 revenue of ~$2.66 billion yields an EV/Revenue of ~12.8x—still elevated but closer to its growth trajectory. For context, CrowdStrike trades at ~9.5x EV/Revenue, but its growth has slowed to ~20% YoY.

Peer Comparison: Outpacing the Competition

• Revenue Growth: Zscaler's 22.6% YoY growth vs. PANW's mid-teens growth and CRWD's ~20% growth highlights its edge in capturing the Zero Trust and AI security markets.
• Margin Resilience: Zscaler's 80%+ gross margin vs. Check Point's 72% reflects its cloud-native cost structure, which scales more efficiently than legacy vendors.
• Customer Metrics: Zscaler's $1M+ customer count (643) and Zero Trust Everywhere adoption (surging 60% QoQ) signal a customer base increasingly reliant on its platform.

Challenges Ahead

• Macro Risks: Enterprises are scrutinizing large deals, though Zscaler's unscheduled billings growth (+25% YoY) suggests demand remains robust.
• Dilution Concerns: Shares rose 2.3% YoY, but management has prioritized growth over buybacks, a trade-off investors must weigh.

Investment Takeaway

Zscaler's valuation is unquestionably rich, but its leadership in cloud security, AI innovation, and ARR growth trajectory justify the premium for long-term investors. While near-term margin pressures may weigh on short-term sentiment, the company's $5 billion ARR target by FY2026 and margin optimization roadmap suggest the stock could outperform peers over 3-5 years.

Hold or Buy: For investors with a multi-year horizon, Zscaler's P/S ratio may compress if growth slows, but its platform's defensibility in a $200 billion cybersecurity market makes it a buy at current levels. Short-term traders, however, should monitor FCF margin improvements and macro deal flow. Historically, a buy-and-hold strategy around earnings announcements—specifically purchasing shares on the earnings release date and holding for 30 days—delivered an 84.13% return from 2020 to 2025, underperforming the benchmark's 108.04% return. The strategy also faced significant volatility, with a maximum drawdown of -53.55%, underscoring the need for caution among short-term investors.

In a sector where margins matter, Zscaler's ability to scale its cloud-native model while expanding into AI security positions it as a standout play in a consolidating market.