Why did Zscaler stock drop 16% in April?

What happened

Shares of Z-scale (ZS -9.18%) fell 16% in April as the stock was another victim of the market correction. Rising interest rates and an economic slowdown are pushing investors to withdraw capital from riskier assets, and unprofitable growth stocks are feeling the pinch, even as companies continue to perform well.

So what

There was no major news on the cybersecurity stock last month, but shareholders were still criticized. Instead, a clear correlation is seen when Zscaler performance is compared to the Vanguard Growth ETF and industry peers such as Cloudy and Crowd.

ZS, VUG, CRWD, NET Total Yield Level Data by YCharts

Zscaler has become much cheaper relative to sales and earnings over time. The company reported net losses, which actually increased year over year last quarter, but its free cash flow is positive. This is important because it shows that Zscaler doesn’t need to spend money to achieve its phenomenal growth rate. It also makes it clear that the company’s management is willingly foregoing profits, instead prioritizing expansion through spending on hiring, marketing, and product development. This is exactly what usually excites growth investors.

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

Image source: Getty Images

Now what

Despite its downfall, Zscaler still isn’t cheap. Its price-to-sales ratio of 27.9 is nearly five times that of Alphabet, much more stable and still showing above-average growth. The stock’s forward P/E ratio is still close to 200. This is not the most meaningful metric, as Zscaler is clearly failing to maximize profits. This still shows that a lot of optimism is embedded in the stock despite its recent declines.

That’s not bad for a company that’s growing around 60%, but that kind of valuation still requires a leap of faith from investors. Fewer and fewer people are willing to take that kind of leap these days. Economic uncertainty causes investors to act with fear, and rising interest rates suddenly make lower-risk assets, like bonds, more attractive.

Zscaler is not the type of investment with a lot of momentum right now. He can clearly take a beating with no news to cause a fall. If the company announces poor results or a lackluster business outlook in its May 26 quarterly earnings call, it could get even uglier.

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

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