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How Risky Is Palo Alto Networks Inc.?

Based on analysts' price targets and investors' reaction after Palo Alto Networks (NYSE: PANW) announced fiscal third-quarter earnings on May 31, there appears to be little in the way of risk for shareholders now. The stock price is up 12% since the Q3 release,  and had climbed even higher before easing back ever so slightly. Analysts' consensus estimates as complied by Nasdaq suggest Palo Alto shares will reach  $156 in the next 12 months.

Based on Monday's closing price of $133, that means expectations are for 17% appreciation, and many analysts have actually revised their target prices downward the past few months. The general good tidings indicate a reasonable amount of risk associated with Palo Alto. But that itself represents one of the risks with Palo Alto: Is the bullishness warranted?

Image source: Palo Alto Networks.

The bullish side of things

There were a couple of reasons Palo Alto's Q3 numbers propelled a share price jump. Revenue  rose 25% to $431.8 million, handily beating industry estimates and Palo Alto's own guidance. Earnings per share excluding one-time items also rose higher than expected, soaring 33% to $0.61 a share compared to last year's $0.46 a share.

Analysts had  forecast just $412.1 million in sales -- which would have equaled a 19% year-over-year improvement -- and an adjusted earnings of $0.55 a share. But the good news didn't stop there, at least in the minds of pundits and many investors. Palo Alto also raised revenue guidance for the current quarter above consensus estimates to a range of $481 million to $491 million.

The high-end of Palo Alto's expectations this quarter would be a 23% gain year-over-year and better the $485.2 million expectations, as would its EPS guidance of $0.78 to $0.80. The Street was targeting EPS of $0.74 a share.

The not-so-bullish

While there were reasons for some optimism following last quarter, the immediate run-up demonstrates one of the biggest risks Palo Alto shareholders endure: wild price swings. For investors without an iron constitution, owning Palo Alto stock may lead to tossing and turning at night. For some perspective, after a "disappointing" fiscal second quarter, Palo Alto shares nosedived 20%.

There's also the matter of the company not really delivering on its restructuring initiative, at least not to any great extent. If the "execution  challenges" that hindered Palo Alto's results a quarter ago have anything to do with becoming more efficient, there's still a long road ahead.

A silver lining to Palo Alto's rampant spending is the rate at which it increased was slightly lower in Q3 than in past reporting periods, but the checkbook remains wide open. Operating expenses jumped nearly 20% to $357.2 million, 64% of which -- more than half of total revenue -- went to the sales and marketing departments.

Palo Alto peer FireEye (NASDAQ: FEYE) was also hindered by a spending problem that was eating away at bottom-line results, until it vowed to improve efficiency -- and its efforts are working. FireEye shaved 29% off its operating expenses last quarter, including 28% from sales-related costs, proving this can be done if executed properly.

How risky is Palo Alto?

As it stands, Palo Alto remains a long way from breaking even, let alone becoming profitable, which means investors can expect more of the aforementioned share price rollercoaster rides. Why? Because today, Palo Alto is running on fumes from its quarterly results and beating expectations, along with demonstrating a few, minor signs of improvement.

FireEye shareholders are enjoying a 29% run-up year-to-date not strictly because its beating expectations or based on the general bullishness of the Street, but because it's delivering on its business initiatives. Palo Alto, on the other hand, has yet to make significant enough strides to warrant all the share price optimism, so it's too risky for all but the most risk tolerant.

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Tim Brugger has no position in any stocks mentioned. The Motley Fool recommends FireEye and Palo Alto Networks. The Motley Fool has a disclosure policy.