Benjamin Graham's Framework on Zscaler, Inc. (ZS)

39% above fair value with -0.11% earnings yield - operational excellence cannot cure valuation excess.

cautiousBearishconviction

This framework sees a company burning capital at current prices with no margin of safety despite operational excellence.

THE LENSES

THE MARGIN OF SAFETYdangerous

Does the price protect me from permanent loss of capital?

•Price of $138.56 sits 39% above DCF fair value of $99.72

•EV/EBITDA at 1124.87x in the 75th percentile over 10 years

•P/E ratio of -232.7x with negative earnings yield of -0.11%

•Market implies 4.41% perpetual growth vs 23.9% trailing growth

This framework finds no margin of safety at current prices. The 39% premium to intrinsic value combined with negative earnings creates substantial downside risk. Even accepting the growth narrative, paying $138.56 for $99.72 of value violates Graham's cardinal rule.

P/E Ratio

EARNINGS YIELD VS BONDSunacceptable

Does equity risk offer adequate compensation over bonds?

•Earnings yield at -0.11% vs treasury yield of 4.33%

•Negative spread of -4.44% between earnings and risk-free rate

•Revenue growing 26% YoY but net income remains negative at -$34.3M

•100% earnings beat rate over 32 quarters with average reaction of only 0.52%

Applying this lens reveals extreme inadequacy - investors accept negative returns while treasuries pay 4.33%. The 26% revenue growth cannot justify a -4.44% yield disadvantage when the company remains unprofitable after reaching $2.67B scale.

Earnings Yield

THE EARNINGS RECORDspeculative

Has the company demonstrated consistent profitability over 7-10 years?

•Net income negative in 15 of 20 quarters examined

•Brief profitability in Q2'24 ($19.1M) followed by return to losses

•Operating margin at -6.3% despite gross margin of 76.6%

•Revenue grew from under $1B to $2.67B while losses persisted

This framework requires demonstrated earnings over 7-10 years - Zscaler shows demonstrated losses. The brief Q2'24 profitability appears anomalous rather than sustainable. Graham would classify this as speculative, not investment grade.

Net Income

BALANCE SHEET FORTRESSadequate

Can the balance sheet withstand prolonged adversity?

•Cash position of $1.2 billion with minimal debt

•Current ratio and interest coverage metrics unavailable in data

•Free cash flow positive with 20.7% FCF margin in Q1'26

•R&D spending at 112% of operating cash flow indicating heavy reinvestment

The $1.2 billion cash position and positive free cash flow provide a reasonable fortress. However, with R&D consuming 112% of operating cash flow, the company depends on continuous market access. This framework sees adequate but not exceptional strength.

KEY NUMBERS

VERDICT

Applying the Graham framework to Zscaler reveals a fundamental mismatch between price and value. Despite operational excellence evidenced by record free cash flow generation, the company fails Graham's essential tests - no earnings record, no margin of safety at 39% above fair value, and negative earnings yield while treasuries pay 4.33%. The $1.2 billion cash fortress provides some protection, but this framework classifies Zscaler as speculation, not investment. Would Graham ever buy a company with a -232.7x P/E ratio, no matter the growth story?

This analysis applies Benjamin Graham's published investment framework to publicly available financial data. It is not authored by, endorsed by, or affiliated with Benjamin Graham. Educational purposes only. Not financial advice.

OTHER PERSPECTIVES

Peter Lynch framework

The Everyday Edge

Bullish→

Warren Buffett framework

The Owner-Operator

Leaning Bearish→

Howard Marks framework

The Cycle Whisperer

Leaning Bearish→

Michael Mauboussin framework

The Expectations Engineer