Cloud computing and network security solutions specialist Sophos (LSE: SOPH) has released a positive update with billings in the first half of the current year up by 15.6% versus the same period of last year. And with Sophos having further growth potential as well as a low valuation, a gain of 30%-plus is very much on the cards.
Its first half results were in line with expectations, although on a cash flow basis they were better than previous guidance. New customer billings increased by almost 20% versus the same period of the prior year, driven by Unified Threat Management (UTM) and Sophos Central Platform. Like-for-like (LFL) subscription billings increased by 19.4%, while Sophos was able to continue to cross-sell its products. For example, the cross-selling of UTM and Endpoint increased to 8.4%.
Encouragingly, Sophos grew at a faster pace than the wider IT security market. It has been aided by a positive operating environment, as well as the reach and quality of its partner channel. It also benefits from a high degree of recurring revenue, while future performance should benefit from a rollout of new products over the medium term.
Despite this, Sophos is forecast to record a fall in earnings of 78% in the current financial year. Clearly, this would be disappointing and could lead to the company’s share price coming under a degree of pressure in the short run. This is unlikely to be longlasting though, since Sophos is forecast to return to strong growth next year when its bottom line is expected to rise by as much as 42%.
When combined with a price-to-earnings (P/E) ratio of 46, this equates to a price-to-earnings growth (PEG) ratio of just 1.1. This indicates that there’s at least 30% upside on offer, with the potential for even more should Sophos be able to deliver on its medium-to-long term potential.
What’s the alternative?
Of course, Sophos isn’t the only tech stock with 30%-plus upside potential. Imagination Technologies (LSE: IMG) is set to turn its disappointing performance around after a challenging period. It’s due to return to profitability in the current year following last year’s £63m loss. Furthermore, it’s forecast to build on that performance with growth in its bottom line of 34% in the next financial year.
Despite its turnaround potential, Imagination Technologies trades on a PEG ratio of just 0.9. This is even lower than the Sophos valuation and indicates that Imagination offers even more upside than its sector peer. Furthermore, the financial impact of its turnaround is likely to last beyond next year and this could prove to be a major catalyst on its performance over the medium term.
Certainly, there’s scope for disappointment for both companies. However, their turnaround strategies appear to be sound and their margins of safety seem to be sufficient to merit purchase. With its lower valuation, Imagination Technologies has higher capital gain prospects, although both stocks could rise by 30%-plus over the medium term.
Peter Stephens has no position in any shares mentioned. The Motley Fool UK owns shares of Imagination Technologies. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.