Motley Fool Hidden Gems Investing - Better Buy: Zscaler or Workday?

Starting point is 00:00:00 Tim Beyers. Who's beating the market now? We've got ideas. You're listening to Motley Fool Money. Welcome, Fools. I'm your host, Tim Beyers. And with me, our longtime Fools, Austin Sharma and David Meyer. Fellas, how are we doing? Both fully caffeinated, good weekends. Doing good. I'm only half caffeinated right now. Dave, you got just a few seconds. Squawk it down. You got to get fully caffeinated before we roll. I'm on it. Half caffeinated is better than uncaffeinated. Let's just say that. All right. Today we'll be talking about a fiscal Q1, 2026 earnings from Zscaler and Q3, uh, 2026 earnings from Workday tickers is ZS and WDAY and predicting which of these two will be the better performer over the next decade. We'll also tackle

Starting point is 00:01:02 some mindset questions and a potential new feature we're calling Mindset Monday. We are going to ask for your feedback. We want to know if you want more mindset content. But we start with earnings and let's quickly review what we saw last week starting with Zscaler. We had some good numbers and I want you both to react to these. So Zscaler said they exceeded their expectations on both the top and bottom line. They say they blew past what they call rule of 78. They're just making stuff up here. There's a rule of 40 number that is very common, which is like growth compared to margins. And then if the growth is materially above 40 over the margin, that's a good sign for the company. So they say, forget about 40, we're at 78. I think that's a little nonsensical,

Starting point is 00:01:52 But revenue did grow 26% year-over-year. Annual recurring revenue was up 26% year-over-year. And their backlog now is $3.2 billion in annual recurring revenue. A billion dollars of that are some very high-growth initiatives, including what they are calling AI security. They say their AI security ARR surpassed their fiscal year 2026 target of $400 million three quarters early. And now they are anticipating they'll hit a half a billion before fiscal 2026. So more AI, more need for security, zero trust, you know, in lots of companies in the market for this, 450 enterprises. Dave, let me start with you here. Would you make it these Zscaler results? And does anything give you pause?

Starting point is 00:02:45 Nothing gives me pause. This is a company that in my opinion is doing very well. They're in a market that needs its technology prowess that needs its products. We always have to remember in the cybersecurity market, it's always growing because there's always a bad actor on the other side, inventing something new that companies like Zscaler need to figure out how to deal with, which is why I'm actually really excited about the company, because now that not only do they have their own expertise from all the years that they've been doing this, but now they have AI tools to complement their experience. So, nothing gives me pause about what they said. Asit, let's talk about the full-year forecast here. They are forecasting some slowing growth.

Starting point is 00:03:31 So, overall revenue growth for fiscal year 2026, the forecast is for 22.8% to 23.5%. year-over-year growth. That's down from 26%. Any of the slowing growth concern you? There are still operating losses here? Or are you with Dave? Is this one that you find particularly compelling? I think I'm with Dave, Tim. The slight slowdown doesn't concern me. That's more of the original core of this business, which is the zero-trust architecture slowing down a bit. But that, as a market, is still growing, even if all the AI business hadn't evolved for this company, zero trust would be a wide field to play in. And Zscaler is one of the leaders in providing this architecture. I do like the AI opportunity. You know, those numbers that you cited before

Starting point is 00:04:18 represent 80% year-over-year growth. When you talk about that artificial intelligence annualized recurring revenue, Zscaler was very early to call out the potential dangers of all of us using so much artificial intelligence. They were early on the idea of prompt injection, that bad actors could take over prompts. They were early on the idea that agents, which are the theme of the day, might not always be good actors. They could be taken over by bad actors. So an agent that you're using in your business could get co-opted and take your data and give it to someone else. So by investing in these and being early in these themes, they're reaping the benefits of that. And I think Jay Chaudhry, the CEO of Zscaler, is someone with a lot of foresight. So I tend to

Starting point is 00:05:04 index more on his and the management team's capabilities, their ability to stay ahead of the game, then I do some temporary slowdowns in the numbers. I wish they would be a little bit more profitable, Tim, but they're not too far away from gap profits if they would optimize the business just a bit more and maybe watch that stock-based compensation expense. I like that you went very Cold War there on watching the agents. You have the Americans and the Soviets each trying to turn each other's other spies here, but you know what? That is the nature. I mean, it very much is, um, in, in the, uh, in the AI agent world here, you're going to have a lot of bad actors that are targeting those agents. Let me give you something to watch your

Starting point is 00:05:46 fools. Something they mentioned during the quarter. It's pretty small now, but if there is out performance or it'll be something to watch Zscaler is among the many companies that is now offering its customers the ability to pay a bucket of money to use any service you want at any time you want it. And they call that program Z-Flex. And that accounted for $175 million in total contract value in the most recent quarter. That was up 70% quarter over quarter. So something to watch there. But let's move on to Workday, which has dramatically underperformed the market. Again, ticker WDAY, about 30% year-to-date. Let me give you some numbers here. For the quarter, non-GAAP operating margin of 28.5%. I think that's pretty good. The overall on a non-GAAP basis,

Starting point is 00:06:37 that margin was up 215 basis points year-over-year. That is very good if that can continue. Operating cash flow was up just about 45% year-over-year to $588 million. Then, of course, lots more AI. Everybody's talking about this. What Workday said specifically is that AI products added more than 1.5 points of ARR growth this quarter, and 75% of net new deals and 35% of all customer expansions were AI-related. Subscription revenue grew 15% to $2.244 billion. So, Dave, starting with you again here. What do you make of where Workday is here? Big cloud-based enterprise resource planning company. So this is something that I've been chatting, talking about on, uh, for about a year now. And that is, um, when are companies going to start telling us how AI is

Starting point is 00:07:36 actually turning into revenue or revenue growth and Workday actually told you, and I don't think it was as high as people were anticipating. Now we have to remember, this is a very big company. Okay. So it's going to be incremental growth from, for them, given that they have been in this business for a long time. But I think that's the one thing that sort of is disappointing, right? You know, AI is great. We're going to put it out to our customers and they're going to use it and they're going to love it, man. I think, I think that's the one thing that the market was sort of like, ah, it's great that your margins are going up, but we kind of wanted to see just a little bit more growth from you, even though you're a very big company. Yeah. I mean, that's

Starting point is 00:08:21 fair. I mean, this is the, these are the guys that founded and sold PeopleSoft. Thankfully, they called their new cloud version of what is effectively PeopleSoft, Workday and not something like Cloud People, because that would be terrible. Workday is a better name. I sort of like Cloud people. Cloud people would make a great kids series, but I don't think it's a good name for an enterprise software company. But where do you land on this, Asit? And I'll give you, they did say that this is one of, not, most of the big tech companies really didn't say anything about impacts from the government shutdown. Workday did. Workday did, because they have a lot of big government contracts. So, anything there, like on the headwinds they faced from

Starting point is 00:09:09 the government shutdown. Anything give you pause here? A little bit of pause, because near-term, the acceleration in the business isn't enough to compensate for any one portion that underperforms, such as this government business. So, we have to look at what this business does to really understand the AI piece. This business provides companies with human capital management, so think HR, payroll services, and also ERP, enterprise resource planning software. So software to run your entire business, all the finance workflows, et cetera. It's very good at what it does. This is a company that generates really nice free cashflow. I like it, Tim. It's a slow growth company in this day and age. It's a little mature, but on the other hand, the agents part of the

Starting point is 00:10:00 business is sort of interesting because if you are a current customer of Workday, you're going to get offered all these different agents to automate workflows. So, if you've got a payroll module, the agents will help you automate part of that payroll. If you're working on, say, the hiring process within your company, you'll have agents that facilitate the hiring of new employees. So, these are nice add-ons that will eventually increase the average revenue per unit ARPU of the company when ARPU grows. And I know that just sounds such a weird acronym to say out loud. But when ARPU grows and starts to accelerate, investors get excited. So here's a company that everyone looks at as being a sort of a sleepy business, but it could surprise some of us with

Starting point is 00:10:45 a bit of upside in the coming quarters. The issue now is that investors are so focused on that part of the business that was soft. They're really not that excited about what the potential could be a year or three years or five years from today from the AI piece. All right. Well, you led us there. So it's prediction time. I want you to give me over the next 10 years. So we're talking 10 years now. Over the next 10 years, which of these is the better outperformer? And give me a range of annualized returns that you think this company could give you. So two things. Which is the better outperformer? And what's your hope? It doesn't have to be a hard prediction. I think based on what you know about this company,

Starting point is 00:11:31 your hope for the range of annualized returns you might expect. And Dave, I'm going to start with you. So Zscaler or Workday? First of all, let me say, I think Asit hit the nail right on the head with his comments about what Workday is doing. I think that is completely underappreciated by the market right now. If you look, it is trading at valuations that it's never seen before in its lifespan. Here you are getting a very high-quality company. Even though it's growing a little bit slower than maybe people would like, it is very well-run, has an amazing balance sheet, amazing cash flow generation. I think Workday outperforms. I think you can probably get somewhere between 10% and 12% annual returns from here with a lot

Starting point is 00:12:21 less volatility. Zscaler, while it is absolutely an essential piece of cybersecurity, trades much higher valuations and it has some growing to do in terms of the overall profitability of the business. Plus it's going to have to reinvest a lot to make sure that its technology stay current with what's happening. So I think then I give the nod to Workday just because it might be a little tougher for Zscaler to do all the things it needs to do to get up into the 10% to 12% annual return range for the next decade. All right, Asit, Zscaler or Workday? Give me a rough return range. I'm going to go with Zscaler. With a wide range, Dave laid out the case for why that range is probably wide. I'm going to say they're going

Starting point is 00:13:08 to land somewhere between 10% and 15% annualized growth. I think they're capable of getting on up to 13% to 15%. It won't be easy, as Dave points out. But hey, when you can call out the rule of 78, no one even knows what that means. Maybe they'll be up to the rule of 96 in a few years. Well played, well played. I think we know what it means. Free cash flow margin plus revenue growth. That being said, Workday's issue is that it is in two commodity businesses, so human capital management and enterprise resource planning. Those are going be harder for it to get a leg up on this ever-competitive space. But I do like what Dave said. I think this could be, for me, a 9% to 12% grower. Dave said 10% to 12%. We are aligned here.

Starting point is 00:13:54 Workday with lower risk could be a really interesting investment. I think Zscaler, because of that cybersecurity market that's ever-growing, because the AI piece is going to outperform, but it's not a given. Workday, don't sleep on it. All right. Fair enough. Up next, we do a little Mindset Monday and we want your comments on this fool. So stay tuned. You're listening to Motley Fool Money. All right. Let's talk mindset. Asit and I used to do this on Fool 24. We want to know if you want to hear more about this, but this is a quick one. I asked Gemini, looking at all your available and most highly credible sources for behavioral finance, give me the three most cited hopes or concerns when it comes to investing in

Starting point is 00:14:37 building wealth right now. So here's what came back, guys. And I want your reactions to all of these. Number one, a big concern around loss aversion and panic selling, the pain of loss stronger than the pleasure of gain. We've talked about this before. The two themes in this one, we're selling winners way too early. Boy, do I feel that. And then the disposition effect that I'm pretty sure that Dave's going to talk about. In this case, Gemini was focusing on holding losers too long. But there's some wrinkles there. Number two, this is both a hope and a concern, FOMO. FOMO and panic, the herd mentality. I don't think we need to really say too much about that. FOMO is something that everybody feels. Fear of missing out is a very powerful motivator.

Starting point is 00:15:25 And then number three, big concern about overconfidence and confirmation bias. And we see this with a lot of new investors, I think. Investors don't particularly know what to do, or they feel so convinced about something that they're just in and they're trading all the time, or they build an over-concentrated portfolio, and that ends up causing some regret. And we don't love regret when it comes to investing. So, Asit, I'm going to start with you. What do you want to tackle here? Your mindset advice based on those three areas. If you're going to give a piece of mindset advice, what do you want to focus on? Well, Tim, since the markets seem to be extended a bit, valuations are near all-time highs,

Starting point is 00:16:12 everything feels so shaky. Let me just go to loss aversion because that might come into play for some of us in the coming months if the market retraces from here. I think that's maybe a misnomer, I feel like it should be life affirmation, not loss aversion, because this is something very primal in us, right? When we build anything like a shelter over our heads, or we build up a little bit of money, we want to protect our ability to survive. So really what loss aversion is, it's something coming from deep within ourselves, which says, I don't want to lose this and go back to a worse position than I was before. Now, that makes a lot of sense when you're thinking about a roof over your head. It makes less sense when you are thinking about a long-term asset that's

Starting point is 00:17:02 going to appreciate because a business that you've invested in is growing its cash flows because they're in a market which hopefully has a lot of demand and the business is well run. I could go on to describe a very nice investment scenario. But just to keep this short, thinking in terms of what the future could look like is a very powerful antidote to that very quick and reactive place that we get to when markets start to shake and to quake. Didn't mean to rhyme that, but there you go. And Tim, you've been great at pointing this out over the years. Our lizard brain really wants us to just react and have instant relief. And that's always a mistake. Put a pause between the stimulus and the response. Take a walk. Think about life

Starting point is 00:17:51 affirmation and the fact that things will probably be there when the dust settles and make your decisions accordingly. Yeah. I mean, don't be afraid to think about the good things that can happen. That's not necessarily bad. All right, Dave, what do you got here? What do you want to focus on for your mindset advice? So first of all, I just want to reconfirm that it is extremely important for every investor to understand all of these biases because they are real and they impact the decisions that we make. But I will say this, the one that has stuck with me the most, and I personally think is the most important one, is the disposition effect. As soon as I learned about it, I was like blown away. But basically what it says is when prices go up, we become

Starting point is 00:18:38 risk averse because we don't like the pain of loss, right? So we don't want to lose something we have. And when prices go down, we actually become risk seekers. So we look, Oh, let me, let me double down. Let me, let me, you know, let me hold on because I don't, I don't want to confirm that actually this loss is, is happening. I actually want to, I want it to go away. Right? Right. If we talk about anything at the Motley Fool, we talk about using time as your greatest ally with great companies and compounding the disposition effect. If you fall prey to it, completely knocks that out because you cut your winners to way too early. And then you don't take capital. That's not working for you and put it into something that is so that you get the double

Starting point is 00:19:25 whammy. So again, I, this is me personally, but the disposition effect is the thing that long-term quality, business-focused investors like us Fools, that's the one that we need to focus on. Yeah. David Gardner calls this watering the flowers and pulling the weeds. It has worked very, very well for him over the course of time. All right. Up next, we're going to preview tomorrow your holiday stock shopping list. You're listening to Motley Fool Money. All right. For Tuesday's show, we have Emily Flippen, who is joined by Jason Hall, and Asit will be back to talk about their favorite rule-breaking stocks to consider for your holiday stock shopping list. Do you already have a list? If you do,

Starting point is 00:20:11 leave us a comment to let us know what you're buying. We will revisit Mindset Mondays if you send us questions. If you send us questions, mindset questions, we will consider them. You can post them on the boards. You can also send them to me. You can send them to tbyers at fool.com. So T-B-E-Y-E-R-S at fool.com with it. And just put mindset question in the subject line and let me know what it is you would like to have us address for you as an investor. What are you concerned about? But that's it for today's show. Thanks to Dave and Asit for joining me, guys. really appreciate it. As always, people on the program may have interest in the stocks they talk about, and The Motley Fool may have formal recommendations for or against, so don't buy

Starting point is 00:21:04 stocks. Buy or sell stocks based solely on what you hear. All personal finance content follows Motley Fool editorial standards and is not approved by advertisers. Advertisements are sponsored content and provided for informational purposes only. To see our full advertising disclosure. Please check out our show notes. Fools, thanks so much for being here. Our engineer today, as always, is Dan Boyd. Our producer is Anand Chakrabarty. Thanks to Dave Meyer and Asa Sharma as our guest today. I'm your host, Tim Byers. See you again soon, Fools. Fool on!

Motley Fool Hidden Gems Investing - Better Buy: Zscaler or Workday?

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