Do Cybersecurity Risks Create Investor Opportunities?
So far in 2023, T-Mobile, Yum Brands (KFC, Taco Bell and Pizza Hut), ChatGPT, Chick-fil-A, Activision, Google Fi, Mailchimp and even Norton Lifelock have all experienced attacks and breaches. AT&T and Verizon were both hit last year. While most of the hacks are happening through employee errors and vulnerabilities (something that has to be solved through training and protocols), cybersecurity software and subscriptions have become an essential cost of business to any company or government agency that is going to store payment or private information.
Not surprisingly, all of the companies in my Cybersecurity Stock Report Card have year-over-year revenue growth, some with the most spectacular growth on the Street. Email info@NataliePace.com if you’d like a copy of our Cybersecurity Stock Report Card.
Snowflake, Crowdstrike, ZScaler, Cloudflare and Fortinet saw sales growth of 32-50% in the most recent quarter. The 2nd quarter is expected to come in slightly moderated, but still quite respectable. Snowflake, Crowdstrike and ZScaler project 2Q 2023 sales growth to be in the range of 33-36% growth. Cloudflare’s projections are in the 30% range, while OKTA expects revenue to increase at a rate of 18% year over year.
Cybersecurity is a fast-growing, innovative, cash-negative business. Staying ahead of the hackers, phishers and government-sponsored cyberattacks requires hiring and retaining the best and brightest computer engineers and programmers, and constant R&D. As a result, many cybersecurity companies are posting net losses. Snowflake and OKTA were the companies with the most losses last year, with -$796.7 million and -$815 million, respectively.
Cybersecurity Cash Flow Concerns
All of these companies know that having a pathway to profitability and generating free cash flow are essential in 2023. Snowflake’s ending cash position of $653 million might appear to be flying too close to the trees. However, the company also has short-term investments of $3.3 billion. There appears to be enough cash on hand for 2023 in the companies that I examined, particularly if revenue continues to grow in pace with the projections. However, liquidity and cash-burn are two things that any investor must monitor when investing in early-stage, cash-negative companies – particularly with high interest rates, tight credit conditions, and a potential recession on the horizon.
In my recent Artificial Intelligence blog, I noted that Wall Street’s darling Nvidia had only $5 billion in net income to support its trillion dollar valuation. A Wall Street insider revealed to me that everyone is investing based on what companies will be valued at in three years. Some traders bank on technical analysis, and ignore fundamentals altogether. Greed is high on Wall Street, as are stock prices, as you can see in two valuation charts directly below.
Sentiment can change on a dime, however. Stocks fell almost 40% between February 19, 2020 and March 23, 2020. The NASDAQ Composite Index, which includes most of these cybersecurity companies, lost 1/3 of its value in 2022.
So, where does cybersecurity fall on the valuation buy low/sell high continuum? Since all of the companies are cash negative, with the exception of the more mature Cisco, Broadcom, Microsoft, VMWare and Akamai, price/sales ratios are helpful indicators. While growth companies can take a higher valuation, most of the price/sales ratios are quite elevated. The pure-play cybersecurity companies all have sales of under $5 billion, with multi-billion market caps. Cloudflare’s 2022 revenue was $975.24 million, yet the company’s valuation, even now trading down -70% from its high of $221/share on Nov. 19, 2021, is $21 billion. Snowflake’s price/sales ratio is even higher than Cloudflare, with a Wall Street value of $55 billion on just $2 billion in sales.
High valuations become a crisis when the company hasn’t carved out a pathway to profitability, and starts to run out of cash. With interest rates 5% higher than they were at the start of 2022, borrowing is tight and expensive, placing even more pressure on cash-negative operations. So far things appear to be moving in the right direction for the cybersecurity companies. However, it’s still difficult to justify such expensive stock in such uncertain times. Recessions and bear markets tend to drag all prices down – even those industries that have become essential to all of us.
New Kids on the Block
Crowdstrike just launched a partnership with Abnormal Security, calling Abnormal the leading behavioral AI-based email security platform. Abnormal Security is pre-IPO and is currently owned by Greylock Partners, with co-founder Evan Reiser as the CEO. It’s a company that I’m putting on my radar. Whenever we see a leader in the industry cherry-pick another company to do business with, it’s worth noting…
ETFs vs. Individual Companies
Individual companies require babysitting. So, for most investors, purchasing a targeted ETF offers less work and risk. Be diligent about purchasing funds from a fund company with a high credit rating, rather than just searching online. The iShares Cybersecurity ETF (symbol: IHAK) offers exposure to most of the companies featured in our Cybersecurity Stock Report Card.
Money is hot, fast and greedy on Wall Street these days. We saw Cloudflare (symbol: NET) tumble from an all-time high of $221.64 in November of 2021 to its current price of $62.78. The valuation nosedived from $70 billion to its current value of $21 billion. Most of the companies mentioned in this blog have seen their share prices plunge over the last two years. So, whenever we see growth shoot up to extremely lofty heights, we have to wonder how swift and severe the fall is going to be.
Our team has a strategy for investing in hot industries with expensive share prices, like artificial intelligence and cybersecurity. It requires learning our pie chart system, rebalancing regularly (just 1-3 times a year), and applying a dollar-cost-averaging approach to our at-risk slices. This is easy and efficacious, prompts us to do what we are supposed to do, and puts our emotions and actions on the right side of the trade. We teach this time-proven, 21st Century nest egg pie chart system at our Financial Empowerment Retreat. The next one is this weekend, June 10-12, 2023, and will be our last opportunity to get safe, hot and properly diversified before fall. Join us!
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Natalie Wynne Pace is an Advocate for Sustainability, Financial Literacy & Women's Empowerment. Natalie is the bestselling author of The Power of 8 Billion: It's Up to Us and is the co-creator of the Earth Gratitude Project. She has been ranked as a No. 1 stock picker, above over 835 A-list pundits, by an independent tracking agency (TipsTraders). Her book The ABCs of Money remained at or near the #1 Investing Basics e-book on Amazon for over 3 years (in its vertical), with over 120,000 downloads and a mean 5-star ranking. The 5th edition of The ABCs of Money was released on September 17, 2021.
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Natalie Pace is the co-creator of the Earth Gratitude Project and the author of The Power of 8 Billion: It's Up to Us, The ABCs of Money, The ABCs of Money for College, The Gratitude Game and Put Your Money Where Your Heart Is. She is a repeat guest & speaker on national news shows and stages. She has been ranked the No. 1 stock picker, above over 830 A-list pundits, by an independent tracking agency, and has been saving homes and nest eggs since 1999.