Cybersecurity Is Strong; Cybersecurity Software Stocks Are Not - Here's Why

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An Introduction

Cyber security is crucial to protect networks, systems and other digital infrastructure from malicious cyber attacks (see here) and it is estimated that cyber security spending should grow at a CAGR of 13.8% between now and 2030 (source) suggesting that many cybersecurity software and hardware companies should be excellent long-term buys.

AI's Role In Cyber Security
 

AI is a perfect value addition technology for cyber security because it is fundamentally a complex mathematical equation that generates outputs with new data by using existing data which enables cyber security companies to train their models with data from previous attacks to create autonomous systems that can detect if an attack is ongoing based on certain readings. This provides companies and users with a critical capability in the risk management framework, as it increases their lead time for an attack and allows them to prepare mitigation and response strategies.

Why Pure-play Cybersecurity Software Stocks Are Down YTD
 

The truth of the matter is that pure‑play cybersecurity software stocks are down, on average, YTD not because demand is weak, but because the market narrative has shifted against them, even as fundamentals remain intact. The YTD drawdown is a valuation and positioning story, not a fundamentals story.

Overall,

• there has been a rotation out of “defensive growth” into AI‑infrastructure and semiconductor stocks (see here). Investor attention has shifted to higher‑beta AI plays and, when that happens, pure‑play cyber names get de‑rated even if revenue is recurring; and
• there has been a valuation compression after years of premium multiples and, as interest rates stay higher for longer, the market is punishing high‑multiple software, especially names without accelerating growth.

Specifically, Zscaler is the weakest of the 8 constituents YTD as a result of:

• billings coming in below expectations in Q3 which investors treat as the most important leading indicator of future growth;
• management forecasting decelerating revenue growth going forward and, for a premium‑multiple SaaS security name, any hint of slowing growth compresses valuation quickly and,
• while Zscaler actually beat revenue and EPS expectations, the market focused on the forward indicators causing sentiment to turn negative.

All the above reasons confirm that the selloff in Zscaler is not about operational weakness, but about expectations resetting.

Our Pure-Play CyberSecurity Software Stocks Portfolio
 

eSecutityPlanet.com provides a list of cyber security companies (see here) of which the 8 largest pure-play companies (i.e. +$5B in market capitalization) that trade on American stock exchanges are included in our Pure-Play CyberSecurity Software Stocks Portfolio. Below is the focus of each constituent,  how they have performed YTD, in ascending order, and their market capitalizations.

1. Zscaler (ZS): DOWN 25.6% YTD
   • Focus: offers cyberthreat, data and application protection products
   • Market Capitalization: $27B
2. CrowdStrike Holdings (CRWD): DOWN 15.6% YTD (as of the February 6th)
   • Focus: offers corporate endpoint and cloud workload security, identity protection, threat intelligence, and data protection
   • Market Capitalization: $105B
3. Palo Alto Networks (PANW): DOWN 13.5% YTD
   • Focus: provides threat prevention and security solutions, including URL filtering, and DNS Internet of Things, API, and SaaS security, data loss prevention, and services to resolve network disruptions
   • Market Capitalization: $115B
4. CyberArk Software (CYBR): DOWN 12.2% YTD
   • Focus: develops, markets, and sells software-based identity security solutions and services
   • Market Capitalization: $21B
5. Cloudflare (NET): DOWN 12.1% YTD
   • Focus: provides website and application security products similar to PANW including web application firewall, bot management, distributed denial of service protection, API security, and SSL/TLS encryption
   • Market Capitalization: $67B
6. SentinelOne (S): DOWN 11.9% YTD
   • Focus: delivers threat prevention, detection, and response capabilities across an organization’s endpoints, cloud workloads, and identify credentials, which enables seamless and autonomous protection against a spectrum of cyber threats.
   • Market Capitalization: $5B
7. CheckPoint Software Technologies (CHKP): DOWN 2.5% YTD
   • Focus: develops, markets, and supports a range of products and services for IT security worldwide.
   • Market Capitalization: $19B
8. Okta (OKTA): UP 0.3% YTD
   • ​​​​​​​Focus: see here
   • Market Capitalization: $16B

​​​​​​​Summary
 

On average, the above 8 pure-play cybersecurity software stocks are now DOWN 13.3% YTD, having gone DOWN 8.0% week-ending February 6th.

Conclusion
 

The YTD drawdown in pure‑play cybersecurity software stocks is a valuation and positioning story, not a fundamentals story.

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