Protect Your Portfolio From Cyber Threats

This article is part of our Rising Star Portfolio series.

Congratulations on getting out of bed today. With all the scary goings-on these days, I'm tempted to just hide under my covers. Our country's global leadership seems to be fading fast. We've got [insert European country here] bankruptcy concerns. But my fear-o-meter really starts buzzing and whirling when thinking of a risk far less reported on: cybersecurity.

It's the enemy we really just don't know about -- until it shows up and causes security breaches, power outages, or worse. But as un-vestors, we know that what smells like fear means opportunity – which is why I bought shares of cybersecurity wunderkind SAIC (NYSE: SAI  ) for the Un Portfolio.

A deeper look at how big the cyber threat is -- and how prepared SAIC is -- will help us make a game plan for further profiting off these fears.

Hackers for hire
In its annual publication Top Risks 2011, global consulting firm Eurasia Group has shed some light on just how far-ranging of a risk cyber attacks could be:

The principal cybersecurity concern of governments has shifted from al Qaeda and China to radicalized info-anarchists undertaking a debilitating attack against either critical infrastructure, a key government agency, or a pillar of the private financial system. This could be a long-term game changer for governments beyond the United States, corporations and banks, all of which are vulnerable to sudden, radical transparency.

Gulp. Cyber threats have increased 445% since 2006 and show no sign of stopping. Sure, the U.S. government has taken precautions, spending $8.6 billion on cybersecurity in 2010. And Uncle Sam plans on writing checks to combat the risk going forward too, increasing its spending almost 10% per year through 2015.

But cybersecurity isn't just a concern of governments. All critical infrastructure is at risk, like our financial and communications systems. And as utilities endeavor to manage power more efficiently by installing smart grids, cybersecurity spending to ward off attacks is expected to triple over the next five years. Turns out we're much better at defending our nation with the lights on and our systems powered up.

Someone Call Security: 1-800-555-SAIC
So how, you ask, is SAIC positioned to benefit from spending by government and industry so they don't join us in hiding under the covers?

  1. Investments from long ago: Cybersecurity is not a new industry -- it has been around for a long time under different names. But the greater sophistication, severity, and frequency of attacks has spelled the need for a more focused, dedicated, and funded counter. SAIC's 40-year history of being a trusted government partner matters when bidding new contracts. Furthermore, it bolstered its capabilities in February 2010 with the game-changing acquisition of CloudShield Technologies.
  2. Investments for today: SAIC's historic investments and research and development have yielded a robust suite of cybersecurity offerings. SAIC specializes in system engineering and testing for clients looking to proactively combat attacks. Or, it can intercept and shoo away attacks by inspecting packets of data as they move through a network. It also provides applications for conducting analytic work to detect threats and analyze a systems performance. It's a one-stop shop.
  3. Investments for tomorrow: With cybersecurity a bit of a buzz word these days, investors need to be careful that cyber-related initiatives are more than just lip service. SAIC has taken pains to invest in cyber for the long run. It has heavily invested in the STEM program, Project Lead the Way, and Project SCOPE to cull an army of young cyber-defense artists. It has also helped design curriculum, in conjunction with the University of Maryland, for undergraduate and advanced degrees to prepare students for careers in the field. Internally, the company foots the bill for employees enrolled in cyber-related graduate programs. The payoff? SAIC is strengthening its existing workforce to handle the increasing demands of a quickly developing field and has been able to source nearly one-third of new hires from these efforts.

Your plan of attack
The seriousness of cyber threats and SAIC's significant experience and investments to date highlight why the company is well positioned. But its cheap valuation is even more exciting. If the sector continues to be beaten down I'll look to add to my position.

But other defense contractors with cyber exposure look cheap too -- fellow Rising Star Anand Chokkavelu, CFA just snapped up five of them! While I think SAIC is going to lead the way in cyberdefense, investors should assess the opportunities and have a plan to keep an eye on these key players as well.

Company

Size (millions)

FCF Yield

P/E Ratio

CACI International (NYSE: CACI  )

$1,601

6.5%

14.9

L-3 Communications (NYSE: LLL  )

$8,497

7.8%

9.8

ManTech International (Nasdaq: MANT  )

$1,483

8.4%

12.3

VSE (Nasdaq: VSEC  )

$166

4.7%

7.0

Data from CapitalIQ, a division of Standard & Poor's.

If you're not confident which company will have the most success in the lucrative cybersecurity market, you can create a basket of them by buying a few of them equal to the size of a regular position. Doing so will help spread your company-specific risk but retain your exposure to an inexpensive sector with good prospects. With SAIC defending the Un-Portfolio I'll be sleeping tight.

This article is part of our Rising Star Portfolios series, where we give some of our most promising stock analysts cold, hard cash to manage on the Fool's behalf. We'd like you to track our performance and benefit from these real-money free stock picks. See all of our Rising Star analysts (and their portfolios).

Bryan Hinmon holds no financial position in any company mentioned above. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. SAIC is a Motley Fool Inside Value recommendation, and The Motley Fool owns shares of L-3 Communications, ManTech, and SAIC. The Fool has a disclosure policy.


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