The key to successful small-cap investing is to find strong businesses with massive growth opportunities in important, emerging industries. Just a handful of these stocks can help you build a fortune as an investor.
The challenge, however, lies in identifying these companies early in their growth cycles. Yet I believe I've found one such opportunity today.
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The problem...and the solution
Cybersecurity is an increasingly vital requirement for organizations of all sorts. Major corporations such as Equifax and Target have been hacked, exposing millions of people's personal data in the process. Even government agencies such as the U.S. Office of Personnel Management have proven to be vulnerable to data breaches. Unfortunately, many more organizations will be targeted by cyber attacks and hackers in the coming years.
Varonis Systems (VRNS -0.31%) helps businesses and government agencies defend themselves from this threat by focusing on an often-overlooked vulnerability: their own employees. Varonis' software analyzes users' activity and watches for unusual behavior. If it senses something out of the ordinary, it sends alerts that help its customers respond to potential threats quickly. Varonis can also prevent and limit the damage of data breaches by automatically locking down sensitive data when necessary.
The opportunity
These cybersecurity solutions are in high demand; Varonis' revenue rose to $217 million in 2017 -- up from $101 million in 2014 -- and is expected to grow another 23% this year. Yet Varonis' current revenue base pales in comparison to a market opportunity it pegs at $15 billion. With such a large addressable market -- and with its leadership position in insider threat detection -- Varonis appears poised to grow its sales at well above average rates for many years to come. In fact, if Varonis can capture just 5% of this market in the next half-decade, its revenue would more than triple from today's levels.
Varonis is well on its way to doing just that. It's built an impressive customer base including the U.S. Army, NASA, Harvard University, Nasdaq, Coca-Cola, Toyota, and 6,000 other organizations across the corporate, government, and educational sectors. These customers value Varonis' offerings, as evidenced by its greater than 90% renewal rate. And while that's a sizable client list, it represents only about 5% of the approximately 120,000 businesses worldwide with more than 1,000 employees. These companies offer a vast market into which Varonis can expand.
I should note, however, that Varonis is not yet profitable. The company has been prioritizing long-term expansion over short-term profits, which is exactly what it should be doing at this point in its growth cycle. Moreover, management expects to reach profitability on an adjusted basis later this year. And, as an enterprise software company, Varonis should be able to scale its profits nicely once it hits critical mass.
Another way to win
I should also note that Varonis competes in some respects with larger cybersecurity giants such as Symantec, as well tech titans with large cybersecurity divisions such as Cisco Systems. But this hasn't impeded Varonis' torrid growth in recent years, and I see these companies more as possible acquirers of Varonis rather than as competitive threats. Investors will likely earn greater long-term returns if Varonis remains an independent entity, but a buyout is another potential way shareholders could profit.
Lastly, Varonis' $2.1 billion market cap is slightly higher than the $2 billion or less typically used to designate stocks as small-caps. But don't let arbitrary market cap limits stop you from buying this cybersecurity leader. Varonis Systems is worth paying up for, and its current market capitalization understates its long-term market opportunity. Investors who buy shares today will likely be well rewarded in the years ahead.
