Following the phenomenal performance of many tech stocks over the last several quarters, it seems the market is taking a break, as evidenced by the more than 10% drop in the Global X Cloud Computing exchange-traded fund (ETF), a basket of cloud stocks, in just one month.
Nobody knows whether that will lead to a market crash in 2021. But if you worry about a deeper tech sell-off, you should consider buying Check Point Software (CHKP 0.01%) stock. Here's why.
Attractive cybersecurity market
Check Point proposes cybersecurity solutions in a market that is poised to thrive over the long term. The research outfit Allied Market Research estimates the cybersecurity market will grow at a compound annual rate of 9.4% to $305 billion by 2027.
Recently, serious and sophisticated threats confirmed cybersecurity has become a critical investment for enterprises. For instance, Microsoft president Brad Smith described the recent SolarWinds hack as "the largest and most sophisticated attack the world has ever seen."
So thanks to internal developments and acquisitions, Check Point diversified its business away from its legacy hardware firewalls (devices that filter traffic between networks) to capture more cybersecurity opportunities by proposing solutions that protect on-premises and cloud environments.
For example, after its acquisition of the cloud-based remote access specialist Odo Security in September, last month it revealed a unified solution, Harmony, that allows remote workers to securely access their computing environments.
Cash is king
Considering the huge $4 billion of cash, cash equivalents, and marketable securities (with no debt) it accumulated at the end of the last quarter thanks to its huge operating margin of 44% in 2019 and 2020, the company has the dry powder to continue acquiring businesses and improving its portfolio.
But with the surge in stock prices in the tech industry over the last several quarters, valuations have become demanding. As an illustration, at the beginning of March Palo Alto Networks CEO Nikesh Arora highlighted "irrational valuations" of growth stocks, which prevent the cybersecurity serial acquirer from pursuing its strategy in favorable conditions.
So a tech sell-off will provide cash-rich acquirers like Check Point with more attractive opportunities to put cash to work.
In addition, Check Point has been consistent over the last several years in spending more than $100 million quarterly to buy back its own shares. As a result, the company's number of diluted shares outstanding shrank from 209.2 million in 2012 to 138.9 million during the last quarter.
That significant 34% decrease in the number of diluted shares boosted earnings per share (EPS). Net income increased by 55.6% in 10 years thanks to revenue growth. But with the boost of share buybacks, EPS jumped by 134.6%, from $2.54 in 2012 to $5.96 last year.
If a tech sell-off intensifies, Check Point's shares are likely to become cheaper too, which will provide the company with the opportunity to buy back more shares at a lower price and further increase its EPS. And beyond the short-term volatility, the stock price should take into account that boosted EPS.
In any case, Check Point's valuation remains modest even before a potential market crash materializes. The stock is trading at a forward price-to-earnings ratio of only 17, and that ratio ignores the large cash pile the company accumulated.
That low valuation is mostly due to the single-digit top-line growth the company has been generating over the last couple of years, as it has been slowly diversifying its legacy hardware business to address cloud opportunities. During the fourth-quarter earnings call, CFO Tal Payne indicated cloud businesses exceeded 10% of subscriptions, which remains low as subscriptions represented 32% of total revenue during that time frame.
Thus, despite strong growth in the company's cloud businesses, management expects revenue to grow by only 3.2% year over year in 2021, based on the midpoint of the forecast revenue range of $2.08 billion to $2.18 billion.
So Check Point stock won't deliver stellar returns over the short term. Instead, you should consider it as an opportunity to stay invested in the tech sector despite concerns about a potential market crash. Thanks to the company's large cash balance and modest valuation, the stock offers downside protection, and it's poised to profit from volatile stock prices to boost its long-term performance.