The world is going digital at a rapid pace in the wake of the pandemic, and companies slow to update their operations or taking a lax approach to security are facing real-world consequences. The widespread hack exploiting SolarWinds (NYSE:SWI) and the Colonial Pipeline shutdown are just two examples.
According to the FBI, reported cybercrime doubled in 2020 with nearly 792,000 reported incidents in the U.S. alone. There is clearly opportunity for cybersecurity services to expand given the massive need to keep tech systems safe.
Dynatrace (NYSE:DT), Fortinet (NASDAQ:FTNT), and Cloudflare (NYSE:NET) are all near all-time highs, but they are great long-term buys right now given the rising demand for security and monitoring technology. Here's why.
Dynatrace: A new layer of defense in the cloud era
The advent of cloud computing is making businesses more nimble and efficient, but the massive amount of data flowing through an IT operation also makes security more difficult than ever. Layers of protection are a necessity, as is software that can help automate monitoring and reporting of potential problems for overworked IT teams.
Enter Dynatrace, the leader in cloud observability and application performance monitoring software. The company's suite of services helps automate the tedious work of keeping cloud-based operations running smoothly, and overlays its system with AI to recommend fixes. Tech researcher Gartner recently called Dynatrace's cloud suite far and away the best-of-breed among peers like Microsoft, Cisco, Datadog, and Splunk.
Apps are an increasingly important part of sprawling businesses' day-to-day workflow, and if these behind-the-scenes systems go down, it can spell disaster for a company. Dynatrace has thus found a steady stream of big new customers over the last few years with its infrastructure monitoring modules, and has expanded on its relationship with existing customers with new functionality like app security.
It capped off its fiscal year ended March 2021 with annual revenue growth of 29% to $704 million, and thinks it can maintain about a 30% sales growth rate for the foreseeable future. This is also a highly profitable firm, generating free cash flow of $206 million in the last 12 months (a free cash flow profit margin of 29%).
Since the cloud is expected to be a high-growth industry for the next decade, Dynatrace will find no shortage of growth opportunities, and it generates ample amounts of cash to self-fund its expansion. Shares trade for a premium 82 times trailing 12-month free cash flow as of this writing, but it's a worthy premium for the best cloud app monitoring and security automation platform out there.
Fortinet: Data centers are a hot target for cybercrime
Though often pigeonholed as a "legacy" cybersecurity software vendor, there's much more to the Fortinet story than meets the eye. The fact that shares are up over 60% through the first half of 2021 (making Fortinet one of the best-performing security stocks this year) is indicative of that.
The argument goes something like this: With the global workforce more distributed than ever and millions now working remotely, firewalls (devices that monitor and filter the network traffic moving into and out of a physical location like an office building) aren't exactly a growth industry anymore. But this isn't true.
While it's true that many organizations are grappling with keeping employee devices safe, a trend that has been a boon for endpoint security specialist CrowdStrike (NASDAQ:CRWD), remote workforces are making liberal use of cloud-based systems like never before. And cloud applications are built and run by data centers -- which are physical assets, even though most of us don't see them.
A massive upgrade cycle for data centers is thus just getting started to support growth of the cloud, and Fortinet's firewalls and software services built on its hardware business are best-in-class options to keep these critical computing units safe. Total sales grew 20% last year driven by services, and sales accelerated to a 23% pace during the first three months of 2021 as hardware revenue picked up again. Free cash flow was $264 million in the first quarter, a whopping 37% profit margin.
Fortinet has a squeaky clean balance sheet ($3.09 billion in cash and investments, $987 million in long-term debt as of the end of March), operates in a steadily growing segment of the security industry, and has a history of organically fostering expansion with new hardware and software cybersecurity offerings.
At 42 times trailing 12-month free cash flow, this isn't the value stock it was at the beginning of the year, but it's hardly overpriced given the opportunity that still lies ahead for it over the next decade. This remains one of my top buys in the security space.
Cloudflare: Keeping the internet safe from bad actors
Cloud computing was a massive secular growth trend of the 2010s, and the pandemic of the last year has only solidified this. But over the next decade, a new movement called edge computing -- in which data and services in a large centralized data center get pushed out to smaller, more localized data centers -- could keep the trend going. Cloudflare has emerged as a leader in this burgeoning edge computing market.
Cloudflare has dozens of services geared toward keeping the internet and content delivered on the web safe. From its edge-based content delivery network (CDN), website and application security, to employee device protection, Cloudflare has a solution for businesses of all sizes.
It has a unique go-to-market strategy that has worked wonders, too. It develops new services and often gives them away for free to individual users and small businesses, then offers a premium version of its software to bigger businesses. The company has picked up millions of users worldwide as a result, and is only just beginning to work its way upmarket to bigger paying subscribers.
The financial results of this model have been impressive. 2020 revenue increased 50% to $431 million, and the pace continued in Q1 2021 with a 51% year-over-year increase to $138 million. Cloudflare is spending heavily to support its expansion, but it's beginning to reach a profitable scale. Free cash flow was just negative $2.2 million during the first few months of the new year, compared to negative $30.6 million the same period in 2020.
This small internet security business is just getting started on its journey. After getting clobbered in the spring along with other high-growth stocks, Cloudflare is back to all-time highs again and trades for a premium of 66 times trailing 12-month sales. This is the result of new capabilities on its platform, including a partnership with NVIDIA (NASDAQ:NVDA) to bring AI to its edge network and new analytics software integrations with the likes of Microsoft, Splunk, and Datadog.
If you haven't bought Cloudflare yet, tread lightly and keep an initial purchase small (I usually start with less than 1% of my portfolio). But the long-term potential for this company is massive. Don't let the steep price tag keep you away for too long.