Cybersecurity companies are receiving even more attention than usual as a result of an increase in global and domestic cyber threats, along with a heightened sense of insecurity related to Russia's war in Ukraine. Companies have an obligation to protect the data of their customers and employees, not to mention that it's a key business need to keep their own critical data secure. The rising demand for tools that can help them do that is providing long-term investors with opportunities to profit from the growth of this market.
For those looking to add some cybersecurity exposure to their portfolios now, two options that will suit multiple investment strategies are CrowdStrike (CRWD 0.78%) and the First Trust NASDAQ Cybersecurity ETF (CIBR 0.36%).
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How CrowdStrike works
Cloud-based CrowdStrike provides protection through software-as-a-subscription solutions that include endpoint security, threat intelligence, and response to cyberattacks. It aids customers in more than 176 countries with ongoing support through training, technical assessments, and advisory services. Its customers range from state and local governments to large enterprises such as Mercedes and Goldman Sachs.
As the platform experiences more threats, machine learning and artificial intelligence systems help it adapt to better protect its clients, much as your immune system recognizes new diseases -- and then evolves to better defend against them. While hackers will at times breach those firewalls and steal or destroy data, CrowdStrike keeps getting better at identifying these threats and defeating those challenges.
In the fourth quarter (period ended Jan. 31), net new annual recurring revenue hit $217 million -- a company record -- and total ARR increased by 65% year over year to $1.7 billion. CrowdStrike's subscription customer count increased by 11% to over 16,000, and the number using four or more of its modules rose by 69%.
The company also kept its gross margin above 70%. If general and administrative expenses and other costs can be contained or reduced as revenue grows, that should make it easier for the company to attain profitability faster. Indeed, profitability may not be far off if growth continues as expected -- the company's fiscal 2023 guidance calls for a 47% jump in total revenue to more than $2 billion.
The stock fell by 42% from nearly $300 in November to a low of around $157 in early March, and while it has since regained about half of that -- due in part to a strong Q4 report -- the slump could be a good thing, as it provides investors an opportunity to buy shares at a discount.
Signs of share price growth could reflect that investors have confidence in the endpoint security market, which the analysts at Fortune Business Insights predict will grow at a compound annual rate of 8.3% through 2028, up to $24.5 billion. The driving force behind this growth will be an expanded work environment that includes more devices -- personal and business -- with more endpoints from which hackers can attempt to access data.
As we all know, the COVID-19 pandemic forced vast numbers of employees to shift to a work-from-home model, and many large businesses intend to keep that model -- at least as an option -- permanently. So the need for cybersecurity solutions like those offered by CrowdStrike should remain strong even as the health crisis eases into an endemic situation. Considering where CrowdStrike could be five years from now, long-term investors who get in now stand to benefit.
Playing the field with a cybersecurity ETF
Competition in the cybersecurity space is abundant, but the projected market growth should help support all the major players. Companies that can win business from enterprise customers and keep them happy will likely achieve success in the end. Meanwhile, smaller companies such as SentinelOne, which went public last year, will certainly come along, too. Some of those will offer attractive pricing to draw in a new base of customers, which will make it look like their revenues are growing at breakneck speed. But over the long haul, one can't predict how many of those companies will be able to keep up the pace. At some point, M&A will become a bigger factor, and as the competition tightens, the players with the best products and cash to spend should rule the roost.
But if your strategy is to minimize your risk a bit while still investing in this flourishing sector, an exchange-traded fund such as the First Trust NASDAQ Cybersecurity ETF might be your best option. The fund's top 10 holdings include many of the best cybersecurity stocks such as Palo Alto Networks, Zscaler, and Splunk. CrowdStrike, with about 6.6% of the fund's total asset weight, is its largest holding.
Over the past five years, the fund has delivered an average annualized return of 20%, and 15% since its inception in 2015. Here's how that stacks up against the top individual cybersecurity company stocks in its portfolio, based on an initial $10,000 investment.
CIBR Total Return Level data by YCharts
As you can see, CrowdStrike and Zscaler have performed the best. But Palo Alto has provided the most consistency with a gradual climb and less volatility. Splunk and Okta trail the pack and are beaten out by the ETF -- which has shown a gradual consistency much like Palo Alto. So, picking the individual top performers can certainly benefit your portfolio, but if you're an owner of Splunk or Okta, you might wish you had taken a more diversified approach.
An ETF generally provides a lower-volatility investment, but still offers the potential to benefit from the gains of a sector's top performers. It's the combination of higher risk/higher reward and consistency that might drive some investors -- like me -- to own both CrowdStrike and the First Trust NASDAQ Cybersecurity ETF in their portfolios.
