Businesses and governments spend billions upon billions each year to protect their assets from cyberattacks. And Statista expects that global market to increase from $183 billion to $539 billion by the end of the decade.
The industry isn't as fragmented as one might think. The top five cybersecurity exchange-traded funds (ETFs) according to The Motley Fool all have CrowdStrike Holdings (CRWD 0.13%) and Palo Alto Networks (PANW -1.71%) as Top 10 holdings, and three of the ETFs have both in their top five. And for a good reason, as we'll discuss below.
We all know about ransomware and breaches, which companies defend against daily, but cyberattacks have also become a strategy for some nations. Cyberattacks increased in Ukraine as the Russian invasion began, and Taiwan was hit with cyberattacks during U.S. House Speaker Nancy Pelosi's recent visit.
Much of our crucial infrastructure defense in the U.S. falls on the private sector. Increasing tensions make cybersecurity companies essential and therefore strong long-term investments.
CrowdStrike is leveraging growth
CrowdStrike is a force in the cybersecurity industry. Its cloud-based solutions powered by artificial intelligence attract major clients, including over half of the Fortune 500 and 15 of the top 20 banks in the U.S. Its total customer base is exploding, and the growth over the prior four fiscal years is shown below.
Data source: CrowdStrike. Chart by author.
CrowdStrike added another 1,620 customers in the first quarter of fiscal 2023 and now has 17,945.
What do we mean by leveraging this growth? CrowdStrike rapidly increases the amount its customers spend with it each period with a dollar-based net retention rate consistently over 120%. For example, a customer might sign a contract for CrowdStrike services for one year at $50,000. Then the following year, it adds more modules and spends $60,000.
CrowdStrike's annual recurring revenue has increased from $71 million in the first quarter of 208 to over $1.9 billion as of the 2023 first quarter. The company is not yet generating profits on the basis of generally accepted accounting principles (GAAP), but posted $442 million in free cash flow last fiscal year.
CrowdStrike should be near the top of the list for growth-oriented investors.
Palo Alto Networks is an industry leader
Palo Alto Networks is an established leader with the most sales of any independent security company. It has tremendous reach, offering network, cloud, zero-trust, and endpoint security, and other products and services.
Management is expected to release fourth-quarter and fiscal-year 2022 earnings after market close on Monday, Aug. 22. Investors should be optimistic since Palo Alto raised its full-year guidance last quarter. It now expects revenue to come in at $5.5 billion for the fiscal year, representing a 29% increase year over year.
The earnings report could boost the stock, given that the valuation lags behind established competitors like Fortinet, as shown below.
PANW price-to-sales (PS) ratio. Data by YCharts. TTM = trailing 12 months.
Palo Alto posts impressive non-GAAP earnings per share and free cash flow but is not GAAP profitable due to stock-based compensation (SBC). Management has made it a goal to reduce its SBC as a percentage of revenue. This should be a positive for shareholders.
Both companies are taking advantage of ballooning spending on cyberdefense. The market can be volatile in the short term, but long-term investors should do well owning a piece of these innovative companies.
