As the economy tightens up, management everywhere will be challenged to cut costs wherever possible to minimize any effects of a slowdown. However, there are a few areas where cutting expenses aren't in a company's best interest. Cybersecurity software falls into this bucket, which leads to the question of which cybersecurity stocks are the best to buy.
Two popular cybersecurity investments are CrowdStrike (CRWD 3.63%) and Okta (OKTA 1.21%), and for a good reason: They are the go-to solutions in their respective offerings. So which one should investors be paying attention to in 2023? Read on to find out.
Each plays a different cybersecurity role
There is no all-encompassing cybersecurity solution. Instead, multiple companies provide different methods to create effective protection. CrowdStrike and Okta are complementary, so you don't have to worry about the investment being a zero-sum game.
CrowdStrike's endpoint and cloud protection solution prevents breaches at access points like phones, laptops, or cloud infrastructure. The software is cloud-based and constantly improves itself using artificial intelligence through trillions of data points gathered weekly. CrowdStrike has a broad offering with over 20 modules, each providing a different functionality that IT teams can use to beef up their security.
Okta's security solution focuses on identity security. Essentially, the software ensures the proper users access the correct information and programs while denying access to unauthorized parties. The solution can be used for customers and employees and is usually associated with various multi-factor authentication products.
Both products are used by thousands of customers, including some of the largest businesses in the world. So now that we know what they do, let's look at what might set these companies apart as investments.
CrowdStrike's free cash flow is impressive
Both companies saw tremendous revenue growth in third-quarter fiscal year 2023 (ending Oct. 31). However, CrowdStrike has a cash flow edge.
| Company | Q3 Revenue | YOY Revenue Growth | Free Cash Flow | Free Cash Flow Margin |
|---|---|---|---|---|
| CrowdStrike | $581 million | 53% | $174 million | 30% |
| Okta | $481 million | 37% | $6 million | 1% |
Data source: CrowdStrike and Okta. YOY = Year over Year.
CrowdStrike's ability to produce substantial free cash flow (FCF) is a crucial difference-maker for an investment, as it doesn't need to worry about going to creditors or issuing more stock to raise capital. While Okta's FCF margin leaves a lot to be desired, management plans a meaningful increase in FY 2024 (ending January 2024) thanks to a new focus on generating profits.
Winner: CrowdStrike
Okta's stock base compensation is a significant risk
As with most software-as-a-service (SaaS) companies, both businesses use stock-based compensation as a tool to avoid paying cash to employees (and thus generating more FCF). There's nothing wrong with this approach, but investors need to be aware that this is still a real expense because it can cause shareholder dilution. Unfortunately for investors, both companies use this tool excessively.
| Company | Q3 Stock-Based Compensation | Percent of Revenue | YOY Share Increase |
|---|---|---|---|
| CrowdStrike | $140 million | 24% | 2.4% |
| Okta | $171 million | 36% | 3.2% |
Data source: CrowdStrike and Okta. YOY = Year over Year.
While CrowdStrike's 2.4% share rise is concerning, it's not nearly as bad as Okta's. Still, this is a risk that investors must understand before taking a position in either business.
Winner: CrowdStrike
Okta has a long way to go before breaking even
Even though both companies are FCF positive, each is working toward actual profitability. This starts with turning an operating profit, which CrowdStrike is much closer to than Okta.
| Company | Operating Margin | Operating Expense Growth |
|---|---|---|
| CrowdStrike | (9.7%) | 50.4% |
| Okta | (43%) | 25.1% |
Data source: CrowdStrike and Okta. YOY = Year over Year.
While CrowdStrike is closer than Okta to turning an operating profit, it grew expenses at nearly the same rate it grew revenue. On the other hand, Okta's operating expense growth was much slower than its revenue growth -- a positive sign. Still, with how much of a gap Okta has to close, CrowdStrike takes another point.
Winner: CrowdStrike
You have to pay extra for CrowdStrike's strong financials
Up to this point, it has been a rout by CrowdStrike, because its financials are in much better shape. However, this comes at a valuation cost.
OKTA P/S Ratio data by YCharts
Intuitively, it makes sense that CrowdStrike is valued higher from a price-to-sales standpoint due to its stronger financial status. But, because Okta is valued much lower, it has greater upside potential if it begins to execute at a high level like CrowdStrike.
Still, 10.8 times sales isn't a historically expensive price for a software company. So while CrowdStrike may be valued higher than Okta, the overvaluation bear case for CrowdStrike isn't as easy to make as it once was.
Winner: Okta
The winner is clear
While both companies provide an essential cybersecurity offering, CrowdStrike's financials are much better than Okta's. While there's nothing wrong with investing in Okta, CrowdStrike presents a more compelling investment opportunity.
