What happened
Shares of cybersecurity leaders CrowdStrike Holdings (CRWD 5.77%), Zscaler (ZS 5.89%), and Cloudflare (NET 3.30%) were pummeled today, down 4.4%, 5.9%, and 6.6%, respectively.
It was curious that these stocks sold off so much, given that a prominent Wall Street analyst delivered positive commentary about the cybersecurity group generally and these stocks specifically.
However, virtually all stocks were pummeled after a stronger-than-expected job openings report was released, which sent long-term bond yields soaring.
NASDAQ: ZS
Key Data Points
So what
It really does appear to be all about the macro economy and bond yields today. This morning, the Job Openings and Labor Turnover Survey (JOLTS) report came in hotter than expected for the end of the month of August, with 9.61 million job openings, above the 8.8 million projected for August.
The JOLTS report sent stocks down, as a hot jobs market rekindles fears that inflation won't go away easily. That appears to have increased chances for more Federal Reserve interest rate hikes.
Also, long-term bond yields rose, with the 10-year Treasury yield up 12 basis points -- a huge move for a single day -- while hitting a 17-year high.
Rising long-term bond yields are damaging for many types of stocks, including bond-like high-yield equities and high-growth stocks. The latter can be especially sensitive, as the bulk of their earnings power typically rests many years out into the future. So, the higher that long-term inflation projections and interest rates are today, the less those future profits are worth in today's terms.
Of note, while the three cybersecurity stocks discussed here tout adjusted earnings that ignore stock-based compensation, none of them are making net profits on the basis of generally accepted accounting principles (GAAP) over the past 12 months.
All three of these stocks had nice run-ups over the past couple of weeks, so today's large-looking losses are really just bringing them back to where they were about 10 days ago. The cybersecurity sector has actually seen optimism from Wall Street analysts, as their research seems to reflect stable demand for cloud software after the past 18 months' slowdown.
Even this week, these stocks received praise from the analyst community. The software team at Piper Sandler (PIPR 2.57%) upgraded Zscaler yesterday, which joined the firm's top five picks overall, which also include CrowdStrike.
Following that upgrade, its analysts Rob Owens and Ethan Weeks endorsed high-growth cybersecurity stocks in general: "Trends coming out of 2Q earnings and our annual tech conference indicate continued signs of stabilization, fueling our optimism around a potential bottoming of headwinds over the coming quarters ... . As the narrative of stability becomes more prevalent in our data and in conversations with vendors and customers, we are confident in the fundamental performance of the security group and see opportunities for multiple expansion throughout the back half of 2023 and into 2024."
However, that potential multiple expansion won't happen if long-term bond yields continue to rise, as they did today.
Now what
At first, it might seem like an excellent time to buy high-growth cybersecurity stocks. Each of these stocks has sold off over the past 18 months, as rising inflation and fears of a recession caused organizations to pull back on their cybersecurity spending. But that protection isn't really a "nice to have" but a "need to have" service, so growth should continue for the space over the long-term.
Not only that, but as organizations look to trim overall spending, they might consolidate their cyber offerings into best-in-class solutions. And as recent results have shown, CrowdStrike, Zscaler, and Cloudflare -- each founded at the beginning of the cloud era and showing impressive customer growth and net expansion -- appear to be in the group to which customers will gravitate.
Still, the bullish outlook for cybersecurity names is well known by the market, and these stocks do command a big valuation premium to most other stocks. That means if these companies hit a speed bump or if interest rates go up, they could have a big re-rating downward.
That appears to be what happened today. Investors should anticipate a continuation of the give-and-take between strong growth and an already-high valuation, until inflation comes down to the Fed's target of 2%.
