As more and more businesses migrate their IT systems to the cloud and adjust to support remote workers, the need for robust cybersecurity solutions is only growing. Many cybersecurity companies have worked to push out more comprehensive software systems that can meet the changing needs of their customers, and the industry is growing increasingly consolidated.
What's more, the biggest companies in the space stand at a distinct advantage these days, as the ability to harness data for machine learning and other artificial intelligence (AI) applications enables them to offer advanced features. More customers equals more data, which equals better AI. As a result, there are only a handful of cybersecurity stocks worth investing in.
However, a strong underlying company isn't enough to make a stock a smart buy -- its shares also need to present an attractive value. Not every cybersecurity stock offers great value right now. Here's one to avoid and two to consider adding to your portfolio.
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This popular security stock is overheated
CrowdStrike (CRWD -1.25%) suffered a huge setback last summer when a flawed software update caused a huge IT outage, crashing millions of Windows-based computers worldwide and putting tons of businesses and organizations in a bind as systems critical to their operations became inaccessible. CrowdStrike crashed on the news -- and with good reason.
The outage has weighed on CrowdStrike's earnings ever since, as the company stepped up its marketing and sales spending, and offered discounts to customers purchasing multiple modules on its platform. As a result, its operating margin fell to 18% in its most recent quarter, contracting from 23% in the prior-year period.
Now, a year past the outage, CrowdStrike looks well positioned to grow again. In its most recent quarter, the company grew sales by 42% year over year. Its bundled discount offerings have led to more customers taking multiple modules as well.
That should ensure high net revenue retention rates, especially about a year into its new pricing. As a result, margins should start expanding again as the company continues to scale.
The problem is CrowdStrike's stock price. The stock was expensive before the outage, and after the plunge that followed, it rebounded and then surpassed its 2024 high. The stock now trades at around 26 times trailing revenue and 18 times sales estimates for the next year.
Even though the stock price has declined since the start of the third quarter, that's still an incredibly high valuation for this company. There are better opportunities in the cybersecurity space.
Two stocks to buy instead
One key component of any cybersecurity system is a good firewall, which controls incoming and outgoing traffic from a network. It can also ensure that no data leaves the network that should not, and that no nefarious packets get in. When it comes to firewalls, two companies stand out from the rest: Palo Alto Networks (PANW -0.67%) and Fortinet (FTNT -2.33%).
Both are working to leverage their strengths in firewalls to build robust cybersecurity software suites for customers. Those comprehensive packages include on-premise security, cloud security, and security operations solutions, which monitor and assess risks in real time.
Fortinet launched its cloud-based security service in 2020 and has made strong progress in expanding its relationships with its clients. Its Secure Access Service Edge (SASE) annual recurring revenue increased by 22% year over year in the most recent quarter, while its security operations platform grew by 35%.
Palo Alto also has seen strong growth in its software-based solutions as it pushes its "platformization" of cybersecurity. It's essentially copying the strategy that made CrowdStrike so successful and leaning into the higher-margin software business. Palo Alto's next-generation security annual recurring revenue grew 32% year over year last quarter. That helped lift its overall revenue by 16%, while its operating margin expanded 340 basis points.
While Fortinet has largely built its cybersecurity suite in-house, Palo Alto has been able to grow much more rapidly by aggressively acquiring smaller businesses. That's worked well for Palo Alto, but investors pummeled the company's stock after it announced plans to acquire CyberArk for $25 billion.
CyberArk specializes in identity security, which helps verify users' identities and ensure they can only access systems they're authorized to use. The much larger Palo Alto has an opportunity to significantly expand CyberArk's customer base by cross-selling its solutions as part of its platformization efforts, which could result in strong revenue growth for the acquirer. However, investors think Palo Alto is overpaying for that opportunity, which is why they sent its shares lower on the news.
Both Fortinet and Palo Alto trade at much more attractive valuations than CrowdStrike. Fortinet stock is changing hands for less than 10 times sales and 9 times forward revenue estimates. Palo Alto shares trade at a price-to-sales ratio of 15 and about 12 times forward revenue estimates.
While both companies are growing more slowly than CrowdStrike due to their legacy businesses, they're each well positioned to grow at a solid pace as demand for one-stop cybersecurity solutions continues to grow. As such, either stock looks worth buying at the current price, especially when juxtaposed against CrowdStrike.
