Cybersecurity is becoming a defensive industry to invest in. However uncertain economic conditions may be, security software will be one of the last items in a corporate budget to be cut. And the frequency and cost of cyberattacks are on the rise, which means cybersecurity vendors also have a clear path to continued growth.
With that in mind, recent equity market volatility presents plenty of buying opportunities in this niche of the tech sector. here’s why Palo Alto Networks (PANW -0.55% ), Dynatrace (DT -3.19% )and Elastic ( IT’S -2.84% ) are three cybersecurity actions worth looking into right now.
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1. Palo Alto Networks: Largest cybersecurity pure-play stock
After turbulence beat peers Fortinet and CrowdStrike Holdings, Palo Alto Networks once again leads the cybersecurity space as the most valuable company measured by market capitalization. And with $4.9 billion in revenue over the past 12 months, it’s also the largest security product specialist by sales.
After a few years of aggressively acquiring smaller cloud-native peers, Palo Alto is stronger than ever. From more traditional types of security using firewalls (devices that protect a physical location like an office or data center) to more modern approaches like endpoint security and SASE (Secure Access Service Edge), Palo Alto covers its clients. A diverse approach to cybersecurity may seem like a barrier to growth, but CEO Nikesh Arora has often said companies are looking for fewer product partners, not more.
Palo Alto’s gamble on expanding its capabilities through acquisition is paying off. Revenue for the second quarter of fiscal 2022 (three months ended Jan. 31) increased 30% year-over-year to $1.32 billion. And as a general indication of future growth, the remaining performance obligation (or RPO, i.e. current and future invoices to be sent to customers based on commercial contracts) increased by 36% from a year-over-year to $6.3 billion.
Arora and the company expect full-year revenue to now be at least $5.43 billion, a 27% increase over last year. Free cash flow adjusted profit margin (which excludes new headquarters expenses) is expected to be 32% to 33%, which would be good for $1.74 billion. Based on that expectation, shares of Palo Alto Networks are currently trading at 31 times current year free cash flow. Considering how important the company’s products are to large organizations around the world and how fast Palo Alto Networks is growing, I say this is a pretty decent long-term deal.
2. Dynatrace: Observability in the cloud is an essential modern IT function
With the rapid migration of IT to the cloud, new management tools are needed. One such toolkit is known as cloud shadowing – software that helps IT teams troubleshoot and resolve issues with large cloud computing operations. This is where Dynatrace and its cloud intelligence and automation platform come in.
The Dynatrace name comes from the software technology known as distributed tracing. Think of it as an indicator or marker that helps track a packet of data as it moves through a computer system’s infrastructure and interacts with different applications and services. This metric can help an IT team quickly identify trouble spots, automate fixes, and optimize performance. It is also extremely useful for spotting potential cyberattacks (Cloud Application Security is one of the modules available on the Dynatrace platform).
These capabilities have been of particular interest to large companies with sprawling operations, and in fact this is the primary target of Dynatrace’s sales and marketing team. His focus pays off. Total revenue increased 32% year-over-year to $241 million in the third quarter of fiscal 2022 (for Dynatrace, the three months ending December 31). Free cash flow was $59.2 million, a 25% margin, a very healthy amount for a company that invests a lot of money in research, development and marketing.
For the remainder of its fiscal year, Dynatrace and its new CEO Rick McConnell (a former Akamai and Managing Director of its Security Technology Group) forecast revenues of at least $922 million and generate free cash flow of at least $268 million. At 45 times expected free cash flow, stocks are still trading for a premium. But given the rapid growth of the cloud and large enterprise automation needs to manage and secure it all, I like Dynatrace’s long-term outlook.
3. Elastic: data analytics learn new tricks
Elastic isn’t exactly the first name that may come to mind when thinking about cybersecurity. This data analytics software company specializes in enterprise research and data log management (which can also be used in cloud observability and application performance management). But another key use of Elastic’s data analytics brand is indeed security, especially in areas like threat detection and response.
Like other companies in this software field (including Splunk), Elastic’s technology was born long before the cloud. But the move to a cloud-based service hasn’t bothered this company. On the contrary, the cloud has been a huge added value for the company’s bottom line. Cloud revenue was $80.4 million in the third quarter of fiscal 2022 (three months ended Jan. 31), a 79% increase that added to the overall revenue growth rate of Elastic by 43% over the period.
One caveat to investing in Elastic is profitability. The company generated free cash flow of just $3.5 million in the first nine months of its current fiscal year. This is by design, as Elastic tries to capture as much of the expanding cloud data and analytics market as possible (estimated at around $78 billion, according to technology researcher IDC and as quoted by Elastic in its latest presentation results). Companies that generate little or no profit have been out of favor for quite some time. Elastic is no exception: its stock price is down 60% from its all-time high from last fall.
But that doesn’t mean Elastic won’t be profitable one day. Margins will improve over time as the business reaches greater scale and sales and marketing expenses become a smaller percentage of revenue. In the meantime, with stocks currently trading at just under nine times expected sales for fiscal 2022, now seems like a good time to buy this fast-moving software security company.
This article represents the opinion of the author, who may disagree with the “official” recommendation position of a high-end advice service Motley Fool. We are heterogeneous! Challenging an investing thesis — even one of our own — helps us all think critically about investing and make decisions that help us become smarter, happier, and wealthier.