We recently compiled a list of the 10 best cybersecurity stocks recommended by hedge funds, and in this article we’ll take a look at how Fortinet, Inc. (NASDAQ:FTNT) ranks against other cybersecurity stocks.
Increased internet usage has made internet connectivity a ubiquitous part of the daily lives of businesses and individuals, and it has also increased the ways in which malicious individuals and organizations can extort money, steal sensitive data, and disrupt critical infrastructure and systems. The scale of this activity is also staggering, with studies estimating that cybercriminals will have caused $6 trillion in damages as of 2021, more than all but the world’s two largest economies.
These threats have led to the growth of a vibrant cybersecurity industry, which became the focus of media coverage worldwide after an outage hit as many as 8.5 million computers worldwide in July 2024. The outage revealed the complex nature of the global computing ecosystem and the risks that exist when there is a single point of failure in security infrastructure. While it is too early to speculate on the losses, insurance company Parametrix estimates that insured losses could reach up to $1 billion for Fortune 500 companies. As if this were not enough, the CEO of the insurance company believes that the global impact could be several times greater. In his estimates, the total financial losses could reach $15 billion, with global insured losses ranging from $1.5 billion to $3 billion.
Looking at the scale of these losses, it’s natural to ask yourself what caused the global cyber outage. The problems began when the cybersecurity provider, the world’s third largest cybersecurity company, rolled out an upgrade to its Falcon security platform. The software upgrade contained corrupted files that run at the deepest layer of a computer, called the kernel, which caused systems using the Windows operating system to crash. The OS displayed the infamous blue screen, a software response to protect users from kernel damage that can lead to data loss. The chaos also lasted for quite some time, as all systems affected by the update could only function properly after being manually booted into safe mode to remove the corrupted files.
Returning to the financial aspects of the cybersecurity industry, like other industries, this industry is also facing disruption from artificial intelligence. According to a study, the AI-driven cybersecurity industry was worth $20 billion in 2023. From then until 2027, the industry is expected to grow at a compound annual growth rate (CAGR) of 25.3% to a final value of $49.2 billion. In other words, the industry is expected to more than double in four years. The cost of cybersecurity breaches is also expected to increase from 2021 levels in the AI era. These costs are estimated to reach $8 trillion by the end of 2023 and jump to $10.5 trillion by the end of 2025. The current era in the financial industry is characterized by high interest rates, which also impacts cybersecurity mergers. In 2023, 363 M&A deals were announced in the cybersecurity industry, a decrease of 18.8% per year.
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Of these deals, strategic acquirers – acquirers buying companies that align with their business strategy – accounted for 57.3% of deals. Although deal volume declined, valuations remained strong. From Q4 2020 to Q4 2023, the average EV/revenue and EV/EBITDA multiples for the cybersecurity M&A sector were 3.3x and 11.6x, respectively, above the broader averages of 2.1x and 10.4x.
Digging deeper, cybersecurity stocks recorded some solid returns despite tough corporate spending and inflation in 2023. This came at a time when broader SaaS (software as a service) stocks were struggling due to uncertainty regarding companies’ future spending plans. The Houlihan Lokey Cybersecurity Index, which tracks the performance of the top 28 cybersecurity stocks, was up 83% year-to-date through the end of 2023, and up 28% in the fourth quarter. These returns were accompanied by 18% revenue growth and strong 29% profit growth, showing the benefits of operating in a high-margin software industry, allowing cybersecurity stocks to earn more pennies in terms of profits. The index’s 83% return by itself represents a large 58 percentage point lead over the flagship S&P, but if we narrow the top cybersecurity stocks further to include only high-growth companies, this band widens. The return over the past 12 months as of the end of 2023 was 101%, with an even wider range of 76 percentage points.
Turning to valuation, cybersecurity stocks, like the broader SaaS industry, are primarily valued on enterprise value to revenue. The median EV/2024 expected revenue ratio for high-growth cybersecurity stocks was 9.8x. The medians for mid- and low-growth stocks were 5.9x and 3.0x, respectively. Importantly, the ratios for high- and mid-growth cybersecurity stocks were significantly higher than the EV/revenue ratios of the acquisition targets profiled above. This means that as far as the current environment for cybersecurity acquisitions is concerned, value appears to be driving at least some of the deals as high interest rates make it difficult for companies to raise capital. In terms of revenue growth, the medians ranged from 33% for high-growth companies to 4% for low-growth companies.
Our Methodology
To compile a list of hedge fund picks for the best cybersecurity stocks to buy, we ranked the holdings of several cybersecurity ETFs based on the number of hedge funds that bought shares in the first quarter of 2024 and selected the stocks with the largest number of hedge fund investors.
Why are we interested in hedge fund concentrated stocks? The reason is simple: our research shows that you can outperform the market by mimicking the top stock picks of the best hedge funds. Our quarterly newsletter strategy selects 14 small and large stocks each quarter, and has returned 275% since May 2014, beating the benchmark by 150 percentage points (more details here).
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Fortinet (NASDAQ:FTNT)
Number of hedge fund investors in Q1 2024: 44
Fortinet, Inc. (NASDAQ:FTNT) is one of the world’s largest firewall providers. The company’s platform allows businesses and governments to protect their network systems from data breaches and external network-based attacks. This business model gives Fortinet, Inc. (NASDAQ:FTNT) an advantage over other cybersecurity companies in that it can benefit from recurring revenue and loyal customers, as organizations are often hesitant to move away from firewalls unless there is a special reason. This also means that Fortinet, Inc. (NASDAQ:FTNT) must continue to maintain billings from existing customers, and if billings fall in an economic downturn, the stock price will fluctuate accordingly. Fortinet, Inc. (NASDAQ:FTNT) is aware of this, too, and through initiatives such as combining its wireless access point security products with security products for edge computing products, it offers new products to existing customers at no extra cost. If Fortinet, Inc. (NASDAQ:FTNT) decides to price when the economy recovers, this move could lead to increased revenue in the future. In the short term, however, the company’s shares are struggling in 2024, down 1.35% year-to-date. Fortinet Inc. (NASDAQ:FTNT) revenue fell 6% year-over-year to $1.45 billion in the first quarter, and the company is forecasting a median decline of 1% for that metric in the second quarter.
Conestoga Capital Advisors mentioned Fortinet, Inc. (NASDAQ:FTNT) in its investor letter for Q1 2024. Here is what the fund had to say:
“FTNT is the global market share leader in network security firewalls (units). During the quarter, FTNT reported revenues that were significantly ahead of expectations and demonstrated early benefits from the strategic shift to non-firewall solutions (SASE, SecOps) announced late last year. This marks the second consecutive quarter of disappointing results, and the stock has nearly recovered to 2023 highs. While FTNT is still digesting the traction of product-led growth, the recovery appears to be on the right track and should deliver better-than-expected margins in 2024.”
Overall, FTNT ranks 9th on our list of best cybersecurity stocks to buy. To see other cybersecurity stocks that hedge funds are watching, check out “Hedge Funds’ 10 Best Cybersecurity Stocks to Buy.” While we acknowledge FTNT’s potential as an investment, we believe some AI stocks have a better chance of delivering higher returns in a shorter period of time. If you’re looking for AI stocks that are more promising than FTNT but trade at less than 5x price to earnings, check out our report on the cheapest AI stocks.
Next: Analysts Predict New $25 Billion “Opportunity” for NVIDIA, 10 Best-of-Breed Stocks to Buy in Q3 2024 According to Bank of America.
Disclosures: None. This article was originally published on Insider Monkey.
