Cybersecurity Stocks Outperform in Bear Market

Companies that produce security software have outperformed in this year’s bear market.  Governments and companies are unlikely to skimp on security spending, even as the threat of recession weighs on corporate budgets. Also, the long-term need for cybersecurity protection has boosted M&A activity in the sector and has made many security software firms attractive takeover targets.

An index of cybersecurity stocks is down -21% this year, including dividends.  However, that is better than the -33% slump in the broader software index.  The Nasdaq 100 Stock Index ($IUXX) (QQQ) is down -31% this year.  Palo Alto Networks (PANW), CyberArk Software Ltd (CYBR), and Check Point Software Technologies Ltd (CHKP) are among the best outperformers in the sector this year.

A recent quarterly survey by Morgan Stanley of corporate technology executives shows that near-term demand for software is waning, even as it is expected to remain the fastest-growing sector for enterprise spending.  However, the survey also showed that executives said security was a top priority and among the most defensive areas for enterprises.  Spear Invest said, “within enterprise budgets, security is the last area businesses will cut, so growth should continue even if we see a recession.”

Cybersecurity stocks are cheaper than overall software stocks.  The cybersecurity index trades at 26 times estimated earnings and 1.3 times sales, less than the broader software index of 28 times estimated earnings and 5.7 times sales.

Software stocks have also emerged as a favorite place for M&A activity this year, with the lower valuations of cybersecurity stocks making them especially attractive. Alphabet recently closed its $5.4 billion purchase of Mandiant, and Visa Equity Partners agreed to buy KnowBe4 for about $4.6 billion.

M&A activity in cybersecurity may continue.  First Trust Portfolios said, “it’s tough to call an end to this trend because the cheaper valuations will continue to make these companies attractive to buyers. What’s different about cyber security compared with the rest of the software sector is that the business model is still really strong.  While we’re expecting a slowdown in economic growth, cyber criminals operate in a growth industry that’s not tied to the cycle.”

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