Three Cybersecurity Defender Stocks
This week, we use AAII’s A+ Investor Stock Grades to give you insights into three cybersecurity stocks benefiting from the modernization of America’s cybersecurity infrastructure. For investors focused on policies aimed to improve the nation’s defenses by requiring the installation and modernization of technology that detects and blocks malicious cyber activity on federal information and operational networks, cybersecurity stocks FireEye Inc., Fortinet Inc. and Palo Alto Networks Inc. may help protect your portfolio.
Modernization of the Nation’s Cybersecurity Defenses
Cybersecurity is one of the greatest challenges facing public and private enterprises. Last week, President Biden signed a cybersecurity-related executive order to modernize the nation’s computer defenses and protect federal government networks. The announcement came in the aftermath of recent cybersecurity incidents such as the SolarWinds and Microsoft Exchange hacks and the Colonial Pipeline breach by ransomware-as-a-service group DarkSide. The incidents are a grave reminder that U.S. public and private sector entities increasingly face sophisticated malicious cyber activity from both nation-state actors and cyber criminals. These incidents share commonalities, including insufficient cybersecurity defenses that leave public and private sector entities more vulnerable to incidents.
The executive order makes a significant contribution toward modernizing cybersecurity defenses by protecting federal networks, improving information-sharing between the U.S. government and the private sector on cyber issues and strengthening the U.S. government’s ability to respond to incidents when they occur. It is the first of many ambitious steps the administration is taking to modernize national cyber defenses. However, the Colonial Pipeline incident is a reminder that federal action alone is not enough.
Much of the critical U.S. domestic infrastructure is owned and operated by the private sector, and those private sector companies make their own determination regarding cybersecurity investments. The announcement encourages private sector companies to follow the federal government’s lead and take ambitious measures to augment and align cybersecurity investments with the goal of minimizing future incidents.
Grading Prominent Cybersecurity Stocks With AAII’s A+ Stock Grades
When analyzing a company, it is useful to have an objective framework that allows you to compare companies in the same way. This is one reason why AAII created the A+ Stock Grades, which evaluate companies across five factors that have been shown to identify market-beating stocks in the long run: value, growth, momentum, earnings estimate revisions (and surprises) and quality.
Using AAII’s A+ Stock Grades, the following table summarizes the attractiveness of three prominent cybersecurity stocks — FireEye, Fortinet and Palo Alto Networks — based on their fundamentals.
AAII’s A+ Stock Grade Summary for Three Prominent Cybersecurity Stocks
What the A+ Stock Grades Reveal
FireEye (FEYE) is a cybersecurity company. The company provides intelligence-based cybersecurity control products, software-as-a-service (SaaS) solutions, managed services and professional services that allow organizations to prepare for, prevent, investigate, respond to and remediate cyberattacks. The company markets its products, solutions and services under two brands: FireEye products and Mandiant solutions.
Its FireEye products provide security control by detecting, blocking and analyzing advanced, targeted and other evasive attacks, including ransomware and phishing attacks in customers’ on-premise, remote, cloud and critical infrastructure environments. Mandiant solutions help customers improve their resilience to cyberattacks by automating and operationalizing its intelligence in software, and by enhancing internal resources with managed services, expertise on demand and consulting services.
Cybersecurity demand is growing rapidly. The company has an early-mover advantage in malware solutions. FireEye seeks higher growth rates with more products focused on cloud-based solutions. Meanwhile, Mandiant’s security experts provide FireEye with a unique selling proposition for breach response and security posture assessments. Its expertise should improve FireEye’s other solutions. FireEye faces robust competition from larger cybersecurity companies that are embedded with customer ecosystems and have security platforms with a wider breadth of offerings.
FireEye has a Value Grade of D, based on its score of 68, which is considered expensive. The company’s Value Score ranking is consistent across several traditional valuation metrics, with a score of 67 for the price-to-sales ratio, 81 for the price-to-book value ratio and 76 for the price-to-free-cash-flow ratio (remember, the lower the score the better for value). Successful stock investing involves buying low and selling high, so stock valuation is an important consideration for stock selection.
The Value Grade is the percentile rank of the average of the percentile ranks of the valuation metrics mentioned above along with the enterprise-value-to-EBITDA (EV/EBITDA) ratio, price-earnings ratio and shareholder yield.
Estimate revisions offer an indication of what analysts are thinking about the short-term prospects of a firm. FireEye’s Estimate Revisions Grade is B, which is considered positive. The grade is based on the statistical significance of its last two quarterly earnings surprises and the percentage change in its consensus estimate for the current fiscal year over the past month and past three months.
FireEye has posted earnings surprises of 27.0% and 18.8% for its last two fiscal quarters, mainly due to its threat intelligence and breach remediation services. These services supplement overwhelmed security teams within organizations and are key differentiators in today’s heightened threat environment. Those capabilities give FireEye an entrance into an organization before being able to cross-sell its security products. FireEye should continue to gain a foothold with its security platform for cloud, endpoint, network and email, alongside its important security services.
In addition, over the last month, the consensus estimate for the fiscal year ending December 31, 2021, has risen 9.6% and there have been 15 upward revisions to the fiscal-2021 estimate and one downward revision.
Fortinet (FTNT) is a network security company. The company provides cybersecurity solutions to a range of enterprises, service providers and government organizations across the world. Its network security solution consists of FortiGate physical, virtual machine and cloud platforms, which provide integrated security and networking functions to protect data, applications and users from network- and content-level security threats. The company’s product offerings consist of its FortiGate product family, along with its FortiManager central management and FortiAnalyzer central logging and reporting product families.
Its cybersecurity platform offers a range of products, which include its FortiMail email security, FortiSandbox advanced threat protection (ATP), FortiWeb web application firewall, FortiDDos and FortiDB database security appliances, as well as its FortiClient endpoint security software, FortiAP secure wireless access points and FortiSwitch secure switch connectivity products.
The company is well positioned in the rapidly growing software-defined wide area networking (SD-WAN) market. Since its firewalls have SD-WAN built in, analysts believe this can make Fortinet an easy choice to procure security and the latest networking trend together as organizations exit routing products. Fortinet’s growing relationship with large service providers sets it up to benefit from 5G rollouts requiring updated security and networking infrastructure. SD-WAN looks like a key growth driver in the long run.
Fortinet’s product pipeline is robust heading into the second half of 2021. Margin expansion should be driven by a shift away from hardware revenue, toward software, support and subscription services.
A higher-quality stock possesses traits associated with upside potential and reduced downside risk. Backtesting of the quality grade shows that stocks with higher quality grades, on average, outperformed stocks with lower grades over the period from 1998 through 2019.
The quality grade is the percentile rank of the average of the percentile ranks of return on assets (ROA), return on invested capital (ROIC), gross profit to assets, buyback yield, change in total liabilities to assets, accruals, Z double prime bankruptcy risk (Z) score and F-Score. The score is variable, meaning it can consider all eight measures or, should any of the eight measures not be valid, the valid remaining measures. To be assigned a quality score, though, stocks must have a valid (non-null) measure and corresponding ranking for at least four of the eight quality measures.
Fortinet has a Quality Grade of A, putting it near the top tier among all U.S.-listed stocks. The company ranks highly in terms of its return on assets and F-Score, ranking respectively in the 92nd and 96th percentile of all U.S.-listed stocks. However, it ranks poorly in terms of its change in total liabilities to assets, only in the ninth percentile.
Palo Alto Networks (PANW) is a cybersecurity service provider. The company offers a security platform that empowers enterprises, service providers and government entities to secure all users, applications, data, networks and devices with comprehensive visibility and context continuously across all locations. The company delivers cybersecurity products covering a broad range of use cases, enabling its end-customers to secure their networks, remote workforce, access to the service edge, branch locations, and public and private clouds and to advance their security operations centers (SOC). The company delivers its solutions in three fundamental areas: Secure the Enterprise, Secure the Cloud and Secure the Future.
Palo Alto Networks has an average A+ Growth Grade of C. The growth grade considers both the near- and longer-term historical growth in revenue, earnings per share and operating cash flow.
The company has exhibited strong sales growth over the past year. Sales increased 24.5% year over year for the quarter ending January 31, 2021, to $1 billion, while billings grew 22% to $1.2 billion and operating cash grew 18.8%. Palo Alto Networks is scheduled to report third-quarter fiscal-year 2021 earnings on Thursday, May 20, after the market closes.
Palo Alto Networks has a Momentum Grade of B, based on its Momentum Score of 63. This means it ranks just below the top tier of all stocks in terms of its weighted relative strength over the last four quarters. The weighted four-quarter relative strength rank is the relative price change for each of the past four quarters.
“The momentum in the business continues to be strong, with second-quarter revenue growth of 25% year over year to over $1 billion, driven by strong execution across the board,” said chairman and CEO Nikesh Arora. “Events like the SolarWinds attack highlights the importance of cybersecurity, and Palo Alto Networks is well positioned to protect our customers with best-of-breed solutions. We are excited about the bets that we have made in secure access service edge (SASE), cloud and AI. Our three-platform strategy is paying off.”
The stocks meeting the criteria of the approach do not represent a “recommended” or “buy” list. It is important to perform due diligence.
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