Why Cybersecurity Stocks Are Soaring

Over the weekend, the FBI and the Cybersecurity and Infrastructure Security Agency warned American businesses about the dangers of potential ransomware attacks, which encrypt company data and hold it hostage until the hackers are paid.

This warning came after hackers launched Denial of Service (DoS) attacks against Ukrainian government websites, flooding the network with traffic and preventing users from accessing the sites. Additionally, data wiping malware was detected, which completely wipes a computer, rendering it inoperable.?

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Cyberattacks pose an enormous threat to businesses, as the damage to their computer systems not only disrupts the supply chain, but also risks leaking company data, damaging reputations, and even halting operations entirely.

I should also mention that cyberattacks are costly. Cyberattacks cost businesses an average of $4.24 million in 2021, nearly 10% more than in 2020 and more than in any previous year in the 17 years since IBM began publishing this data.

Expeditors International of Washington, Inc. (NASDAQ:EXPD), NVIDIA Corporation (NASDAQ:NVDA), and Toyota Motor Corp. (NYSE:TM) are all feeling the pain of recent cyberattacks.

On February 20, EXPD announced that its systems had been hacked. The company has launched an investigation into a cyberattack that caused the company to lose control of the majority of its global operations. EXPD did not confirm whether the attack was a ransomware attack or if it was connected to Russia.

In a new investor filing, the company made the following statement "The Company anticipates that the prior shutdown's impact, as well as the ongoing cyber-impact, attack's will have a material adverse effect on its business, revenues, expenses, results of operations, cash flows, and reputation. At this early stage, the Company is unable to estimate the cyber-ultimate attack's direct and indirect financial consequences."

Last week, NVIDIA Corporation was the victim of an attack that resulted in the theft of company data. The attacks, which exposed employee passwords, credentials, and company proprietary information online, were carried out by a ransomware operation known as 'LAPSUS$. The group has urged NVIDIA to discontinue using the Lite Hash Rate (LHR) technology in its graphics cards, threatening to leak additional data if the company does not comply.

While operations have continued, NVIDIA was taken offline for two days, most likely to prevent any further damage. The company even retaliated with a "hack back," infiltrating and encrypting the group's servers, rendering them incapable of recovering the stolen files.

Toyota lost 13,000 vehicles in production Tuesday as a result of a cyberattack that shut down all of the company's plants in Japan. The attack on domestic supplier Kojima Industries Corporation, which supplies automakers with plastic and electronic components, halted production until Wednesday.

On the investing side, it's unsurprising that Wall Street has recently flocked to cybersecurity firms. The reality is that cybersecurity firms stand to profit as businesses improve their security. Thus, while the Russian invasion of Ukraine sent markets into a tailspin, cybersecurity stocks actually increased in February.

As illustrated in the chart below, the First Trust NASDAQ Cybersecurity ETF (NASDAQ:CIBR), which invests in 35 cybersecurity companies, outperformed the NASDAQ, the S&P 500, and the Dow. CIBR ended February up 6.4%, while the NASDAQ, S&P 500, and Dow fell 4.1%, 3.4%, and 4.1%, respectively.

While you may expect that all cybersecurity stocks are safe bets, this is not the case. Returning to CIBR for a moment, let us examine its top ten holdings.

As you can see below, not all of the stocks in Portfolio Grader receive a good standing.

Half of the top ten earn a grade of 'B' or higher on a cumulative basis. However, the remaining half of the top ten are classified as "Hold" or "Sell." Zscaler Inc. (NASDAQ:ZS), CIBR's largest holding, earns a C rating.

Alternatively, we can consider Okta Inc. (NASDAQ:OKTA), which is the fourth largest holding in CIBR and has a steadily declining Portfolio Grader rating. OKTA, in particular, has a D-rating for its Total Grade, indicating that the stock is a "Sell."

Its D-rating makes perfect sense in light of the company's fourth-quarter fiscal year 2022 earnings results, which were released on Wednesday, March 2. OKTA reported a $0.18 loss per share on revenue of $383 million. Analysts expected a loss of $0.24 per share on approximately $360 million in revenue, so OKTA exceeded analysts' earnings and revenue estimates. Revenue increased 56 percent year over year to $1.30 billion in fiscal year 2022.

However, when it comes to fiscal year 2023, Okta's guidance is less optimistic. Revenue is expected to be between $1.78 billion and $1.79 billion. Additionally, it anticipates an operating loss of between $185 and $180 million and a net loss of between $1.27 and $1.24 per share.

The disastrous forward guidance alarmed Wall Street, precipitating a more than 8% drop on Thursday. Now, those who have been following the Portfolio Grader would have known to avoid Okta heading into earnings.

Okta is most emphatically not a top ten stock in Portfolio Grader.

Having said that, not all of the top ten cybersecurity holdings are bad stocks Indeed, there are two companies that I believe are excellent buys at the moment: Cloudflare Inc. (NYSE:NET) and Fortinet, Inc. (NASDAQ:FTNT). Both companies reported solid earnings and are rated as 'Buys' in my Portfolio Grader. Additionally, they are two of my preferred cybersecurity stocks, which I recommend in my Growth Investor service. Consider the following

Cloudflare Inc. operates one of the world's largest networks, with approximately 25 million internet properties hosted on its platform. Simply put, Cloudflare's online platform acts as a conduit between users' internet requests and the servers that host these internet properties, ensuring that users can access websites and applications quickly and securely.

Cloudflare's system protects users from cyberattacks. The detection and blocking of these attacks has resulted in a 30% increase in website loading speeds. The company operates data centers in over 200 cities worldwide to handle all of these requests (an average of 20 million HTTP requests per second) and to provide security solutions to safeguard internet properties against malicious attacks. Additionally, the company's platform enables businesses to reduce costs by eliminating the need to manage or integrate individual network hardware.

I should mention that NET serves over 3.2 million customers, including approximately 16% of the Fortune 1000.

On February 10, the company announced its fourth-quarter results. Earnings for the fourth quarter increased to $0.1 million, up from a loss of $7.4 million in the fourth quarter of 2020. Revenue increased 54 percent year over year to $193.6 million in the fourth quarter, exceeding analysts' expectations of $184.9 million.

Cloudflare generated total revenue of $656.4 million in fiscal year 2021 and reported a loss of $0.05 per share in earnings per share. This represented a 52 percent increase in annual revenue, compared to a $0.12 loss in earnings per share in fiscal year 2020. Analysts anticipated a loss of $0.05 per share and revenue of $647.59 million.

Cloudflare's management noted that 2021 marked the fifth consecutive year of compounded revenue growth of 50% or more. Additionally, the company anticipates that momentum will continue in fiscal year 2022. Cloudflare anticipates total revenue of $927 million to $931 million and earnings per share of $0.03 to $0.04.

The company scores highly in Portfolio Grader, earning an overall 'B' grade, indicating that it is a good buy.

Fortinet, Inc. offers unified security solutions for protecting users against malware, spam, and network intrusions. Individuals and businesses have increased their security efforts, which has increased demand for the company's services and products.

On February 3, FTNT reported earnings that were higher than expected for the fourth quarter and fiscal year 2021. Revenue increased 28.8 percent year over year to $963.6 million in the fourth quarter, exceeding consensus estimates of $960.46 million.

Earnings for the fourth quarter increased 17.3 percent year over year to $205.8 million, up from $175.5 million in the fourth quarter of 2020. Analysts expected earnings of $1.15 per share, so Fortinet surprised by 7%.

For fiscal year 2021, Fortinet generated $3.34 billion in revenue and earned $666 million in profit. These results exceeded analysts' expectations for earnings of $3.91 per share on revenue of $3.34 billion by 28.8 percent and 18.4 percent, respectively, and surpassed revenue growth of 28.8 percent and earnings growth of 18.4 percent.

Fortinet has grown its revenue by at least 20% annually for the last three years. FTNT anticipates revenue of between $4.275 billion and $4.325 billion and earnings per share of between $4.85 and $5.00 in fiscal year 2022.

Fortinet received a 'A' Total Grade after earning a 'B' Fundamental Grade and a 'A' Quantitative Grade. Thus, it not only has strong fundamentals, but also faces persistent institutional buying pressure. This alone makes it a compelling purchase in my opinion.

While cybersecurity stocks have become popular among investors, this does not mean that every cybersecurity company is a good buy at the moment. Therefore, before investing in any cybersecurity stock, consider its fundamentals.