The Nasdaq CTA Cybersecurity Index has outperformed the S&P 500 by 12% over the past year, and it’s easy to see why: a host of factors has brought attention back to the sector, from cyberwarfare to the advent of quantum computing. Let’s dig into these factors a bit more, and find out how you can lock down your own profits from the cybersecurity industry.
Why is the cybersecurity sector outperforming the wider market?
Covid created a permanent shift in the number of people who work from home. Employees now handle their workload – and pretty sensitive corporate data – via the internet, while businesses worldwide have been forced to take their operations online – both of which have significantly bumped up the threat of cyberattacks on vulnerable systems.
The ongoing Russia-Ukraine conflict has seen a spike in cyberattacks, and plenty of experts are worried that battlefield hacks might accidentally spill over to personal computers – or worse, that Russian hackers might launch intentional attacks on Western governments and corporations in retaliation for the West’s sanctions. After all, Russia has displayed both a strong capability and willingness to launch damaging cyberattacks in the past.
Other malicious groups are also trying to get their hands on vast amounts of encrypted data now to decrypt later, when quantum computers can easily hack even the most secure data. And rumor has it intelligence agencies across the world are doing this too. That means governments and private organizations need to start securing their systems against quantum computers long before everybody’s got one. Likewise, cybersecurity firms are working on developing quantum-enabled defenses that can withstand an assault from a quantum computer – defenses governments and corporations will pay an arm and a leg for when quantum finally goes mainstream.
Global spending on cybersecurity mergers and acquisitions grew more than 300% in 2021 compared to the year before, hitting a record $77.5 billion. And this year is already off to a flying start: Google agreed to buy cyberattack specialist Mandiant for $5.4 billion last month – its biggest deal in a decade. And then just this week, private equity firm Thoma Bravo announced it’s buying cybersecurity company SailPoint for $6.9 billion. That M&A activity is boosting cybersecurity stock valuations – both because of how much the acquirers are willing to pay and because investors are now expecting other firms to be snapped up.
And finally, there’s more and more talk of a looming recession. If it does happen, it’s possible the cybersecurity sector will outperform the wider market since it displays some defensive characteristics: cybersecurity doesn’t come cheap, but it’s a must-have for companies, after all. And unlike expenses like marketing, companies can’t risk dialing back on cybersecurity, even when times are bad. That means cybersecurity firms’ revenues could hold steady or even grow during a recession.
So what’s the opportunity here?
While you could research and invest in individual cybersecurity stocks like Crowdstrike, Fortinet, Palo Alto Networks, and NortonLifeLock, you could also use ETFs to more easily gain wide exposure to the sector.
Two of the biggest are the ETFMG Prime Cyber Security ETF – listed under the delightful ticker HACK – and the First Trust Nasdaq Cybersecurity ETF, listed under the comparatively mundane ticker CIBR. Here’s how the two compare:
HACK vs. CIBR. Source: Finimize (with data from Bloomberg)
Of the two ETFs, CIBR is larger in size and its holdings are more concentrated. But the median EV-to-forecasted-sales ratio of its constituent holdings is higher, implying that the ETF is invested in more expensive-looking stocks that could see their valuations hit harder in the current environment of rising interest rates. So perhaps the HACK ETF – which has a lower median valuation multiple and is more diversified – is a safer bet.
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