2 Stocks to Watch From a Prospering Security Industry

The Zacks Security industry is benefiting from the solid demand for cybersecurity offerings and the heightening need for secure networks and cloud-based applications amid growing hybrid working trends. Companies in this space are benefiting from the rising demand for IT security solutions due to a surge in the number of data breaches. Increasing requirements for privileged access security with digital transformation and cloud migration strategies are also fueling the demand for cybersecurity solutions.

Industry participants like Qualys, Inc. QLYS and Varonis Systems, Inc. VRNS are gaining from the aforementioned trends. However, the industry’s near-term growth prospects are likely to be hurt as organizations push back their investments in big and expensive technology products on growing global slowdown concerns amid the current macroeconomic challenges and geopolitical tensions. Additionally, elevated operating expenses related to hiring new employees and sales and marketing strategies to capture more market share are likely to strain margins in the near term.

Industry Description

The Zacks Security industry comprises companies offering on-premise and cloud-based security solutions. The solutions can be used for identity access management, infrastructure protection, integrated risk management, malware analysis and Internet traffic management, to name a few. Industry participants offer different types of security solutions, most of which can be used interchangeably. These solutions can be roughly categorized into three types — Computer Security, Cybersecurity and Information Security. Computer Security solutions provide protection from vulnerabilities in the software and hardware of a computer system. Cybersecurity includes sections like web security, network security, application security, container security and information security. Information Security is concerned with any form of data-security issue, be it physical or digital data.

Major Trends Shaping the Future of the Security Industry

Rising Cyber Threats Boost Demand for IT Security: Frequent cyberattacks are spurring the demand for security solutions. This trend has not only affected certain companies but also threatened the national security of some countries. The prevailing global health crisis has given rise to newer forms of hacking and cybercrimes, which are difficult for firms and individuals to deal with. Firms operating in the security industry are working hard to address these concerns. These companies are positioned to benefit as protection against spear phishing, credential-based attacks, account takeover and ransomware attacks, among others, has become the need of the hour.

Accelerated Digital Transformation Aids Growth: Increasing the requirement for privileged access security with digital transformation and cloud migration strategies is fueling the demand for cybersecurity solutions. Organizations are witnessing increased cyber onslaughts following the pandemic as businesses of all sizes are transitioning their operations to various online platforms. From education to entertainment, working to shopping, and even health care has gone virtual, causing high technology percolation in everyday lives. This not only puts businesses but also schools, hospitals and other organizations at risk of online assaults. While public institutions and large companies have always been the target of hackers, smaller organizations with lower security standards are also on their radars. Further, the advent of 5G will enable other devices to connect to the Internet, thereby expanding the scope of the Internet of Things (IoT) and artificial intelligence (AI). While IoT and AI will simplify things, these will also aggravate the rate of cybercrimes, given the increased reliance on technology.

Macroeconomic Headwinds Might Hurt IT Spending: Enterprises may postpone their large IT spending plans due to an uncertain macroeconomic environment and geopolitical issues. Amid the ongoing macroeconomic challenges, organizations are most likely to prefer to retain cash and lower their spending. This does not bode well for the Security market’s prospects in the near term.

Elevated Operating Expenses to Hurt Profitability: To survive in the highly competitive IT security market, each player is continuously investing in broadening its capabilities. The players in the space are aggressively investing in research and development to enhance their product portfolio and boost their capabilities to provide a complete security solution to clients. Moreover, companies are investing heavily to amplify their sales and marketing capabilities, particularly by increasing their sales force. Therefore, elevated operating expenses to capture more market share are likely to dent margins in the near term.

Zacks Industry Rank Indicates Bright Prospects

The Zacks Security industry is housed within the broader Zacks Computer and Technology sector. It carries a Zacks Industry Rank #103, which places it among the top 41% of more than 250 Zacks industries.

The group’s Zacks Industry Rank, which is basically the average of the Zacks Rank of all the member stocks, indicates solid near-term prospects. Our research shows that the top 50% of the Zacks-ranked industries outperform the bottom 50% by a factor of more than 2 to 1.

The industry’s positioning in the top 50% of the Zacks-ranked industries is a result of a positive earnings outlook for the constituent companies in aggregate. Looking at the aggregate earnings estimate revisions, it appears that analysts are optimistic about this group’s earnings growth potential.

Industry Outperforms the S&P500 and the Sector

The Zacks Security industry has outperformed the S&P 500 composite and the broader Zacks Computer and Technology sector over the past year.

The industry has soared 46.8% during this period, while the S&P 500 and the broader sector have risen 24.1% and 42.2%, respectively.

One-Year Price Performance

Industry's Current Valuation

On the basis of the trailing 12-month price-to-sales ratio (P/S), which is a commonly used multiple for valuing Security stocks, the industry is currently trading at 13.36, higher than the S&P 500’s 4.01 and the sector’s 5.16.

Over the last five years, the industry has traded as high as 21.82X and as low as 8.07X and recorded a median of 13.10X, as the charts below show.

Price-to-Sales Ratio (Industry vs. S&P 500)

 

Price-to-Sales Ratio (Industry vs. Sector)

2 Security Stocks to Watch

Qualys: The company offers cloud security and compliance solutions that enable organizations to identify security risks to their information technology infrastructures, thus helping protect their IT systems and applications from cyberattacks.

Qualys is gaining from the surging demand for security and networking products amid the growing hybrid working trend. Accelerated digital transformations by organizations are also fueling the demand for the company’s cloud-based security solutions.

Qualys' recurring subscription-based business model has been providing relative stability to its top line amid post-pandemic disruptions. The company expects to drive durable top-line growth and leverage its highly scalable model to maintain strong cash flow and industry-leading profitability.

Qualys' ability to attract new customers and retain existing ones underscores its strong market positioning and value proposition. For the last few quarters, Qualys has been able to close a significant number of six-figure deals.

Currently, Qualys carries a Zacks Rank #3 (Hold). You can see the complete list of today’s Zacks #1 Rank (Strong Buy) stocks here.

The Zacks Consensus Estimate for 2024 earnings has remained unchanged at $5.17 per share over the past 60 days. Qualys shares have risen 25.8% over the past year.

Price and Consensus: QLYS

 

Varonis Systems: The company provides an innovative software platform that allows enterprises to map, analyze, manage and migrate their unstructured data. Its products include DatAdvantage, DataPrivilege, IDU Classification Framework, Data Transport Engine and DatAnywhere. The company sells its products to small and medium businesses and large multinational enterprises in financial services, consumer and retail, industrial, healthcare, and energy and utility industries.

Varonis Systems is benefiting from the rising demand for cyber security solutions due to the long list of data breaches. Increasing demand for privileged access management solutions due to digital transformation strategies remains a key growth driver. Strong presence across small and medium businesses and large multinational enterprises in financial services, consumer and retail, industrial, healthcare, and energy and utility industries is driving revenues.

Varonis Systems currently carries a Zacks Rank #3. The consensus mark for its 2024 earnings has been revised downward by a penny to 13 cents per share over the past 60 days. Shares of VRNS have soared 70.3% over the past year.

Price and Consensus: VRNS

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Zacks Investment Research

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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