For years, the cybersecurity sector has been closely monitored by growth investors, given its increasing importance in the global economy. When Russia invaded Ukraine in February of last year, the cybersecurity sector made headlines as it was revealed that Russia attacked Ukraine’s key digital infrastructure weeks before the invasion. Many cybersecurity stocks have had a stellar run in the market since this revelation, and Fortinet Inc. (FTNT, Financial) is no exception.
So far this year, the stock is up 46% and is one of the few stocks that have delivered positive returns over the last 12-month period too. On the back of this stellar market performance, Fortinet is now valued at a forward price-earnings ratio of 46, which suggests the company is not cheaply valued anymore.
Despite being valued at a premium, Fortinet still seems like a good bet on the future of the cybersecurity sector.
The recession-proof nature of the cybersecurity industry
According to economists polled by Bloomberg, there is a 65% probability of a recession in the U.S. within the next 12 months. With recession risks continuing to hover over the performance of global capital markets, many investors are looking to gain exposure to business sectors that are expected to be resilient during a recession.
The cybersecurity sector does not get the same attention as the consumer staples sector, but could be one of the most resilient business sectors during an economic downturn. According to data compiled by CXOToday, during the 2008 recession, revenue, operating income and many other financial performance metrics of cybersecurity companies improved compared to previous years, in complete contrast to many other tech industries that saw their financials deteriorate due to a sharp decline in consumer discretionary spending. Investing in Fortinet is likely to help investors generate alpha returns in the long term and also stabilize investment returns in the short term if the U.S. economy enters a recession.
The cybersecurity sector has a long runway for growth
The cybersecurity sector has benefited from favorable macroeconomic trends for a few years now, and this trend is likely to continue in the foreseeable future. According to Check Point Research, the number of cyberattacks increased by a staggering 38% in 2022 compared to 2021, despite security companies introducing groundbreaking technologies to prevent cyberattacks. More agile hackers, the rise of remote working and the increasing number of companies wanting to do business online were among the major reasons for the acceleration in cyberattacks last year. Notably, the average cost of a data breach is continuing to rise, which does not come as a surprise given the sensitive nature of data that is being stored online. According to International Business Machines Corp. (IBM, Financial), the average cost of a data breach in 2022 was $4.35 million, up 2.6% from 2021 and 12.7% from 2020. With businesses of every size being exposed to cyberattacks and data breaches, the demand for high-quality cybersecurity solutions is expected to remain elevated for many years. According to Global X ETFs, security spending is expected to grow at a compound annual rate of over 12% through 2026, which creates a good platform for Fortinet to grow.
The 360-degree product suite will help Fortinet gain market share
For a cybersecurity company, it is important to offer a product suite that caters to a wide range of security applications to capture and retain clients in the long run. More importantly, the product suite must adapt to changes in the technological landscape to remain ahead of the innovation curve.
Fortinet’s integrated platform approach offers security capabilities across local networks, wide-area networks, various endpoints and the cloud. This expansive portfolio of security solutions has enabled the company to build competitive advantages over time, which are now helping it earn economic profits. Across these use cases, Fortinet’s total addressable market is currently estimated at $180 billion, which is expected to swell to $280 billion by 2026. To penetrate this market, the company is investing in both software and hardware-based technologies.
The highly diversified nature of Fortinet’s business is another appealing characteristic. With recession risks continuing to loom on the horizon, investors need to ensure that the companies they are considering for investment are not reliant on one business sector. As illustrated below, Fortinet’s revenue streams are well-diversified across customer types, geographies and industries.
Source: Investor presentation.
Strong free cash flows will support future investments
One of the key challenges faced by growth investors is the lack of profitability of many high-growth companies. Fortinet, however, is an exception.
Fortinet’s revenue has grown in double digits in each of the last 10 years, and the company has been profitable in all these years as well. In 2022, the company reported a net profit of $857.3 million, an increase of 41% from 2021. This improved profitability boosted free cash flows to $1.44 billion in 2022. Over the last four years, free cash flows have grown at a stellar CAGR of 27%, which is a testament to how Fortinet has converted revenue growth into cash flows. As a cash-rich company with promising growth prospects, Fortinet will be able to utilize free cash flows to fund capital investments in the coming years without having to tap into capital markets unnecessarily.
Takeaway
Fortinet is a leading cybersecurity company that has carved out competitive advantages over the last decade with its high-quality security solutions portfolio. Aided by favorable macroeconomic developments, the company seems well-positioned to grow.
Even at premium valuation multiples, Fortinet seems like an attractive bet for growth investors looking for market-beating long-term returns.
