Cloud security stocks are likely to accelerate once Covid-19 starts to abate. Here are my three favorite. Which should you buy now?
When news first broke in early November that we would likely have an effective vaccine for Covid-19 soon, there was a knee-jerk negative reaction in many growth stocks. The idea at the time was that when the world returns to “normal” many growth stocks that have done well during the pandemic would falter, as their growth rates would slow.
Time will only tell if that thesis plays out. But my two cents on the topic is that the argument is too broad and doesn’t apply to all growth stocks. Sure, there are some that have enjoyed only a temporary bump in business due to the pandemic, but there are many others for which growth is likely to persist at a faster rate after the pandemic than it otherwise would have.
Today I want to focus on three such stocks. They’re all cloud-based security software stocks.
A quick look at these three cloud security stocks provides interesting insight into the dynamics of the “stronger for longer” argument that I’ve been making to subscribers of both Cabot Small-Cap Confidential and Cabot Early Opportunities. And because these three companies just reported recently, we can evaluate them based on relatively recent results and management’s latest public comments.
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Without further ado, here we go.
Cloud Security Stock #1: Okta (OKTA)
Okta has a market cap of $33 billion and developed the first cloud-based platform for identity and access management solutions, which is a roughly $25 billion dollar market today. The company is moving upmarket from mid-size to larger companies, and now has more than 320 accounts worth over $500,000 a year and 35 accounts worth over $1,000,000 a year.
Revenue was up 47% in fiscal 2020, which ended in January, and it is tracking toward being up 40% in fiscal 2021. That trajectory was confirmed after the company’s Q3 fiscal 2021 report which showed that revenue grew by 42%. Dollar based net retention was 123%. Management also issued preliminary revenue growth guidance of 30% for fiscal 2022, which was slightly ahead of expectations.
The stock recently reached all-time highs, but OKTA is largely unchanged since the report came out. Stepping back, the report hasn’t changed the trajectory of the stock in a meaningful way. It just continues to move slowly higher, albeit with a pattern of roughly 15% to 20% pullbacks along the way (at least since May).
Cloud Security Stock #2: Zscaler (ZS)
Let’s move on to Zscaler (ZS), which has a market cap of $24 billion. The company is a provider of network security solutions for many of the biggest companies out there. Its software does things like replacing VPN appliances and providing connections that are used to route traffic between an organization’s headquarters and remote locations.
Naturally, these services are in high demand during the pandemic. The company is going after a roughly $20 billion dollar market and it is grabbing more customers and landing bigger deals as customers are now all in on cloud transformation.
Revenue was up 42% in fiscal 2020, which ended in July. But growth accelerated to 52% in the first quarter of fiscal 2021, which ended in October and was just announced recently. The quarterly result suggests consensus estimates of around 37% revenue growth for the current year are too low and that actual growth will be in the low-to-mid 40% range.
Even better, EPS should grow faster as the business keeps scaling up and more money flows to the bottom line. We’re looking for EPS of around $0.37 this year, up almost 60%, and it looks like EPS could stay near a 50% growth rate through fiscal 2023.
Put it all together and you get a stock that rallied 30% in December alone. When you see a big jump like this a few things could be going on. It could be a little bit of a short squeeze, or also just a lot of demand for the stock due to evidence that the stronger for longer thesis is likely to play out.
Either way you slice it the growth here is impressive, as is the stock’s reaction. ZS has held on to its post-earnings report gain and is trading just a few percentage points off its all-time high.
Cloud Security Stock #3: CrowdStrike (CRWD)
Last up is CrowdStrike (CRWD), which has a market cap of $38 billion. The company provides endpoint security solutions for things like laptops, desktops and IoT devices. CrowdStrike’s platform was born in the cloud so it’s always been there – no messy changes from the on-premise to cloud business model or anything like that here. CrowdStrike is taking market share from legacy players as enterprises are more comfortable turning off their old solutions and moving to the cloud now.
Revenue was up 93% in fiscal 2020, which ended in January, and it is on pace to grow by almost 80% this year. We’re also looking for EPS to turn positive for the first time. The company reported Q3 fiscal 2021 results this month. Revenue was up 86% to $233 million and adjusted EPS was $0.08. Management said the company signed way more clients than expected – around 1,200, versus the roughly 550 analysts had forecast. Better still, customers are using more modules than expected too. Net revenue retention is over 120%, showing that customers are spending more money with CrowdStrike over time.
The stock has reached all-time highs since the report and, although it’s given a little back, is still trading comfortably near those prices.
My Favorite Cloud Security Stock
Stepping back, what we see here is evidence of the stronger for longer thesis playing out among cloud-based security software stocks. The transformation that was happening prior to the pandemic has only gained momentum during it, and should sustain afterwards.
If you already own these stocks, I think you should continue to hold on. If you don’t, my preference is to buy CrowdStrike, followed by Zscaler. The pace of customer growth, as well as number of modules per customer, make total revenue growth for CrowdStrike just too attractive to pass up.
That doesn’t mean you need to chase it right now, however.
As always, position sizing matters. After this recent run a smaller amount invested makes more sense. Average in, try to buy on pullbacks, and let the dollar cost averaging strategy pull you into your desired position size over time.
*This post has been updated from a previously published version.
Tyler Laundon is chief analyst of Cabot Small-Cap Confidential. The circulation of Small-Cap Confidential is strictly limited because the undiscovered stocks with sky-high-potential that Tyler recommends are often low-priced and thinly traded. Don’t share these recommendations!Learn More