3 Top Cybersecurity Stocks to Buy After the Market Sell-Off

Cybersecurity is becoming a defensive industry to invest in. Regardless of how uncertain economic conditions get, security software will be one of the last pieces of a business budget to get slashed. And the frequency and cost of enduring a cyber attack is on the rise, which means cybersecurity providers have a clear pathway to continued growth as well.

With that in mind, recent stock market volatility presents many buying opportunities in this niche of the technology sector. Here's why Palo Alto Networks ( PANW -0.55% ), Dynatrace ( DT -3.19% ), and Elastic ( ESTC -2.84% ) are three cybersecurity stocks worth taking a look at right now.

1. Palo Alto Networks: The largest cybersecurity pure-play stock

After turbulence beat down peers Fortinet and CrowdStrike Holdings, Palo Alto Networks once again tops the cybersecurity space as the most valuable company measured by market cap. And with $4.9 billion in trailing 12-month revenue, it's also the largest security product specialist by sales as well. 

After a few years of aggressively acquiring small cloud-native peers, Palo Alto is stronger than ever before. From more traditional types of security using firewalls (devices that protect a physical location like an office or data center) to more modern approaches like endpoint security and SASE (secure access service edge), Palo Alto has its customers covered. A diversified approach to cybersecurity might seem like a hindrance to growth, but CEO Nikesh Arora has often said that enterprises are in search for fewer product partners, not more.

Palo Alto's bet on broadening its capabilities via acquisition is paying off in spades. Second-quarter fiscal 2022 (the three months ended Jan. 31) revenue increased 30% year over year to $1.32 billion. And as a general indication of future growth, remaining performance obligation (or RPO, meaning current and future invoices to be sent to customers based on business contracts) increased 36% year over year to $6.3 billion.

Arora and company expect full-fiscal year revenue to now be at least $5.43 billion, an increase of 27% from last year. Adjusted free cash flow profit margin (which excludes new corporate headquarters spending) should be 32% to 33%, which would be good for $1.74 billion. Based on this expectation, Palo Alto Networks' stock currently trades for 31 times current-year free cash flow. Given how important the company's products are to large organizations around the globe, and how fast Palo Alto Networks is growing, I say that's a pretty decent long-term deal.

2. Dynatrace: Cloud observability is a critical modern IT function

With computing rapidly moving to the cloud, new management tools are needed. One such toolkit is known as cloud observation -- software that helps IT teams troubleshoot and fix problems with large cloud computing operations. That's where Dynatrace and its platform for cloud intelligence and automation come in.

Dynatrace's name comes from software technology known as distributed tracing. Think of this as a flag or marker that helps trace a packet of data as it moves through an IT system's infrastructure and interacts with different applications and services. This flag can help an IT team quickly identify problem spots, automate fixes, and optimize performance. It's also tremendously helpful in spotting potential cyberattacks (cloud application security is one of the modules available on the Dynatrace platform).

These capabilities have been of particular interest to large enterprises with sprawling operations, and that is in fact the primary target of Dynatrace's sales and marketing team. Its focus is paying off. Total revenue increased 32% year over year to $241 million in Q3 fiscal 2022 (for Dynatrace, the three months ended Dec. 31). Free cash flow was $59.2 million, a margin of 25% -- a very healthy amount for a company that is funneling lots of cash into research, development, and marketing. 

For the rest of its fiscal year, Dynatrace and new CEO Rick McConnell (a former executive at Akamai and general manager of its security technology group) expect revenue to be at least $922 million and generate free cash flow of at least $268 million. At 45 times expected free cash flow, shares still trade for a premium. But given the rapid growth of the cloud and big company needs for automation to help manage and secure it all, I like Dynatrace's long-term prospects.

3. Elastic: Data analytics learns some new tricks

Elastic isn't exactly the first name that may come to mind when thinking about cybersecurity. This data analytics software company specializes in enterprise search and data log management (which can also be used in cloud observability and application performance management). But another key use of Elastic's brand of data analysis is indeed security, specifically in areas like threat detection and response.

Like other companies in this area of software (including Splunk), Elastic's technology was born in an era that mostly predates the cloud. But migrating to a cloud-based service hasn't hindered this company. On the contrary, cloud has been a huge value-add for the company's financial results. Cloud revenue was $80.4 million in Q3 fiscal 2022 (the three months ended Jan. 31), a 79% increase that added to Elastic's overall revenue growth rate of 43% in the period. 

One caveat to investing in Elastic is profitability. The company generated free cash flow of just $3.5 million through the first nine months of its current fiscal year. This is by design, as Elastic is trying to scoop up as much of the expanding data and cloud analytics market as possible (estimated to be worth some $78 billion, according to tech researcher IDC and as cited by Elastic in its last earnings presentation). Businesses that generate little to no profit have been out of favor for a while now. Elastic is no exception -- its stock price is down 60% from its all-time high last autumn.

But that doesn't mean Elastic won't be profitable someday. Margins will improve in time as the company reaches greater scale, and as spending on sales and marketing become a smaller percentage of revenue. In the meantime, with shares now trading for just under nine times expected fiscal 2022 sales, now looks like a good time to buy this fast-moving software security company.

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