Global X Cybersecurity ETF (BUG) Is A Buy At $20 (NASDAQ:BUG)

Investment Thesis

The Global X Cybersecurity ETF (NASDAQ:BUG) is an exchange-traded fund that gives exposure to companies which benefit from the increased adoption of cybersecurity technology. Since the fund's inception, it has outperformed peers such as the ETFMG Prime Cyber Security ETF (HACK) and the recent price correction amidst heightened geopolitical tensions could present a buying opportunity for long term investors if the price reaches around $20.

Catalysts are mounting and as the broad market works its way through continued volatility, the ETF is poised for a rebound after capitulation. Patience will be needed for investors who wish to buy into this fund, as valuations in the space are still considered high and the sector is trading at multiples which to some degree reflect the future growth potential.

Introduction

BUG is an ETF which I have been watching for some time now, after getting interested in the cybersecurity sector of the market last year. I began looking at companies such as CrowdStrike (CRWD) which have shown quite a bit of growth in recent years and outperformed the market. While many of these stocks seemed too expensive to buy at that time, after a 20-30% crash in growth stocks this year, the valuations are looking substantially more attractive.

Given the current environment of uncertainty amidst geopolitical tensions, the ETF could provide investors with exposure to the cybersecurity sector using a diversified strategy as the industry prepares for supercharged growth in coming years.

However, valuations of many of the holdings are still high even after a large price correction. Some caution is warranted here for investors, as rising interest rates could cause the prices to drop even more on multiple contractions in the more high-growth stocks. An even price of $20 for BUG would likely present a great buying opportunity for long-term investors, but it is unclear if Mr. Market will give us the price we are ultimately looking for.

BUG's Clear Outperformance

In the chart shown below, it is crystal clear that BUG outperforms peers such as HACK. The technical pattern is very similar but the percentages vary substantially.

Not only does BUG outperform HACK on the upside, but it also limits downside and has been much more stable over the last year. While the two ETFs started out looking more correlated during the summer of 2021, the divergence has expanded over time and now shows that there could be a support level we are close to hitting. While the ETF has now rebounded above $25, more volatility in the market needs to work its way out and a buying opportunity is likely in the near term, should the fund test the lows of $24.36 and fall further to around $20.

Growth Potential

According to Grand View Research, the global cybersecurity market is projected to grow to from nearly $180 billion to more than $370 billion by 2028. This projection suggests that the cybersecurity market as a whole could more than double over the next five to six years, with an impressive CAGR and high profitability to go along with the growth.

This massive industry growth is enticing, but valuations are high to match the expectations. For this reason alone, some caution is warranted for investors who wish to invest in cybersecurity stocks. Overpaying for growth is something that many market participants fell prey to last year, and while valuations have improved for many companies in the sector, they are still considered high. Picking one single company to invest in is also, in my opinion, somewhat risky because of the complexity of the businesses. Many investors would put these companies in the "too hard" pile, but with an ETF, the risk is more spread out and volatility is more limited.

With mounting geopolitical tensions, this sector is getting a lot of attention in recent months. According to the World Economic Forum's Global Cybersecurity Outlook report, the number of cyberattacks more than doubled globally in 2021. Last week, Interpol gave an astounding warning that "Military-made cyberweapons could soon become available on the dark web" within a couple of years. With these high-tech weapons falling into the hands of organized crime, the rate at which cyber-crimes occur could prove to be exponential in the coming years.

It is also important to note that a "huge number" of cyberattacks go unreported, so the data coming through is very likely low-balling the actual number of occurrences globally. The need for cybersecurity is extremely apparent, and the solutions are already in front of us.

Our problem is not needing ‘next-gen’ AI, blockchain or whatever else... Our problem usually is just about rolling out with things that we’ve already invested in.”

Source: Robert Lee, CEO of Cybersecurity Firm Dragos

BUG's Holdings

The Global X Cybersecurity ETF holds 29 securities, with many of the top holdings some of the most recognizable and respected companies in the industry.

These top 15 holdings comprise approximately 77% of the entire ETF, with the top 5 making up nearly 30% of net assets. Companies such as Palo Alto Networks (PANW) and Check Point Software Technologies Ltd. (CHKP) are highly rated, and newer public companies such as CRWD also rank high on the list.

However, many of these companies trade at lofty Price-to-Sales ratios, with CrowdStrike coming in at 23x sales, Fortinet (FTNT) at 13x sales, and Okta (OKTA) at just over 10x sales. While these companies are rapidly growing, more established peers such as Check Point Software Technologies are trading at more reasonable valuations of 7x sales and 19x earnings. This is still expensive however, and the valuations of these growth stocks invite a lot of volatility into one's portfolio, should an investor choose to pick individual stocks from the fund's holdings.

Risks include rising interest rates and multiple contractions, with certain stocks with higher growth rates possibly in for further drawdowns of 25-40% before reaching valuations one would call cheap. Still, with industry growth estimated to be very high for years to come, valuations are beginning to look more attractive. A good buying opportunity for BUG is likely in the near term, should market volatility persist.

Stock-Picking Versus An ETF

While there is nothing wrong with trying to be a stock-picker in the cybersecurity sector, ETFs such as BUG offer a more diversified approach and limit downside risk. Sometimes picking the stock with the lowest relative valuation works out tremendously, but sometimes an investor can be unknowingly sacrificing quality and growth for a cheap price-tag. I believe in more of a 'quality above all else strategy' if one chooses to be a stock-picker, especially in the long term. Oftentimes, the highest quality stocks will appear to be the most expensive, although this is not always the case. While some of these cybersecurity companies might be more speculative, the risks are always apparent and no investor is infallible. I think at this moment in time, judging cybersecurity stocks individually is very difficult unless you have wide knowledge of the industry, and so an ETF could make a lot of sense for the average retail investor.

Conclusion

The Global X Cybersecurity ETF has shown relative outperformance compared to peers over the last year, and after a correction in the market, the fund is beginning to look attractive from a long-term investment standpoint. However, with valuations still elevated across the board, it may be smart to wait until the price comes closer to $20 before starting a position. Cybersecurity is arguably one of the most important sectors in the market right now, and with geopolitical tensions mounting, investors may want to get exposure to the sector at the next great opportunity. Growth potential of the industry is massive over the next five to six years, but valuations already reflect this potential to some degree. I currently see BUG as a Hold, and would be a buyer on a meaningful drop in the sector to bring the ETF closer to $20.

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