Tom Barker, Director, ARK Invest Europe, tells us why and how cybersecurity’s rapid growth outpaces concerns over profitability, and presents a compelling investment case in a critical, resilient, and evolving sector.
Only around half the companies in the public cybersecurity market are profitable based on the net income figure disclosed in their latest set of financial results.
In many industries this could be cause for concern, however, in the case of cybersecurity, this reflects more positive market dynamics, where companies exercise financial prudence by sacrificing short term profitability for longer term growth.
The first cybersecurity indices emerged in the early 2010s, recognising its growing importance of as a critical sector within the broader technology industry and aiming to capture this secular growth. Yet over a decade later, cybersecurity as an industry continues its trajectory of rapid growth. This is driven primarily by increasing digitalisation and the rising frequency of cyberattacks. Here are some eye-opening market expectations:
· Market Size and Projections: In 2023, the global cybersecurity market was valued at approximately $250 billion. It is projected to grow at a compound annual growth rate (CAGR) of 12.3%, reaching around $657 billion by 2030. (Source: Statista, Next Move Strategy Consulting, 2024)
· Rising Cybercrime Costs: The global cost of cybercrime is expected to surge from $9.22 trillion in 2024 to $13.82 trillion by 2028, underscoring the escalating threat landscape. (Statista)
· Increased Corporate Spending: Organizations worldwide are allocating a growing portion of their IT budgets to cybersecurity, with expenditures expected to reach $298.5 billion by 2028, up from $190.4 billion in 2023. (MarketsandMarkets)
· Employment Growth: The demand for cybersecurity professionals has surged, with an estimated 3.5 million unfilled cybersecurity positions globally in 2023, reflecting the critical need for skilled experts in this field. (Cobalt)
The growth of the industry is mirrored by the top line revenue growth of cybersecurity companies. Excluding Q2 2023, companies, on aggregate, have announced double digit annualised revenue growth in each quarterly earnings season. Revenue growth also has a strong track record of surpassing estimates, with most companies growing revenues beyond analyst estimates. This highlights the sector is not just growing, it is growing more quickly than projections.
Cybersecurity is the ‘consumer staples’ of technology, as its growth remains unperturbed by market developments that have impacted other sectors over the past year such as the Fed’s rate hiking campaign, supply chain issues and geopolitical tensions.
Why Cybersecurity companies elect to have lower earnings
The cybersecurity industry prioritises growth over short-term profitability, reinvesting heavily in research and development (R&D), talent acquisition, and market expansion. This investment positions cybersecurity companies to capture greater market share and achieve scale, which can lead to significant future profitability.
· Innovative Business Models: Emerging cybersecurity firms often operate on innovative, subscription-based models that take time to generate substantial profits. These models
build recurring revenue streams, creating more sustainable long-term income, even if the initial years are lean.
· Market Leadership Aspirations: Cybersecurity companies can only establish themselves as industry leaders by developing cutting-edge solutions. A lack of profitability is often the result of aggressive spending on technology development, partnerships, and customer acquisition, all of which are key strategies to dominate a competitive market.
· Sector Characteristics: Cybersecurity requires staying ahead of constantly evolving threats. Firms invest in continual product updates and innovation, making profitability a secondary goal compared to ensuring relevance and resilience in a fast-paced environment.
Earnings growth
Financial sectors around the world consistently underestimate the growth in earnings of the industry. For Q3 2024 earnings season, over 90% of the companies grew earnings and 78% have exceeded analyst expectations. In many cases, earnings results are notably higher than analyst estimates.
The increase in large-cap companies within the cybersecurity industry, from around a third in March 2020 to just over half today, is a positive sign that reflects the sector’s maturity and resilience. This, of course, is positive for earnings growth, allowing large-cap companies access to capital markets, economies of scale, and resilience to macroeconomic pressures.
Larger market capitalisations indicate that these companies have successfully scaled their operations, established strong customer bases, and gained investor confidence.
This growth enhances their ability to invest in advanced technologies, expand globally, and withstand economic fluctuations, making them more stable and reliable players in an increasingly critical industry. It also signals broader market recognition of cybersecurity’s long-term importance in the digital economy.
Valuations remain constructive
Despite strong performance since the US election result, valuations look attractive on a historical and relative basis, with the current leading P/E ratio of the cybersecurity market (28.49x, 06 December 2024) sitting more than one standard deviation below its historical mean.
2024 saw strong revenue and earnings growth in each earnings season, yet cybersecurity performance, until the start of the fourth quarter, remained flat, and one could argue it was becoming increasingly disconnected from fundamentals growth.
We are now beginning to see performance gaining traction, yet valuations remain attractive, suggesting now is a compelling entry point into a sector that has been overlooked and underappreciated.
The market often values cybersecurity firms based on revenue growth, customer acquisition, and product pipeline rather than near-term profits. A low level of profitability signals that investors are willing to fund innovation and trust in the long-term scalability of these companies.
The strong secular growth, attractive valuations currently on offer and declining losses with many of the companies in the sector, presents a compelling investment case in the cybersecurity sector.