HACK ETF: Cybersecurity Should Be Considered Part Of The Defense Sector

Cybersecurity has become one of the most critical components when it comes to protecting the interests of individuals, corporations, and national governments. In recent years, we have seen numerous ransomware and cyberattacks on corporations, US government agencies, and critical infrastructure assets such as the Colonial Pipeline, the largest gasoline pipeline in the US that connects refineries in Texas to the coast. East. In my opinion, cybersecurity has become so important that serious consideration should be given to placing it under the umbrella of the US Department of Defense. There are a couple of additional positive catalysts for cybersecurity companies: the fast-growing crypto market and the potential for consolidation across the cybersecurity industry. Meanwhile, earnings are growing and the sector continues to outperform the broad S&P500. Today, I'll take a closer look at the ETFMG Prime Cyber ​​Security ETF (NYSEARCH:CUT TO SLICES) as a possible participation in a well-diversified portfolio.

investment thesis

According to Fortune Business Outlookthe global cybersecurity market is poised for a significant growth acceleration in the coming years: from a $139.8 billion market in 2021 to $376.3 billion in 2029 (a CAGR of 13.4%):

Research indicates that the expected growth of the cybersecurity market is due to the same reasons I am so optimistic about the semiconductor segment in the future: high growth in 5G infrastructure, mobile 5G, Internet of Things proliferation ("IoT"), cloud computing, e-commerce, cryptography, high-speed networking, and AI, among other growth trends. All assets related to these technology subsectors will require protection against cybersecurity threats.

The rapid growth of cryptocurrencies is another positive catalyst. Crypto, being a digital blockchain-based technology, is particularly exposed to hacking and needs to be highly protected against hacking to gain investor acceptance and for the industry to continue to grow.

In the meantime, note that this week's Barron's magazine suggested that the cybersecurity industry is ripe for consolidation (see Cybersecurity threats — and profits — are on the rise).

So let's take a look at the HACK ETF to see how it has positioned investors to benefit from these trends.

Top 10 Holdings

The top 10 holdings in the HACK ETF are shown below and equate to what I consider to be a relatively well-diversified 45.4% of the entire portfolio:

Note that the top 10 holdings have the same relative weight. Typically, in a fast-growing industry like cybersecurity, I'd rather see more concentration in a few of the more dominant companies (Palo Alto (PANW), CrowdStrike (CRWD), Z-Scaler (ZS), etc). However, if Barron's is correct in its assertion that the sector is ripe for continued M&A activity, smaller players may outperform over the next year.

The #1 holding in HACK ETF weighing 4.7% is cloud flare (NET). Cloudflare currently has a market cap of $34.5 billion, but is barely profitable. With a forward P/E of over 3400x, it is a curious choice to anchor the portfolio in my opinion. Last month, NET announced that acquire Area 1 Security for $162 million, with 40-50% of the purchase price in NET shares and the remainder in cash.

More to my liking is the #3 holding Akamai Technologies (MY BROTHER). Akamai has evolved its leading and legacy global content delivery network ("CDN") into one of the leading providers of global cybersecurity. See my article Finding Alpha: Akamai is fast becoming a leading power in cybersecurity. Unlike many companies in the cyber security space, AKAM is extremely profitable, poised to generate EPS of ~$6 per share this year and, with a forward P/E of just 19.9x, is trading at a discount Regarding the S&P 500. M&A issue, note that AKAM recently announced that acquires Linode for $900 million.

Leading cybersecurity provider crowdstrike it is the holding company #6 with an allocation of 4.6%. In my opinion, the weight of this portfolio is too low for one of the fastest growing respected companies in the industry. On March 9, CRWD announced Q4 results that exceed both on the top and bottom lines. Quarterly revenue of $431 million (+62.7% year over year) beat consensus estimates by $18.62 million, while non-GAAP EPS of $0.31 topped $0.11. Better yet, net new annual recurring revenue ("ARR") was a record $217 million, the second consecutive quarter of accelerated growth in new ARR.

network infrastructure company cisco systems (CSCO) is the #8 holding company with a weighting of 4.5%. With a P/E of 16.3x and a yield of 2.7%, Cisco is seen as a value bet within the industry and adds a measure of balance to a portfolio that has some "high-end travelers."

Leading cybersecurity provider Palo Alto Networks it is the holding company #9 with an allocation of 4.4%. Again, similar to CrowdStrike, I'd rather see significantly more weight given to a high-quality company like Palo Alto. After strong second quarter reportJPMorgan upgraded its PANW price target to $620 while Morgan Stanley named the company its first option in the PANW sector closed on Friday at $577 and has a forward PER = 79.1x.

Performance

Over the past 5 years, the HACK ETF has generated an average annual return of 15.2%. The chart below compares the three-year returns of the HACK ETF against several competing cybersecurity funds (ERROR, IHAKand CIBR) along with the broad market averages represented by the TO SPY, DAYand QQQ ETFs:

Leading the pack by a significant margin is BUG, ​​the Global X cybersecurity ETF. I cover the BUG ETF on Seeking Alpha and it remains my favorite fund in the space (see Recent Cybersecurity Earnings Reports Are Why You Should Own The BUG ETF NOW). BUG has outperformed the HACK ETF by 40% or more in the last three years.

risks

All the investment risks typical of the current market environment also apply to the HACK ETF: rising inflation and interest rates, supply chains impacted by covid-19 and factory closures, geopolitical risks related to the invasion of Ukraine by part of Putin and China's growing belligerence as it is affecting US-China trade relations. That said, it could be argued, and I am arguing, that the growing conflicts with Russia and China are actually a positive tailwind for the cybersecurity industry.

Additionally, the HACK ETF owns several companies that currently have sky-high valuation levels that make the fund particularly susceptible to a significant market correction.

Meanwhile, HACK's expense ratio is 0.60%, which is pretty high in my opinion given its relative performance. The BUG ETF is outperforming HACK and has a lower expense fee (0.50%).

Summary and conclusions

The global cybersecurity market is expected to grow at a CAGR of 13.4%, which means it should double in ~5.5 years. That being the case, investors should consider allocating some of their portfolio to the sector, either through individual stocks or a diversified fund like the HACK ETF. However, I have reviewed several stocks and funds in the sector and have decided that BUG ETF is the best cybersecurity option for a well-diversified portfolio that does not want to take the risks of owning single stocks within a sector that typically trades at a lower level. quite high rating. For individual stocks, I'd suggest Palo Alto or Akamai. AKAM may well be the best risk/reward opportunity in the industry for the more conservative investor.

I'll end with a chart comparing the 1-year returns of some of the leading cybersecurity stocks alongside the HACK and BUG ETFs. Note that the second best performer of the selected stocks is Z-climbera company that isn't even in the top 10 holdings of the HACK ETF (ZS is the 11th holding in BUG with a weight of 4.6%):