Small Cap Guru's Cybersecurity Buys

04/15/2016 10:00 am EST

Focus: TECHNOLOGY

James Oberweis

President, Oberweis Asset Management, Inc.

Small cap expert Jim Oberweis, Jr. of the Oberweis Report discusses the cybersecurity sector, highlighting its potential and volatility, while offering an overview of the best-positioned stocks and ETFs for investors seeking exposure to this sector.

Joining us today is Jim Oberweis, Jr., industry leading money manager, a small cap expert and editor of the Oberweis Report.  

Steve Halpern:  How are you doing today, Jim?

Jim Oberweis, Jr.:  Doing very well.  Thanks for the opportunity to be on the show today.  

Steve Halpern:  In your latest newsletter, you discuss cyber security and you talk about spending in this area continues to grow explosively.  What are some of the drivers behind this sector?

Jim Oberweis, Jr.:  Yes, sure, I mean.  One of the main drivers is a lot of money that's flowing into the sector is expanding dramatically.  Gartner Group estimates that by 2018, spending on global cyber security should increase to over a $100 billion versus about $75 billion right now.  

Domestically at home, we can see it too.  Obama, in his most recent budget, is asking for $19 billion versus only $14 billion last year -- so a $5 billion increase.  In Europe in 2018, new data protection laws kick in, which will dramatically increase fines for data breaches.  

I think companies and governments both have really recognized that they're behind the curve in catching up with cyber security protection.  

Steve Halpern:  In your research report, you note that network security has become more complex to the three specific trends.  Could you walk us through these issues?

Jim Oberweis, Jr.:  Yes, sure can.  Traditionally, the simple way to protect a network was to put a firewall around the perimeter of the network checking data flow that was coming in and out.  

Unfortunately, that model doesn't really work anymore.  First of all, companies are putting more and more of their business in the cloud so it's outside of their traditional network.  

Secondly, employees these days are bringing their own devices to work, so rather than cell phones being supplied by the companies, people are using their own.  

The last one is the Internet of Things -- of having anything from your TV to your refrigerator to your sensor as you walk around the office all connected to the internet so that's really greatly increased the complexity and the need to protect networks against cyber security breaches.  

Steve Halpern:  So this industry in recent years has been a bit of a roller coaster and you note that they were market darlings first and then more recently have plummeted in price.  Could you explain this volatility?

Jim Oberweis, Jr.:  Yes, sure.  I think the growth in cybersecurity at this point is widely appreciated by the Wall Street community.  That means that the market leaders are generally being very highly valued, not only in the public markets but also in the venture world.  

Some of them will end up working out really well and others won't.  I think when you see data points that go either way, or even changes in overall market valuations, it can really affect the valuations.  

Just to put it in a context in the first half of 2015, some of the industry leaders like FireEye (FEYE), Imperva (IMPV), Palo Alto Networks (PANW) and Cyberark (CYBR) reported gains ranging from 30% to 60%. But the second half of 2015 up until the end of March, we saw a very different picture.  

FireEye dropped 63%, Imperva came down 30%.  Cyberark dropped 36%. Palo Alto, while it's still 20% off it's 2015 high, it's still about 25% higher than at the beginning of 2015 and that's really kind of the bellwether for the industry and that has held up a little better.  

This is not for the faint of heart. But what we do think is that it's hard to find growth in this kind of economy.  These companies will grow.  

They're going to grow quite strongly and valuations are probably at a more reasonable level; even though they're not cheap, they're probably at a much better entry point than they were before.  

Steve Halpern:  Can you highlight a couple of stocks that you would recommend for investors who understand the risks in this sector but they're looking for longer term exposure?

Jim Oberweis, Jr.:  At the larger cap then, it's hard to overlook Palo Alto Networks. That's the largest of the cyber security stocks of the market capitalization of 13 billion.  We think that should be a core holding.

But some of the other small caps probably will have higher growth rates and higher risk but higher return potential so that would include companies like Imperva, Cyberark, Gigamon (GIMO), all three of which are held in our model portfolio and our client portfolios.  

Alternatively if somebody just wants to pick something to set it and forget it and not try and pick individual stocks, there are two ETFs that specialize in cybersecurity.

Pure Funds ISE Cyber Security (HACK) has an expense ratio of 75 basis points so you're paying for that in this ETF.  That's the largest ETF.

And then the second one would be the First Trust NASDAC Cyber Security (CIBR).  It's a much smaller ETF but with a little lower expense ratio at 60 basis points.  

Steve Halpern:  Again, our guest is Jim Oberweis of the Oberweis Report.  Thank you for your time.  It was really a fascinating look at an important industry.  

Jim Oberweis, Jr.:  My pleasure, Steve.  Nice to talk to you again.

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