The need for data security solutions continues to increase but data security stocks have underperformed during 2016 says Michael Berger, Associate Editor of, who highlights his favorite stock in this sector, Palo Alto Networks.

Data security is critical for governments, businesses, and even home computer users. Data lost due to natural disasters is upsetting, but the loss of it to hackers will have greater consequences.

PureFunds ISE Cyber Security ETF (HACK) is the largest data security ETF and is often used to measure the strength of the industry. HACK has declined approximately 10% so far this year and we see upside in some of its constituents.

In the Middle of a Multiyear Security Investment Cycle

The data security industry is in the middle of a multiyear security investment cycle and we expect 2016 to be another strong year.

Advancements in technology continue to drive a next-generation replacement cycle of outdated firewall solutions and this will support continued elevated growth rates.

We expect to see a continuing next-generation firewall upgrade cycle with spending broadening into next generation endpoint protection, identity, and analytics solutions.  

An Industry Leader 

Palo Alto Networks, Inc. (PANW) remains our top pick in the data security sector and the stock looks very attractive after a 10% decline during the last month.

Palo Alto specializes in multi-function next-generation firewall appliances, which can replace several point solutions with one stand-alone appliance. The company pioneered application control technology which allows firewalls to place selective usage policies for an application rather than block it entirely.

When you look at 2016 estimates for data security companies, Palo Alto has the highest revenue growth and cash flow margin. The company has the second-highest EBIT margin of any public high growth (as defined as greater than 20%) software company that generates more than $500 million in revenue.

Valuation has Improved

Palo Alto reported better-than-expected earnings during the last two quarters and we expect the company to benefit from weak January sector sales already behind it.

At Palo Alto’s analyst day, the company made investors nervous by providing margin guidance that came in below expectations. This has been the primary driver behind recent share price weakness and we see value at current levels.

We expect to see PANW beat expectations as demand for next generation firewall appliances combined with sales of adjacent products like Wildfire, continues to grow. We believe that we are in the middle of a multi-year security spending cycle that should disproportionately benefit PANW as the dominant security platform vendor.