BUG - BUG With Potential 13% Upside

2023-09-05 01:07:31 ET

Summary

• BUG ETF holds 23 cybersecurity stocks with a consensus-weighted upside of 13%.
• The ETF has a 28% EPS CAGR valued at 47x PE.
• BUG has slightly underperformed the Nasdaq Composite since YE20, up 49%.

Overview

Cybersecurity is a secular growth industry. While this statement is no revelation, picking the best companies to invest in may be difficult for most with little experience or knowledge about the nuts and bolts of the cybersecurity area. Hence, I chose Global X Cybersecurity ETF (BUG) in order to get diversification in a volatile and expensive sector that is far from being dominated by a few industry leaders.

The BUG ETF run by Global X started trading in 3Q2019, tracks Indxx Cybersecurity Index and has US$650m in AUM a fraction of CIBR and half of HACK .

BUG is a reasonably diversified portfolio with the largest component, Zscaler (ZS), at 8.5% despite less than half the market cap of Palo Alto (PANW). I only found four companies with mediocre EPS growth estimates of under 6%.

Looking Under The Hood

To better assess the medium and long term outlook of the ETF I conducted a bottom up analysis of the 23 stocks it holds. Using consensus estimates I calculated upside potential, revenue, EBITDA, and Adjusted EPS growth. I then compared these fundamental traits to each stocks valuation using the PEG (PE to Growth) method.

Adjusted EPS adds back stock based compensation. In my view, this is a reasonable adjustment to make as long as one uses fully diluted shares. Otherwise you may be double counting, i.e. reducing EPS by the monetary cost of the shares granted as well as new shares to be issued. Stock based compensation cost is not cash flow item.

BUG May Have 12.7% Upside Potential

The first analysis is on the potential upside of the portfolio using consensus price targets' that are generally a 12 month view or to year-end 2024. Most of the stocks have a large analyst following that tends to even out very bullish and negative forecasts.

The ETF has a 12.7% 12 month upside based on consensus price targets. The average, if all stocks had equal weight, is 13.2%. This means it's a relatively well balanced portfolio in terms of upside potential.

High Growth Does Not Come Cheap

The BUG portfolio has a 28% EPS (adjusted) 5 year CAGR, which is very high and on par with what an investor might expect from this sector. At the same time this growth is priced at 47x PE YE24. To better place this valuation into perspective I compared the growth rate under the PEG method. The rationale is based on the premise that a PE close to the growth rate or a ratio around 1, indicates a reasonable valuation. Below 1 it's cheap and far above 1 expensive.

BUG has a PEG of 1.69x, not crazy expensive and in line with the SP500 which appears to be trading at 20x PE on 12% EPS growth or a PEG of 1.6x.

Some outliers in the consensus screen are Rapid7 (RPD) with PEG of .51 and on the negative side Checkpoint (CKPT) (at 2.7x).

Conclusion

BUG is a solid ETF to gain diversified exposure to the top Cybersecurity stocks, a high growth space that is prone to significant volatility. Its stock weights do favor Zscaler that hits above weight class at 8.5% yet has half the market cap of Palo Alto. Valuation appears reasonable relative to high EPS growth and may outperform the broader market long term.

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