BUG ETF: $20 Buy Point Here, But Is It A Buy Now?

Investment Thesis

Cybersecurity remains as an increasingly important sector for investors to be mindful of. One ticker that I have covered previously is the Global X Cybersecurity ETF (NASDAQ:BUG), which is an exchange-traded fund that gives exposure to this large, fast-growing market.

While BUG has shown relative outperformance compared to peers in the past, the holdings in the fund with the largest weighting have corrected substantially, as predicted in my previous article, Global X Cybersecurity ETF: Buy This At $20 And Never Look Back.

Now that the fund has reached a new 52-week low just below $20, I am revisiting the ETF and assessing whether this entry point makes sense, or if there is a possibility for further deterioration in the share price. A break down well below the $20 level may present with a good buying opportunity in the event that the pre-Covid technical support between $17 and $18 holds. In any case, I am once again suggesting a Hold rating for the BUG ETF at this time, and still recommending patience for investors wishing to start a new position in the cybersecurity sector of the market.

Introduction

In my previous article, I identified that while BUG was beginning to look attractive as an investment opportunity, it was wise to wait for a better entry point into the ETF. This has played out over the course of the last seven months, and while I was not sure if the $20 buy price would occur, it appears that the time to buy under $20 is quickly approaching.

Looking back from May of last year, my statements on the ETF still ring true:

… valuations of many of the holdings are still high even after a large price correction. Some caution is warranted here for investors, as rising interest rates could cause the prices to drop even more on multiple contractions in the more high-growth stocks. An even price of $20 for BUG would likely present a great buying opportunity for long-term investors, but it is unclear if Mr. Market will give us the price we are ultimately looking for.”

Source: Author’s previous article

Not much has changed in terms of the current environment of higher interest rates, economic uncertainty, and geopolitical tensions, but one thing that has changed is the prices of stocks such as CrowdStrike (CRWD), Okta (OKTA), and Check Point Software Technologies (CHKP), among many others included in the ETF. While some have declined by a large margin of between 20-40%, others have outperformed and provided stability to the diversified portfolio of stocks.

Another thing to keep in mind is that the holdings of BUG have changed in terms of weighting in the portfolio since last May. Several new stocks have been added and given high ranking, but core holdings such as Fortinet (FTNT) and Check Point Software remain near the top of the list.

New Additions, Changes To Holdings

ETFs are constantly changing quarter after quarter, with new holdings coming into the portfolio and others being swapped out. As of last May, the Global X Cybersecurity ETF was composed of 29 holdings, but the fund has now reduced this number to 25. In a sense, this makes the ETF more concentrated and could prove to be more volatile as time goes on. This is one of the risks to keep in mind when considering an investment in the fund.

Some companies, such as Sailpoint Technologies, were taken private last year, while other notable companies in the identity protection and cybersecurity space such as NortonLifeLock Inc. (GEN) have changed their name (in this case to Gen Digital).

Below is an updated list of holdings from the Global X ETFs website:

Price-to-sales ratios have come down quite a bit since last May, but many companies still trade at expensive valuations. With former market favorites such as CrowdStrike trading at over 10x sales and Fortinet at 9.2x sales, the higher interest rate environment has done considerable damage to these companies’ share prices over the last year. I believe that there is still more pain ahead if the Fed is serious about fighting inflation, and many of these cybersecurity stocks also fall into the cloud sector of the market as well. With new concerns in the cloud space and more headwinds approaching, it seems likely that the pre-Covid support level of between $17 and $18 is to be tested over the coming months.

Technical Support Levels

It seems increasingly likely that the BUG ETF will break down further below the key $20 price point, the question is by exactly how much? Looking at the exchange-traded fund’s chart and technical picture, a clear support level in the $17-18 range is a good target to aim for based off of prices set in late 2019 and early 2020.

The above chart shows that there is considerable selling pressure in the ETF and a bearish trend is still intact from the high set in November of 2021. A break down further under the $20 price would invite more selling and a likely test of the pre-Covid highs close to $18.25.

The next range would be between $17.25 and $18.25 if this pre-Covid high does not hold, which would act as a support level and invite a buying opportunity for long-term investors. While the Covid low set in March of 2020 around $13 per share could be potentially retested sometime later this year, I see this as unlikely given improving fundamentals of the underlying holdings in the ETF. However, capitulation has yet to occur, but with headwinds mounting and further panic selling, I could see a buyable opportunity coming up once a clearer support level has been reached.

Cloud Headwinds, CrowdStrike’s Outlook Lowered

Just yesterday, Microsoft (MSFT) caught a downgrade on concerns about weakness in the cloud sector and growth deceleration of the Azure platform. This sent peers in the cloud sector lower, with many holdings in the BUG ETF selling off over the course of today’s trading session as well. While this development is mostly speculation on the outlook for cloud stocks in 2023, an industry leader such a Microsoft showing potential weakness does not bode well for ETFs with exposure to the cloud sector.

Following this downgrade was renewed focus on CrowdStrike’s recently lowered outlook, and weak key metrics despite an improving bottom line and free cash flow margin. Many of these high-valuation stocks with lofty price-to-sales ratios tend to trade together, and continued selling pressure combined with a lowered outlook for the year points to a lower price for the BUG ETF.

It is also likely that companies in the cybersecurity space will adopt cost cutting initiatives and reducing head counts, which we have seen emerging as a pattern among some of the world’s largest tech companies over the last few months.

While cost cutting measures will undoubtedly improve profitability for cybersecurity companies in the near term, growth targets may be revised even lower still throughout 2023. Industry growth in coming years is still projected to be quite high, but short-term risks include continually rising interest rates due to a strong jobs market and persistent inflation, as well as the possibility for further multiple contractions in many high growth stocks. The higher concentration of the BUG ETF into 25 stocks, (down from 29 as of last May) also points to potentially higher volatility compared to other exchange-traded funds focusing on the same sector.

Conclusion

The Global X Cybersecurity ETF has recently hit the key $20 price level and is looking a bit better from a long-term investment standpoint. Although more pain is expected in the cloud and cybersecurity space, a further break down closer to the $17-18 price range could present with a great buying opportunity for long-term investors looking to start a new position in BUG. A clear bounce off of the pre-Covid support level has not been reached yet, and as the $20 level is currently showing no signs of holding, I am leaning towards a Hold rating at this moment in time. Cybersecurity is still a very important sector in the market, and considering the long-term growth potential of the industry, the ETF is increasingly attractive as part of one’s diversified portfolio. However, there are some risks to keep in mind, and even after the greater than 20% drawdown since last May, valuations of several companies in the ETF are still above 10x sales. A capitulation moment has yet to occur, and I currently view BUG as a Hold, but would be a buyer after a bounce off of the $17-18 support level identified from the pre-Covid trading range.