Software stocks suffer from AI "bloodbath" while cybersecurity stocks may be hiding opportunities. Investors may be missing out on a golden opportunity.

This year, cybersecurity stocks and software sectors have both experienced sell-offs. However, with the increasing threat posed by malicious attackers due to artificial intelligence (AI), investors may be missing out on the rising demand for services in this area. Manthan Shah, the U.S. investment manager at WestBridge Capital, managing over $7 billion in assets, says: "Currently, software investors are selling first and then trying to figure out why, but I believe that in the future we will find that now is an excellent time to enter the security field. This is one of the areas we see as having great long-term potential." In recent months, software stocks have been widely sold off due to concerns that products from AI companies like OpenAI or Anthropic may divert demand from traditional suppliers, weakening their growth potential and pricing power. Particularly, the proliferation of so-called "AI agents" (able to complete multi-step processes without human intervention) has presented significant challenges to Software as a Service (SaaS) stocks. Cybersecurity software manufacturers have also not been spared. The Cybersecurity ETF-Global X (BUG.US) has dropped by 15% in 2026, recently hitting its lowest point since November 2023. Although this is better than the 31% drop seen in indexes focused on SaaS, it still lags behind the S&P 500's 3.4% decline this year and the Nasdaq 100's 4.2% drop, which is mainly composed of tech stocks. However, not all software is the same, and when it comes to cybersecurity, investors may be misreading the situation. AI agents that are considered to erode traditional businesses are also being used for malicious purposes - as AI models become more powerful, this risk may become more prominent. Hackers have already used AI tools to bypass over 600 firewalls in dozens of countries, including Mexican government agencies. Based on this threat, there is a belief that as AI becomes more widespread, customers will need more protection from cybersecurity software. "AI will greatly expand the potential attack surface, meaning the demand for security will significantly increase in the future," Shah says. Take JFrog Ltd. (FROG.US) for example. The California-based company's stock price rose by 17% in March, marking its best monthly performance since November last year, as analysts pointed out that attacks on the software supply chain highlighted the value of its security product portfolio. Guggenheim analyst Howard Ma wrote in a report to clients on March 25: "As AI agents become more widespread, these attacks may only become more common." Sell-offs stem from news headlines Due to heightened market sentiment and high uncertainty - whether from AI or Iran's conflict - investors are currently very sensitive to news headlines. Last month, cybersecurity stocks saw a drop in response to a report that an AI model from Anthropic PBC posed an "unprecedented cybersecurity risk". A similar situation occurred in February when Anthropic introduced new security features for its Claude AI model. However, Wall Street believes that investors' reactions may be the opposite, as these dynamics increasingly highlight the growing importance of digital security. Baird analyst Shrenik Kothari wrote in a report on March 27: "Stronger models increase the need for governance, not decrease it." He described the recent sell-off as "another outbreak of irrational panic." Raymond James' Adam Tindle also shares the same view, stating, "The idea that AI will disrupt the security field fundamentally is wrong, but the herd mentality is frustratingly hard to combat and may lead to surrendering to panic selling without considering fundamentals." This also explains why analysts are raising their ratings on cybersecurity stocks. Arete Research upgraded Palo Alto Networks Inc. (PANW.US) from "sell" to "buy" last month, believing that the weakness in the stock is being overstated, as AI agents are shifting IT budgets towards different types of security products. Crowdstrike Holdings Inc. (CRWD.US) has also received multiple upgrades, with Piper Sandler analyst Rob Owens suggesting that AI is an "opportunity, not a threat of substitution," as AI will "create the next billion-dollar security market" as businesses seek protection from new attack surfaces. Indeed, AI developers may eventually introduce services that are highly similar to traditional providers, sparking disruptive concerns again - even as the overall demand for security services is increasing. Additionally, cybersecurity stocks are not cheap, at least compared to other sectors in the software industry with lower valuations. For example, Crowdstrike's price-to-earnings ratio is around 78 times expected earnings, making it the ninth most expensive stock in the S&P 500, even though its valuation has significantly decreased from 128 times in July. Palo Alto Networks' stock is trading at around 42 times expected earnings for the next 12 months, placing it among the top 50 most expensive stocks in the index. Fortinet, Inc. (FTNT.US) and SentinelOne Inc. (S.US) also have significantly higher price-to-earnings ratios compared to the S&P 500 and Nasdaq 100 indexes. "It's hard to say these are value stocks, especially since it will take a few years to determine whether growth has been disrupted, and during this time, this risk cannot be falsified," says Ryan Isherwood, Chief Investment Officer at Significance Capital Management, which holds shares in Palo Alto Networks. "Whether security stocks can command the premium multiples of the past seems hard to say, but it's still the most worthwhile area in the software sector," he adds. "We're not interested in many application software stocks, but cybersecurity looks like the best house in the bad neighborhood in the software sector."