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Early Opportunities
Get in Before the Crowd

Cabot Early Opportunities 113

In September’s Issue of Cabot Early Opportunities we continue our search for companies that have some of that special sauce that can take them from good to great. We serve up a mix of software, consumer and MedTech names, as well as a Top Pick that’s growing like a weed despite participating in a seemingly stodgy industry. Enjoy!

Cabot Early Opportunities 113

Stock NameMarket CapPriceInvestment Type
Kinsale Capital (KNSL)
$4.2 billion191.94Rapid Growth – P&C Insurance
Nevro (NVRO)$4.9 billion144.55Rapid Growth – MedTech
Peloton (PTON)$24.7 billion85.45Rapid Growth – Exercise Equipment
Varonis (VRNS)$3.6 billion112.46Rapid Growth – Software
Vital Farms (VITL)$1.5 billion36.65Rapid Growth – Eggs & Butter


Current Investing Environment

Time Is on Our Side
In 1964 the Rolling Stones released their version of Jerry Ragovoy’s song, Time Is on My Side.

The group’s version became their first top ten hit in the U.S. Like so many of the Rolling Stones’ songs it still holds up today, 56 years later.

Great stocks, just like great songs, don’t have an expiration date. They can just keep rolling on year after year, getting better and better. They won’t always be on the Billboard charts of top performers. But a stock slide here and there only means better prices for long-term investors.

There are, of course, a lot of differences between a great song and a great stock. Notably, while a great song remains exactly the same over the decades, a company evolves.

That’s a good thing – Amazon didn’t get to where it is today by maintaining a focus on selling books. But it also means uncertainty for investors. A company you buy shares in today may just be a shadow of what it will become in ten years.

This is especially true of early-stage companies where things change all the time.

Some, like last month’s pick Nikola (NKLA), have not yet fully developed their business plan and things are changing daily.

Others, like one if this month’s picks, Vital Farms (VITL), have a pretty well-defined growth plan and future developments are more likely to be evolutionary rather than revolutionary.

My advice is to lean into that uncertainty. Embrace it. This evolution is exactly what we’re looking for out of management teams.

They need to be nimble enough to adapt to changing times, but steadfast enough to execute a rational growth strategy that will hopefully take their company from good to great. When a piece of the puzzle is missing, management teams must go out and hire, acquire or build. That doesn’t happen overnight.

For us, “buying early” isn’t just some bogus marketing message. We are legitimately looking to buy good companies before the masses (a term somewhat open to interpretation) are aware of them, then hold on to them as they evolve into great companies. Then keep holding.

Additionally, I’m typically looking for companies that deliver incremental growth, meaning they get bigger and better month after month, quarter after quarter and year after year.

We can’t expect that the companies we invest in today have it all figured out. If they did, the market would have it all figured out too, as would competitors. There’d be no room for opportunity.

That doesn’t mean we’ll blindly hold stocks regardless of what they, and the market, are doing.

But stepping back and thinking about our strategy in big picture terms, once we find compelling companies to invest in, our biggest challenge may just be to simply let time work its magic.

What to Do Now
Continue to average into the stocks that are most attractive to you and which you think you’ll have the best chance of holding onto through the inevitable corrections.

The September selloff may or may not be over. The market is trying to look forward into the first half of 2021 at a time when vaccines could hit the market. There is lot of uncertainty surrounding what could happen, and how evolving business and consumer trends will shift. And that’s going to continue to work through the market in hard-to-predict ways.

Our game plan will continue to be to find companies that can excel now, in 2021, and beyond. Since we often don’t know exactly how things will play out it’s important to always average in.


Kinsale Capital (KNSL)


Kinsale Capital (KNSL) is the only publicly traded property and casualty (P&C) insurer focused exclusively on the excess and surplus (E&S) lines market in the U.S. E&S is a specialized market for insuring things that standard carriers won’t cover due to high-risk, and includes things like mobile homes, auto garages, commercial transportation companies and day care centers.
In the world of insurance E&S is a highly attractive market as it has historically generated the best returns in the broader P&C market. Kinsale has capitalized on that dynamic by leveraging technology and underwriting expertise, along with a focus on smaller accounts, to grab and retain market share.

Palomar Holdings (PLMR), which is a high-quality insurer that provides specialty insurance (earthquake, hurricane, etc.) has recently entered the E&S insurance market. While this may create competition for Kinsale, Palomar’s entrance also helps to validate the attractiveness of the market and suggests significant room for growth for multiple players.

Speaking of growth, Kinsale has it in spades. The company’s 2019 revenue growth rate of 42% (to $316 million) makes it far and away the fastest growing publicly traded P&C insurer out there. In 2019 net written premiums rose by 33%.

When management reported Q2 results on July 30 Kinsale demolished expectations, growing revenue by 62% to $118 million, beating by $15 million. Net written premiums were up 42% to $134 million, while adjusted EPS of $0.84 was up 47% and beat by $0.16.

Big picture, the quarter was marked by management’s continued success of disciplined underwriting and relentless focus on using technology to keep costs low and customer service high.

In short, Kinsale’s management runs a tight ship and generates high returns. That’s the name of the game in the insurance underwriting market, and it explains the stock’s strong performance since its 2016 IPO.

I don’t see any reason why the trend can’t continue, albeit with the occasional correction and pullback of 10% to 30% along the way.

The Stock
KNSL came public in July 2016 at 16 and immediately moved higher. By the end of the year it was trading near 35. Since then there have been pullbacks but the big picture pattern is one of higher highs and higher lows. Shares fell “only” 39% during the worst of the March market crash. The latest breakout was right after Q2 earnings. KNSL rocketed 17% higher, from 170 to 195. Shares topped out near 212 on September 1 and then pulled back with the market. KNSL now trades roughly 10% off its high.


Nevro (NVRO)
The coronavirus pandemic has disrupted many types of medical procedures, and especially elective surgeries and treatments. During a pandemic, if it’s not broken, you don’t need to fix it. At least not right away.

Now that the world is learning how to better cope with COVID-19 there is a lot of catch-up activity in the medical procedure world. This creates a bad-to-better-to-good, eventually-type scenario for many MedTech firms. One that’s particularly appealing right now is Nevro (NVRO).

Nevro is a $4.8 billion market cap company that offers the Senza spinal cord stimulation (SCS) system. Senza delivers Nevro’s proprietary HF10 therapy, a non-pharmacologic neuromodulation platform for the treatment for chronic pain of the trunk and/or limbs.

The procedure requires implantation of a small device that transmits mild electrical pulses to the spinal cord which calm the nerves and reduce pain signals to the brain.

Senza systems help people dealing with chronic pain get back to some semblance of a normal life. There is no tingling sensation, and no sleep or driving restrictions. According to Nevro and the FDA the system is the most effective SCS solution on the market for both back and leg pain.

Despite having a superior product, Nevro’s rapid growth began to decelerate in 2018. After missing expectations for four consecutive quarters and watching shares decline by 60%, institutional investors helped Nevro bring in new management in early 2019.

That move flipped the script. With consistent, albeit modest, improvements in revenue and profit growth (2019 revenue was up 1%), along with planned new product introductions, Nevro’s stock had a great 2019 and was trading near all-time highs in early 2020. The future looked great.

You know what happened next. The pandemic washed through the door and swept everything away.

With a business that’s completely reliant on deferrable procedures, shares of Nevro were cut in half in March. Revenue in Q1 2020, which included just a month of the pandemic, was up 6% to $87.5 million, but Q2 looked bleak.

And it was. Second quarter revenue plummeted 40%, to $56.4 million. Adjusted EPS fell 33% to -$1.21.

However, Q2 was actually far better than expected. Disciplined spending also drove better-than-expected net loss.

Management said the recovery was brisk and June 2020 volumes were about even with June 2019. The company now expects growth to return in Q3. In Q4 growth is expected to be roughly flat as Nevro’s focus shifts back to the new patient trial activity that began to return in June and July.

Nevro’s future isn’t without risks. The company is the upstart challenger and has been grabbing market share from larger incumbents who will start to fight back.

But the company appears to have a better mousetrap and is working on new products that should pull even more patients in. New indications, including ulnar nerve injury (ULN), add to the addressable market.

While revenue is seen down 5% to $370 million this year, adjusted EPS losses should improve 13% to -$2.94. In 2021 growth is seen accelerating to 24% while adjusted EPS improves 42% to -$1.70.

In short, we are in the “better” phase of this bad-to-better-to-good story, making now an attractive time to accumulate shares.

The Stock
NVRO went public in 2014 at 18 and popped 45% the first day. By late 2016 shares were trading near 106. Then growth slowed and the stock waffled between 65 and 95 for a couple years. The wheels came off in 2018 as NVRO fell all the way back to 35. With new management at the helm NVRO ran up to 148 by the end of February 2020. Then the market’s crash took shares down by 56%. The initial recovery to 130 was swift – NVRO traded up to that level in May. Since then the stock has traded as high as 145 but a big breakout has been elusive, thus far. With the stock looking stable and the story evolving, now’s an attractive time to buy.


Peloton (PTON)
Peloton (PTON) has been one of the hottest consumer companies during the pandemic. The company’s stationary bikes and treadmills are some of the coolest and best-performing on the market. People that can’t or don’t want to go to the gym or to a spinning class are loving that they have a sleek at-home alternative.

The exercise equipment is just the beginning. Peloton also offers a subscription membership that streams on-demand classes anytime, anywhere. Classes cover the full spectrum, from cycling and running to yoga, meditation, strength and stretching. This is a key part of the special sauce as lack of consistent engagement often turns exercise equipment into annoying dust collectors.

Beyond content, Peloton’s classes allow people to follow along with instructors, track their progress, engage with other Peloton users, and stream instructor-curated music playlists. All of this helps keep consumers coming back for more.

That’s good for Peloton and part of why the stock has been a pandemic favorite for Wall Street.

Growth, which was already good before the pandemic – revenue was up 99% in 2018 and 110% in 2019 – has remained incredibly strong even off a rapidly expanding revenue base. In fiscal 2020, which ended in June, revenue doubled.

That result included relatively modest 66% growth in the quarter ending in March, and massive 172% revenue growth in the June quarter. Demand was so strong that wait times for bikes stretched beyond a month in some markets. This year, analysts see revenue growing 93% to $3.53 billion, but clearly there is a lot of wiggle room here.

While Peloton hasn’t yet achieved consistent profitability (fiscal 2020 loss was -$0.32) the trend is up. Analysts see the company delivering EPS of $0.03 in fiscal 2021, then growing EPS by over 1000%, to $0.36, in 2022. In short, this business appears to be able to scale profitability.

Management is working to prepare Peloton for an extended growth trajectory. It has recently introduced a higher priced Bike+ (starts at $2,495) that includes a few more bells and whistles then the Bike, which sees its price drop $350 to $1,895.

The company is also expanding its treadmill product lineup with a lower priced solution to better address a market that is likely two to three times the size of the bike market. The new Peloton Tread goes for $2,495 while the larger Tread+ is priced at $4,295.

In all cases consumers will need to pay $39 a month to keep their Peloton All-Access Membership, without which the dazzle of the equipment is greatly muted. Access to a Peloton Digital Membership costs just $12.99 and is fine for those wanting some classes but lacking a Bike or Tread.

In short, Peloton is working to build an at-home connected fitness company that should thrive after the pandemic. It’s a young company, formed in 2015, that just went public in 2019. The stakes are high given how well PTON’s stock has done lately but I believe investors will continue to be drawn to the story and management’s ability to execute on the growth plan.

The Stock
PTON came public at 29 almost exactly a year ago and had a ho-hum debut. The stock traded in a range of 20 to 37 through February then fell to 18 during the market crash. From there it was a series of higher highs and higher lows until PTON hit an intra-day all-time high of 99 on September 10. The stock has since pulled back roughly 18% but is still well above its 25 and 50-day moving average lines.


Varonis Systems (VRNS)
We took a swing at Varonis (VRNS) before the pandemic hit and it was one of the stocks we cut when the market was in freefall. Now, with a couple more quarters under its belt and a growth story that’s as intact as ever, we’re stepping back up to the plate.

The back story is that Varonis is a data security company. It has developed a platform using metadata framework technology that helps companies visualize, analyze, optimize and protect human-generated, unstructured data.

Think of all the types of sensitive documents within a company’s various computer systems, like pdfs, images, videos, spreadsheets, word docs, etc. It used to be that if you worked in a company you could have unfettered access to all this. No more. Companies are transitioning to a Zero Trust Model where everyone, even the CEO, needs to prove their identity before accessing documents on the network. Even then, access is limited only to what they need.

Altogether, data security is a roughly $20 billion market growing around 27% a year. Varonis’ security platform sits in the middle of other solutions on the market from players like Splunk (SPLK), CrowdStrike (CRWD) and Okta (OKTA), and fits a need those companies don’t yet meet as well.

Varonis addresses the two key needs of data classification and data access. This is typically handled by security teams who can locate, map and classify data, monitor who touches it, and control who has rights to access it. Varonis has done particularly well with customers using Microsoft Office 365.

The second part of this story is about Varonis’ transition to the cloud. The company began its change to a software-as-a-service (SaaS) delivery model in late 2018.

The SaaS business model streamlines sales, operations and R&D processes, while making it easier for customers to purchase larger software packages. But it does mean a transition period of roughly three years during which revenue from existing customers takes a hit. That That’s why revenue was down 6%, to $254 million, in 2019.

Varonis is making rapid progress now and new customers today are spending more than before the transition. The dynamics of this may not be showing up in consensus estimates, as evidenced by the company’s big Q2 beat in which revenue grew 12% to $67 million and beat by almost $10 million. Adjusted EPS of -$0.15 beat by $0.20.

Management said that purchasing patterns returned to normal in the quarter and that shifting work from home dynamics are driving demand. Some of these factors may be transitory, but the big picture story isn’t – more companies are learning they need this type of protection and Varonis is the arguably the best vendor for it.

The positive inflection point for the revenue transition is now. The second quarter marked a return to growth after four consecutive quarters of revenue contraction. Revenue should be up at least 6% this year, then accelerate into the 20%-plus range in 2021 and beyond.

Adjusted EPS, which fell into negative territory in 2019 (to -$0.92), is seen trending back toward breakeven this year and next; then Varonis should flip to significant profitability in 2022.

The Stock
VRNS went public in February 2014 at 22 and doubled on its first day, but then shares retreated and were mired in the mud for several quarters. The trend improved and by June 2018 VRNS was trading just north of 80. VRNS then shed 40% of its value and bounced around while the subscription transition began. A nice run began in October 2019 which carried VRNS to all-time highs near 93 in February 2020. The March market crash cut the stock in half, but the recovery has been steady and VRNS broke out to fresh highs in July. The stock traded up near 127 a couple weeks ago then pulled back around 15% with the market.


Vital Farms (VITL)
Vital Farms (VITL) is an easy story to tell. In 2007 Matt and Catherine O’Hayer took a big step forward in their mission to build a sustainable business producing ethical food. They opened a 27-acre farm in Southwest Austin, TX, and began selling pasture-raised eggs. To qualify, a pasture-raised egg must come from a hen that has at least 108 square feet of outdoor space per bird. Feed can be organic, or not.

Since that first farm, Vital Farms has partnered with around 200 family farms and has become the leading U.S. brand of pasture-raised eggs and pasture-raised butter. It holds roughly 60% market share in the pasture-raised egg category. By retail dollar sales, it is the second largest egg brand in the country.

The company is still focused on sustainable agricultural practices and the humane treatment of animals. That mission carries through in everything it does and its relationships with all stakeholders, from employees and farmers to retailers and customers.

As you’d expect, Vital Farms is a premium-priced product. That doesn’t make their eggs and butter right for everyone, and there is always risk that a luxury product like this will fall down the priority list if and when food budgets get constrained.

But thus far Vital Farms has excelled. A large part of that success is because, like so many other brands, consumers feel a connection to the product and the mission. Many people like protein these days, and there is growing demand for better-for-you and ethically sourced food.

That’s all helped Vital Farms deliver consistently impressive growth. Revenue was up 44% in 2018 and 32% in 2019. In the first two quarters of 2020 sales jumped 44% and 84%, respectively.

Granted, the pandemic has helped. More consumers are eating at home now. Still, factoring in some moderation in sales in the back half of 2020, analysts see around 50% growth this year, to $210 million. A more modest growth rate of 14% in 2021 may easily prove to be conservative.

Vital Farms is expected to be profitable this year. Analysts see adjusted EPS of $0.18.

With the company having broken into roughly 450,000 more households this spring, and 20% to 45% of them repurchasing one or more times since their first trial, Vital Farms has an excellent shot at retaining a healthy share of the customers it has recently attracted.

An initiative to increase distribution by 700 stores, along with new product introductions (Egg Bites launched in August), should help draw in new customers while keeping current ones buying from Vital Farms.

The main risks here are that Vital Farms is highly dependent on egg sales and pricing. It is not yet a diversified company. There are pros and cons to this. The company is also newly public, having just debut on the Nasdaq on July 31, 2020. To balance the IPO risk, we will start with a half-sized position.

The Stock
VITL came public at 22 on July 31, 2020 and jumped 60% its first day to close at 35. The stock climbed in the four sessions afterward to hit a high of 42.5. It has since traded as low as 34 and has high as 42.5. As is typical of new IPOs, there is no trend here yet. BUY A HALF.


Previously Recommended Stocks
Today we are making the following changes to our portfolio.

Descartes Systems (DSGX) is moved to SELL. The company reported a fine quarter a week ago but also filed a shelf registration, meaning a secondary offering could be in the relative near future. The stock pulled back after the report and hasn’t participated in any of the market’s rebound lately. That suggests to me that big investors aren’t looking to add shares at this time and there could be some downside risk in the near-term. This is a high-quality company and I like it, however at this moment I think there are more attractive places for the capital. Let’s take our roughly 40% gain and move on, then come back to DSGX in the future. SELL
CrowdStrike (CRWD) is moved back to BUY

Cloudflare (NET) is moved back to BUY

An updated table of all stocks rated BUY and HOLD, as well as recent stocks SOLD, is included below.

Please note that stocks rated BUY are suitable for purchasing now. In all cases, and especially recent IPOs, I suggest averaging into every stock to spread out your cost basis.

For stocks rated BUY A HALF, you should average into a position size that’s roughly half the dollar value of your typical position. We may do this when stocks have little trading history (for instance IPOs), when there is more uncertainty in the market or with a stock than normal, or if a stock has recently jumped higher.

Those rated HOLD are stocks that still look good and are recommended to be kept in a long-term oriented portfolio. Or they’ve pulled back a little and are under consideration for being dropped.

Stocks rated SOLD didn’t pan out, or the uptrend has run its course for the time being. They should be sold if you own them. SOLD stocks are listed in one monthly Issue, then they fall off the SOLD list.

Please use this list to keep up with my latest thinking, and don’t hesitate to call or email with any questions.

StockSymbolDate CoveredNotesOriginal Price^Price 9/15/20 Current Gain
10x GenomicsTXG12/17/1966.78118.7978%
Altair EngineeringALTR8/26/2042.7539.70-7%
The AZEK CompanyAZEK8/26/20Top Pick38.8433.94-13%
Formula One GroupFWONK5/20/20Top Pick33.5137.0110%
Jamf HoldingJAMF8/26/20Buy a Half39.1232.35-17%
Kinsale CapitalKNSL9/16/20Top PickNEW191.94NEW
NikolaNKLA8/26/20Buy a Half39.1132.83-16%
Sprout SocialSPT2/19/2020.3833.9667%
Virgin GalacticSPCE4/15/20, 6/5/2017.6617.700%
Vital FarmsVITL9/16/20Buy a HalfNEW36.65NEW
TFF PharmaceuticalsTFFP8/26/2013.1914.9713%
Adaptive BiotechADPT4/15/2027.9145.9565%
Bloom EnergyBE7/15/2016.0614.47-10%
DatadogDDOG4/15/20Hold 1/2 Position38.6988.54129%
DynatraceDT9/18/19Hold 3/4 Position20.4940.5398%
Five9FIVN11/20/19Hold 3/4 Position64.37120.6587%
GFL EnvironmentalGFL5/20/2017.7220.9618%
LivongoLVGO11/20/19Top Pick, Hold 1/228.23124.43341%
OneWater MarineONEW6/17/2022.7522.820%
SchrodingerSDGR7/15/20Top Pick82.6253.01-36%
Solaredge Tech.SEDG1/15/20104.18199.0091%
Company NameTickerDate CoveredDate SoldReference Price^Price Sold^Gain/Loss
Descartes SystemsDSGX4/15/20 9/16/2038.8253.92 (est.)39% (est.)
Purple InnovationsPRPL6/17/208/26/202018.2019.859%
Viela BioVIE5/20/208/13/202060.1637.38-38%
Datadog - Sold 1/4DDOG4/15/208/7/202038.6978.93104%

^Average of high and low price if published intraday, or closing price if published after 4 PM ET

The next issue of Cabot Early Opportunities will be published on October 21, 2020

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