Cabot Growth Investor Issue: February 22, 2024

Shaking and Baking

Let’s start out with something we’ve written a few times since the market got going in early November: While there are never any sure things, the market’s big-picture view looks as good as it has for the past few years, with our key market timing indicators (Trend Lines, Tides, Two-Second Indicator) in good shape and with secondary measures (like our Aggression Index) also telling us things are on track. After the past two years, interest rates remain an ever-present worry, but overall, the odds favor the market will be nicely higher in the months ahead. (See more on our Aggression Index and interest rates later in this issue.)

That said, we invest in leading growth stocks, which can move around a lot, and near term we’re finally seeing many leaders wobble—the super-hot AI stocks bore the brunt of it before today, but most areas have seen some selling. And, probably more important to us, this action comes on the heels of some yellow flags in late January and early February, such as some frothy action and a narrow environment, on top of the fact that most stocks were extended in time and price.

All of that leaves us a bit cautious near term—we’ve been limiting new buying and paring back on some names, coming into this week with about one-third of the Model Portfolio in cash.

“But Mike—what about Nvidia’s (NVDA) report and the big rally today?” Good question: It’s definitely a good sign for such a key stock and many other leaders (mostly AI-related) to find support, but after seeing more than a few names get whacked around for a couple of weeks, we want to see a bit more before concluding we’re off to the races again.

As we said above, the big picture remains in good shape, and we’ve also seen very little truly abnormal action (out-of-this-world selling volume, a rash of huge breakdowns, etc.), so we’re not anxious to raise more cash if we can help it—and, frankly, if today’s upmove really does put in a floor for leaders that have taken hits, we could start putting money back to work soon, possibly within a couple of days.

For now, though, we look at it like this: It’s been a very solid few months for names we own and are watching, but we started to see some yellow flags a few weeks ago and now the leaders are getting volatile and taking on some water. To us, we think it’s a good time to do more watching than acting, seeing if this pullback morphs into a deeper correction—or whether the buyers step up and this ends up being just a shakeout within a steep uptrend.

What to Do Now

Watch and wait for now—but be ready to act depending on how things play out during the next few sessions. In the Model Portfolio, we sold one-third of Arista Networks (ANET) last week after a sour earnings report, and we placed a few stocks on Hold in yesterday’s bulletin. But we’re sitting tight tonight and remaining flexible, keeping our buy list fresh should the recent action turn out to be just a hiccup.

Model Portfolio Update

The market remains in solid shape from a top-down perspective, and today’s action was obviously great to see—and, if all goes well, could kick off another upmove. That said, we’re not ignoring what we’ve seen in recent weeks, with an accumulation of yellow flags in late January/early February and many leaders finally taking on water after big, prolonged advances.

Now, big picture, we’ve seen little “real” abnormal action—mostly sharp profit-taking after big moves as opposed to signs big investors are completely abandoning ship (like we saw many times in 2022-2023); thus, we still believe the market and the best leaders can be nicely higher when looking down the road. Even so, we’re going slow for the moment (we have just one stock rated Buy right now) and watching how things go in the days ahead.

While we haven’t been immune to the wobbles, in recent weeks we’ve built up cash due to the signs mentioned above (34% coming into this week), giving us leeway to hold most of our top performers, which snapped back nicely today. We’ll stand pat tonight, but stay tuned: We do have a decent list of stocks we’d like to own, so we could put some cash to work … if leaders continue to stabilize.

CURRENT RECOMMENDATIONS

Arista Networks (ANET)—We took partial profits on one-third of our stake in Arista following its poor earnings reaction, and we’re holding on to the rest. Fundamentally, the firm sits in a middle ground, where (a) it’s very likely business will pick up with the AI boom down the road, but (b) that’s looking like a 2025 situation, and the stock may have trouble getting moving until a quarterly report or two says the boom is on—and that assumes AI infrastructure names remain in favor and don’t correct and consolidate further in the weeks ahead. To be fair, management has historically low-balled expectations (some analysts on the conference call prodded the top brass to admit the outlook looks artificially weak), so we’ll just play it by the book: We’re more than happy to hold our remaining shares and give them a bit more wiggle room, but we’d like to see ANET build on today’s bounce going forward. HOLD

CrowdStrike (CRWD)—CRWD has been one of the market’s bigger leaders, but it got whacked yesterday after peer Palo Alto Networks reported not just a poor quarter—what spooked investors was that the firm (which does have a good track record fundamentally) actually cut guidance for earnings and billings (which are forward-looking) for the next quarter or two, citing delayed purchasing decisions by clients, which knocked around all cybersecurity players. We’ll see, though: CrowdStrike has some newer-age offerings than Palo Alto and we’re not ruling out that its forensics arm (with the new regulations that came into place in December; firms must disclose any good-sized breaches they detect) is helping, too. As we wrote yesterday, if you have a “big” position (whatever that means to you), we’re OK trimming some here if you haven’t already—for our part, though, we’re holding on and seeing how CRWD reacts to yesterday’s wallop, with today’s bounce obviously a good start. Earnings are due March 5. HOLD

DraftKings (DKNG)—DKNG reported a very solid Q4, with revenues up 44%, earnings well into the black, monthly unique users up 37% and EBITDA of $151 million, up from a loss a year ago—and the top brass said revenues and EBITDA would both have been nicely higher if not for some “bad luck” (good customer betting outcomes) in late November. Indeed, the top brass hiked EBITDA guidance for 2024 (now $460 million, up from $400 million previously), and it also announced some new ventures, with a good-sized purchase of Jackpocket (an official lottery app that should eventually open up an entirely new market for the company) and a new deal with Barstool sports. As with most other leaders, the stock has been volatile of late, with some downside this week to the 25-day line since the quarterly report. Overall, though, our view hasn’t changed—DKNG is in a choppy uptrend and business (and cash flow) should continue to surge in the quarters to come. We’re sitting tight with our position. HOLD

Elastic (ESTC)—ESTC got caught up in the AI-related selloff in recent days, sinking from new highs last Friday to its 50-day line yesterday morning, before bouncing nicely today. If we’re being critical, the relative performance line (not shown on the chart) hasn’t made any net progress since the big gap up in early December, but the weekly chart looks fine and the real tale will likely be told next week. Elastic will report earnings on Leap Day (February 29), with analysts looking for $323 million of revenue (up 18%) and 31 cents of earnings (up 82%), but just as important will be any hubbub (or real results) relating to clients signing up for its search offerings for AI purposes. We moved to Hold yesterday given the choppiness of late, so we’ll stay there tonight and see what the quarterly report brings. HOLD

Nutanix (NTNX)—NTNX has had a beautiful, persistent run higher, so a pullback was due—and, frankly, so far, we’ve been very encouraged with how the stock has handled itself, with a couple of bad days here and there but with the stock remaining nicely above its 10-week line (now near 53). Like many key tech plays, the firm has earnings coming up soon (February 28)—analysts are looking for 13% sales growth (likely faster growth in recurring revenue) and a 45% bump in earnings. If NTNX can rest normally for another week or two (and should leading stocks hold firm after today’s rally), we’d like to restore our buy rating for those who don’t own any. Right now, though, we’ll stay on Hold and see what next week’s report brings. HOLD

PulteGroup (PHM)—PHM has basically rested for a few weeks, which we think is totally normal given the backup in interest rates—and now shares are bouncing off the century mark, thanks in part to a solid earnings report from higher-end peer Toll Brothers (TOL). Our thoughts here haven’t changed much: Obviously, if interest rates really skyrocket all bets are off, but given the strong economy and the fact the Fed is likely to ease sometime in the months ahead, we think housing will surprise on the upside fundamentally, which should help Pulte’s results remain strong—and likely top even the current lofty numbers (earnings of $11.92 per share this year). We’ll stay on Hold tonight, though we could restore our buy rating if we see a bit more evidence that the rest period is over. HOLD

Shift4 Payments (FOUR)—FOUR tried repeatedly to get through resistance in the 78 to 80 area, but it couldn’t pull off the trick—leaving it open to a sharp pullback this week as growth stocks weakened, though it should be said the stock is still sitting within its recent range. As with ESTC and NTNX, though, earnings next week (February 27) will probably determine the stock’s intermediate-term path: Analysts are looking for 41% sales growth and earnings of 82 cents per share (up 105%), while free cash flow and any updated 2024 payment volume outlook (in October the firm said organic payment volume should lift 47% this year) will be key. At heart, we remain optimistic because of the terrific current and projected growth (analysts see earnings of $3.29 per share this year, up 29%), not to mention many newer ventures (the acquisition of Finaro opens up the huge European restaurant market), thinking more big investors will sign on if the top brass hits its lofty targets quarter after quarter. But as always, we’ll take it as it comes—we went to Hold yesterday to respect the stock’s action and will see how it goes after earnings. HOLD

Uber (UBER)—UBER remains in fine shape, with not only Q4 results looking great but last week’s super-bullish investor update keeping buyers interested. We’ve written before that Uber quacked like an emerging blue chip, and that seems to be playing out, as there aren’t many dominant firms in growing sectors with stocks that are very liquid that also have a rapid, reliable growth path for years to come. Indeed, management’s view that it can grow EBITDA at a “high 30% to 40%” clip from 2024 to 2026 while free cash flow grows much faster than that was eye-opening, with a big share repurchase plan (up to $7 billion) also helping the cause. Of course, that doesn’t mean the stock can’t pull back, especially if leading stocks don’t find their footing—the 10-week line is near 67 (and rising steadily), so UBER is certainly extended to the upside. Still, this looks like relatively rare merchandise, so while near-term wobbles are possible, we’re thinking the stock will be higher down the road. Hold on if you own some, and if not, we’re OK starting a small position here or (preferably) on dips. BUY

Watch List

• AppFolio (APPF 230): APPF has chopped around the past couple of weeks but remains in great shape in the wake of its Q4 report. We think the firm’s leading position in serving property managers via a comprehensive cloud platform should lead to continued rapid and reliable growth.
• AppLovin (APP 58): APP had been resting for five months after a huge run, but last week’s Q4 report likely kicked off a new advance. The firm’s Axon advertising platform is not only growing rapidly but producing mind-boggling profit margins, too. See more later in this issue.
• Celsius (CELH 64): CELH is now 23 weeks into a new launching pad, with earnings coming up on March 7. The story here is as good as ever, and the stock has been perking up in recent weeks.
• Freshpet (FRPT 90): FRPT is a bit thinly traded for our taste, but we do think the straightforward, consumer-facing story should produce continued surging sales and booming EBITDA growth for years to come. The stock is super tight in here, too.
• Nextracker (NXT 57): Nextracker is a leading provider of solar arrays, and the Q4 report lifted the stock to new highs—and we see more upside ahead if the solar group as a whole (which has been awful) can turn around. See more later in this issue.
• Palantir (PLTR 24): PLTR has taken a couple of hits with the retreat in AI stocks, but it’s still holding on to the vast majority of its post-earnings gains. It’s super-volatile, but the longer it can hold its recent move, the better. We could start a position in the stock assuming the market settles down.
• Robinhood (HOOD 14): HOOD doesn’t have the cleanest history, but it’s a classic bull market-type stock that should attract plenty of new investors if the bull market really runs. See more later in this issue.
  

Other Stocks of Interest

Cava Group (CAVA 50)—We’ve been keeping a distant eye on Cava for a few months now, and while it needs to continue growing up (volatility can be tough here—see yesterday’s drop), the past couple of months suggest the big picture here is very bright. The firm is a classic cookie-cutter restaurant story, looking to follow in the footsteps of names like Wingstop and Chipotle but with a different angle: Cava’s claim to fame is its Mediterranean fare, with bowls and pitas filled with seasoned chicken, hummus, falafel, tzatziki, feta, lentils, pickled onions and veggies—thus, it’s operating in a big industry niche and plays into the healthy-eating movement, too, especially among the white-collar crowd for lunch. The chain got a boost with the acquisition of Zoe’s (another Mediterranean-focused restaurant chain) back in 2018, with Cava since converting those locations to its namesake brand. All told, at the end of Q3, Cava had 290 restaurants, but the expansion pace is rapid, with around 70 likely opened in 2023 and the top brass expects 15% growth in the restaurant count each year. In support of that, the firm is aiming to internally place three-quarters of the general managers of new restaurants (partially through a “GM Academy” training program) and to produce more items in-house (like its dips and spreads) in order to have better control over costs (a new production facility should ramp this quarter), all while adding to the menu (steak likely to be introduced nationally this year). It’s hard to get an exact read on new store economics, but there’s no doubt the numbers here are enticing—in Q3, the average store brought in $2.6 million of revenue and restaurant-level profit margins were a very solid 25% on the back of 14% same-store sales growth, leading to another quarter of profits and EBITDA, which came in larger than all of 2022! Granted, the focus here is on growth, so expect margins to narrow somewhat going ahead, and there are some very tough comparisons early this year—but more big investors are focusing on the bigger picture, which has helped the stock rally back to its highs in recent months after a big (but typical) post-IPO droop. Yesterday’s drop was tedious, but not abnormal; we’ll be watching the Q4 report, due February 27, to see if institutions pounce.

Robinhood (HOOD 14)—If we’re being honest, Robinhood was little more than a meme stock three years ago and one that engaged in some dodgy practices at that; we weren’t surprised to see the stock (which came public right near the peak in 2021) implode more than 90% from its peak. That said, the company has proven to be a survivor, with a growing offering of products attracting more customers, and with the market in good health, HOOD looks like a Bull Market Stock that can go far. The firm is best known for its easy-to-use and intuitive trading app as well as its various fee-free trading services for stocks, options and even cryptocurrencies, while offering a 1% match on all IRA deposits (with some restrictions, of course). Basically, it’s a natural place for many newer investors to start their investing journey—and while there remain holes in what can be traded (bonds, mutual funds, preferred stocks, closed-end funds, etc.) the firm has steadily expanded geographically (launched in the U.K. last November; launched crypto trading in the E.U. in December), boosted its offerings for active traders (24-hour trading in many products; 2024 should see index options and futures available for trading), launched a retirement account program (490,000 accounts after one year, holding $1.7 billion in assets) and even launched a subscription tier (Robinhood Gold) that offers unique benefits (for $5 per month, you get a much higher yield on your cash deposits, a 3% match on IRA deposits and better trading tools). All of that has led to some solid metrics: At year’s end, Robinhood had 23.4 million clients that put away $17.1 billion of deposits during 2023 (up 27% from 2022) and had $103 billion in assets under custody (up 65% from a year ago, thanks partly to the market rally); about 6% of total users are paying for Gold, too, which makes them stickier and higher-value. And along with rising interest rates (higher interest income is helping the entire brokerage sector), that’s led to some solid results, with revenues up 24% in Q4 (interest income was up 41%, transaction revenue up 8%) while earnings nosed into the black and the top brass said it’s aiming to have expenses rise just 5% for all of 2024. (One interesting stat: The company brings in $867,000 per employee, a big number.) Big investors are clearly warming up to the stock—543 funds owned shares at year’s end, up from 319 six months before—and HOOD itself looks to be getting going from a year-and-a-half-long bottoming effort thanks to its Q4 reaction last week. If the market’s bull move keeps going and big-picture sentiment gets bubbly, Robinhood could easily surprise on the upside.

Nextracker (NXT 57)—Most of the screening we do is relatively basic and involves the metrics we usually write about—strong sales and earnings growth (and projections of future growth) and a strong stock—that help us narrow down what names we want to research further. But we also have some screens that point us toward the strongest stock in a weak group—the idea being that, if a stock (and its fundamental numbers) can hold up well when the sector is out of favor, it can really launch if/when the group turns up. That leads us to Nextracker, one of the leading providers of solar trackers, which move photovoltaic panels gradually during the day so they’re receiving the maximum amount of sunlight (and, hence, electricity yield). For large-scale solar farms, the product can be up to 25% more output, which makes up for the added up-front cost (estimated to add 7% to the construction cost of a big farm). Business here has been solid for a while, but besides the awful sector action (solar names have been about the worst area out there for a few months), the one overhang was from its former parent—Nextracker used to be a subsidiary of Flex Ltd. (a big contract manufacturer in Singapore), and that firm owned a ton of shares even after the spinoff a year ago (raising the possibility of secondary offerings), but Flex spun off its entire position when the calendar flipped, which cleared the way for big investors to step up should perception improve. And the Q4 results may have been the trigger: Nextracker saw sales boom 38% (including a 78% boom in the U.S.), earnings more than triple and EBITDA more than double, all of which came in well above expectations, while backlog actually increased, too. With solar deployments expected to continue growing here and overseas, the firm is in great position—and, very impressively, NXT gapped to new highs on the report and has held its gains despite the choppy environment. As a heads up, First Solar (FSLR) reports results February 27; if the group can get going, there’s little doubt NXT should do well.

Still No Bearish Rush into Safety

One of the clues that often pops up ahead of a period of market trouble is that you’ll see defensive stocks begin to catch a bid—following a big rally where most people are chasing the hottest sector or theme, all it takes is a few big funds looking to shift their portfolios a bit to the defensive side of the ledger to see safe, stodgy areas rally nicely.

Recently, while the economy remains strong, some fears have definitely come into the market’s view. First, the intermediate-term trend of interest rates has turned up (or at least not down)—shown below is the inverse 10-year Treasury yield, which has clearly broken its 50-day line (in red). Second, partly as a result of rates and expectations of a less-easy Fed, you have regional bank stocks (symbol KRE) also cracking their 50-day line and showing some iffy action around the turn of the month.

Despite that, though, big investors haven’t run back into their storm cellars. Shown below are a couple of relative performance lines for growth-oriented measures compared to the toilet paper and toothpaste-heavy Consumer Staples Fund (XLP), which is the best measure of defensive stocks in our view: The Nasdaq (which is our traditional Aggression Index) and the IBD 50 Index (the thin green line in the chart is the relative performance line). While XLP itself has been in an uptrend, you can see that it continues to underperform these three growth measures.

While it’s secondary to the action of the major indexes and leading growth stocks, we think this analysis will be key going forward. Nothing is 100% accurate, but we’ve seen many examples over the years where the Aggression Index and its peers diverge from the major indexes ahead of a market break: 2021 was a classic example, with the Index remaining below its February peak all year (until one week in November) before the bears took control (it was actually below its 40-week line when the S&P 500 topped at year’s end!), while a decade before in 2011, the Index peaked in February and slid for months before the indexes had a mini-crash in the summer.

Conversely, the Aggression Index has a history of hanging in there and pushing ahead during initial market pullbacks in a bull phase—like we saw in 2003, when the indexes consolidated from mid-June until early August but, as you can see in the chart below the Index advanced net-net during that time and never really broke its steep uptrend.

The evidence can always change, but right now, things suggest that big investors are trimming positions in extended names and rotating a bit into other areas—but they’re not hiding in their storm cellars by purchasing very defensive names, which is one reason we think the market has a bright future beyond any more near-term wobbles.

“Late” Breakouts Can Still Work in Proven Leaders

Applovin (APP)

If you follow relative strength like we do, you’ll want to focus on the first dozen or two growth stocks that really get moving when the market comes out of a prolonged funk—in this case, many of the best performers of this rally lifted off in November, soon after the market’s late-October bottom.

However, while those that get going are usually leaders, it doesn’t necessarily mean the rest are laggards: We learned many years ago that you’ll sometimes see stocks do extremely well while the market is still in a bottoming-out phase—a sign of real strength—but that can lead to a rest early in the market’s “real” rally ... before they eventually kick into gear again. The classic example of this was Netflix (NFLX) toward the end of the humongous bear market of the Great Recession, when shares bottomed in November 2008 and ran all the way to all-time highs (!) by April 2009, just a month after the market kicked off. However, shares then went dead for many months before a decisive kick-off in January 2010, which led to a ridiculous move.

AppLovin (APP) might be following a similar path, albeit on a smaller scale. While it didn’t get back to new highs, the stock staged a massive turnaround from its gigantic bear market drop (more than 90%), rallying from under 10 in December 2022 to above 40 in September of last year, thanks in large part to its AI-powered advertising engine, dubbed Axon 2.0, which, very simply, is able to rapidly tweak an ad or ad campaign that results in vastly better monetization of app and mobile users. Right now, most of that is for app game users, but the firm is planning on expanding into other areas like connected TV, too. Even so, the big run meant a rest was in order, so APP went sideways for 21 weeks, including after the market got going in November.

But now the stock has taken off on the upside, thanks to Q4 results, likely kicking off a continuation of its overall advance. In the quarter, the firm’s traditional game business (which it still operates to attract users and data) dipped 18%, though it should stabilize this year and remains solidly profitable. But the Axon-driven marketing side of the business is soaring—revenue up 76% in the quarter—and more impressive are the margins, with EBITDA lifting 58% for the ad segment with EBITDA margins of 69%! (Free cash flow is also giant here, likely to be $4 to $5 per share in 2024.) We think AppLovin could be the next big thing in digital advertising, and while growth will likely slow some, the profits here should remain enticing. APP is on our watch list. WATCH

Cabot Market Timing Indicators

Overall, our three key market timing indicators remain in good shape, as well as some secondary measures (like our Aggression Index, talked about earlier in this issue)—and we continue to think the bigger-picture view looks good. Leading stocks, though, have turned tricky: Today’s big rally was obviously great to see and could start another run, but we’re OK holding some cash and seeing how things play out given the recent distribution in many key titles.

Cabot Trend Lines: Bullish
Nothing new to report with our Cabot Trend Lines, which remain firmly bullish as both the S&P 500 and Nasdaq levitate about 10% above their rising 35-week moving averages. As we keep writing, at some point, there will be a narrowing of the gap (ideally through a rest in the indexes as the trend lines catch up), but when and how that occurs is up in the air. Either way, the big picture continues to look bullish.

Cabot Tides: Bullish
Our Cabot Tides continue to plug along, with all five of the indexes we track (including the NYSE Composite, shown here) holding north of their lower (50-day) moving averages. Of course, the daylight between the indexes and those 50-day lines has shrunk a bit, so there’s not as much leeway if the sellers finally step up—but as always, we never anticipate what’s to come. Right now, both the intermediate-term (Tides) and longer-term (Trend Lines) trends are pointed up.

Two-Second Indicator: Positive
We’ve seen a smattering of plus-40 new low readings during the past couple of months—including four in January and another four in February—but (a) there’s been no sustained streak, and (b) even the very worst readings (in the mid-80s) haven’t been indicative of the bottom falling out of the broad market. All told, then, our Two-Second Indicator remains bullish, with the broad market in solid health.

The next Cabot Growth Investor issue will be published on March 7, 2024.

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