Cabot Growth Investor Issue: June 15, 2023

Big Picture Very Encouraging

If we were to have made a list a few weeks ago of what the market needed to do in order to get us excited, we would have come up with the following. First, of course, we’d need to see the market’s intermediate-term trend turn up. Second, we’d want any advance to be broad, with our Two-Second Indicator giving an all-clear. And of course we’d want to see clear, decisive strength in our Aggression Index, telling us that, after a year and a half of mostly caution, big investors were mostly ditching defense and playing offense.

Just as important, we’d need to see leadership emerge—meaning the endless sell-on-strength action of the past year and a half would have to be replaced not only by powerful breakouts, but in powerful follow-through action after the breakout, too. All of above is classic bull market behavior, and all of it has transpired during the past few weeks!

Of course, to the investor who emphasizes the news and economic fundamentals, nothing has really changed: Recession later this year seems to be the consensus, valuations seem elevated and this week’s Fed meeting, while not bringing a rate hike, again has economists raising expectations of how high rates will go (some now see another two or three small hikes by year-end).

That latter point isn’t to be overlooked—the sharp, broad rise in January was derailed by the Fed cranking up the hawkishness another few notches, after all. To us, that’s a good reason not to go hog wild on the buy side, especially as so many stocks are extended; indeed, we’re starting to see some leaders pull in after big recent moves.

But if you just stick with the facts, the bottom line is that the market’s evidence is as bullish today as it has been in a long time—certainly since the start of the bear market in late 2021, and for growth stocks, the batch of breakouts from top-quality names is the most we’ve seen since the middle of 2020.

What to Do Now

Thus, while there’s never any surety, we think continuing to step into a more heavily invested position is the right move. In the Model Portfolio, we’ve put a slug of money to work during the past three weeks, though coming into today we still had around half the portfolio in cash. Today we’ll continue with the plan, filling out our position in Celsius (CELH) and adding a new half-sized position in Monday.com (MNDY). That will leave us with around 40% in cash.

Model Portfolio Update

Big picture, the evidence continues to improve, with all three of our key market timing indicators bullish, other measures (like our Aggression Index) looking great and more leading stocks joining the parade. That said, near term, things are a bit trickier—the major indexes (especially the leading Nasdaq—it’s about 1,100 points above its 50-day line) are extended to the upside, and some individual names have started to meet with selling.

Nothing would surprise us, but at this point, the odds favor these pullbacks are normal shakeouts after good-sized runs; they could easily go further given that investors have gotten a bit near-term giddy, but as opposed to the blowups of a month or two ago, there’s not much abnormal action out there. That doesn’t mean you should plow into a bunch of stocks that are sticking straight up in the air, but in the Model Portfolio, we’re going to fill out our position in Celsius (CELH) by adding another half-sized stake, while starting a half position in Monday.com (MNDY). Our cash position will be around 40% after these moves. Details below.

CURRENT RECOMMENDATIONS

Celsius (CELH)—Celsius normally wouldn’t have the juice to be a leader again after its run-up during the last bull market—while growth would have been solid, it was bound to slow some as the rate of distribution expansion would do the same. But it certainly looks like the Pepsi deal supercharged the growth story, and after a couple of quarters of rejiggering the operation, the benefits are becoming obvious. Indeed, one analyst’s channel checks reveals that growth is not only up triple digits in many areas but actually accelerating as Q2 goes on. And given Pepsi’s ability to get Celsius into various non-convenience store areas like food service (management sees big potential there), hotels, universities, casinos and more, the runway of growth should be very long. The stock has had a big move before finally seeing some selling over the past couple of days; with a huge short interest here (10.4 million of the 77 million shares are short), volatility will be extreme. That said, we’re going to use the weakness to fill out our position by adding another half-sized stake (5% of the portfolio), while continuing to use a loose leash for the position (mid- to upper-teens). BUY ANOTHER HALF

DoubleVerify (DV)—DoubleVerify will never be a household name, but its story is straighforward—the massive and accelerating move to digital ads of all sorts and placed in all channels needs third-party verification (i.e., not provided by those selling ad slots or from the likes of the government) to prevent fraud, make sure they’re actually viewed (30% aren’t!) for a couple of seconds, are shown in the proper geographies and aren’t sitting next to objectionable content, among other things, effectively boosting the return clients get on their ad dollars. The ad verification market does have a few players, but DoubleVerify has the industry’s most comprehensive platform, and the data it collects (billions of transactions a day!) is itself a competitive advantage, providing insight and boosting the capabilities of the platform. Put it together and the company is capturing a lot of new customers (80% win rate when bidding for a new contract; two-thirds of new clients have no ad verification solution at all), keeping the ones it has around (95% overall retention rate, including a 100% retention of its top 75 clients each of the past four years) and current clients are expanding their usage, too. Granted, growth here isn’t insane (looking at 20%-ish sales and EBITDA) and could be subject to economic factors, but big picture, it’s a good bet that DoubleVerify will get much, much bigger over time. The stock had a big shakeout in April on a short seller report, but it quickly snapped back, broke out and has advanced persistently since. We started a half position last week—we could average up if the strength continues, but right here, we’ll sit with what we have. BUY A HALF

Inspire Medical (INSP)—INSP continues to act fine, holding above its 25-day line, though we think the mixed action among many medical names has kept a lid on the stock; shares have chopped sideways during the past four weeks as its moving averages catch up. Fundamentally, the firm continues to make progress—last week it received an expanded FDA approval for its sleep apnea system, with Inspire now able to serve patients that are suffering severe symptoms (up to 100 events per hour of sleep, up from a prior indication of 65), many of which have few treatment options available. As always, we’ll take it as it comes: Should the stock crack, we’ll take a small loss on our half position, but overall, we remain optimistic the next big move is up. We’re OK buying a small position here if you’re not yet in, and we could average up on a decisive show of strength. BUY A HALF

Monday.com (MNDY)—So, we definitely prefer to hunt for liquid leadership, but we’re obviously not against taking a swing at some very volatile names, either—and Monday.com is one of those. As we wrote in the last issue in Other Stocks of Interest, the firm seems to have something special here, with enterprises stampeding to its door as it has one of the best “low-code” or “no-code” work management platforms, which effectively means non-programmers can use intuitive tools (drag and drop, etc.) to build effective workflow systems that fit exactly what they need (as opposed to pre-programmed software offerings). It’s obviously not the only player in the field, but it’s catching on fast because of its features (very visual, intuitive dashboards, etc.) and its flexibility, which is where some of the upside here is—Monday.com isn’t strictly a work management offering, with a recent customer relationship management (CRM) release seeing rapid adoption and many clients using its platform for things like inventory tracking, marketing, bug tracking and more. The Q1 report was terrific, with sales up 50% and earnings of 14 cents per share destroying estimates of a big loss; free cash flow was actually around 80 cents a share. Interestingly, management sees growth slowing from here (revenues up 25% to 30% by year-end), but the upside is that profits are here to stay—Monday.com should be free cash flow and earnings positive every quarter from here (two years ahead of schedule), which lit a fire under the stock, with shares exploding to multi-month highs on three straight weeks of massive volume … and since then, MNDY hasn’t given up an inch, with a couple of brief dips quickly being gobbled up. To be clear, the stock is extended to the upside here, and daily moves of a few percent aren’t unusual, so there’s risk here; we’re going to use a loose mental stop (150 area) because of that. But we also think the upside power in May and lack of giveback should lead to good things. We’ll buy a half-sized position (5% of the portfolio). BUY A HALF

ProShares Ultra S&P 500 Fund (SSO)—Back in January, we built a good-sized position in SSO based on a few factors—our indicators, of course, but also the massive negative sentiment, the prior bear market and the 2-to-1 Blastoff Indicator. And all of that … did not work out. However, while we don’t make excuses, there’s a difference between losing money because you reached or got too far over your skis, versus losing money because the odds didn’t pay off—we wrote at the time that piling into SSO was a good “bet,” and we’d do it again if the same set of evidence presented itself. Fast forward to today, and the evidence is similar and probably even better than it as in January: All three of our market timing indicators are now bullish, various longer-term studies point to higher prices (we write more about this later in the issue), things have broadened out and, of course, we’re now coming off an even longer bear/sideways phase that has left most investors very bearish. (The latest Bank of America institutional money manager survey showed big investors historically underweight stocks and overweight bonds.) Could the rally fail? Of course—there are never any sure things in the market. But the weight of the evidence is turning bullish, so we not only held our small position but bought more SSO last week. Hold on if you’re already in, and if not, you can start small here or (preferably) on some normal weakness. BUY

Shift4 (FOUR)—We’ve been patient with Shift4 because the story and numbers are great, and the chart, while not perfect, is mostly sideways after a solid run earlier this year. That’s still the case, but the next couple of weeks could be key—the stock has been unable to join the market’s party of late, though some on Wall Street (two analysts had positive words this week) are beginning to defend it ... though today, news of some more competition in the restaurant payment space (by DoorDash and others) brought in some sellers. To be clear, given what should be continuing terrific growth, if FOUR can show some decisive accumulation, we think it can have a big run … so much so that we wouldn’t rule out adding back some shares we trimmed a while back. However, the flip side is also true—the stock has had plenty of opportunity to digest its prior move and shake out the weak hands, so a decisive dip from here (meaningfully below 60) would have us selling our remaining small position and moving on. Right now, we advise continuing to grit your teeth and see if the buyers can step up. HOLD

Uber (UBER)—While it won’t be the fastest horse out there, we filled out our position in Uber last week and continue to think the company’s consistent, rapid improvement in the bottom line (EBITDA), combined with its steady growth in both rideshares and delivery, has big investors confident Uber will meet, if not exceed, its lofty 2024 goals ($5 billion in EBITDA and huge free cash flow). A potential sale or spinoff of its freight business would be another plus, and while economic concerns will always a factor here (big drop in travel or jobs could crimp rideshares, etc.), competition has been lessening, which is always a good thing. A drop back into the mid-30s would be iffy and suggest the Q1 earnings blastoff may be failing, but having hit new highs today, the path of least resistance is up. Hold on if you’re in, if not, start small or aim for dips. BUY

Wingstop (WING)—We’re doing our best to give Wingstop some rope, as the long-term growth story is very much intact and, after its solid upmove in recent months, the recent pullback isn’t outrageous. (The fact that we took partial profits a while back also helps us hang on.) That said, the stock is on a tight leash—it’s dipped below its 50-day line, volume is picking up a bit and, after surging to new all-time highs after earnings, WING has pulled back to its prior peak. We do think the odds favor the stock eventually resuming its overall uptrend, but we don’t want to hold the stock much lower, especially with many other names acting well. Right here, we’re holding on, but if all’s well, we’d expect buyers to begin stepping up soon. HOLD

Watch List

• Axcelis (ACLS 172): ACLS has finally started to shake out, with a quick 11%, three-day decline before finding support today. We think some more rest is likely, but we also think such action could prove buyable. Watching for now.
• DraftKings (DKNG 25): DKNG isn’t grabbing the headlines, but it continues to act just fine, with the 25-day containing any dips of a few days. With the NBA season over, it’s a slower part of the sports betting calendar, but much of the focus remains on the firm’s improving bottom line, with lower customer acquisition costs (down 27% in Q1!) and expected EBITDA breakeven in Q2.
• Duolingo (DUOL 158): DUOL has taken a couple of hits but is holding above the highs of its prior consolidation and its moving averages. After a big run since early March, further wobbles are possible, but we’re considering starting a position if the stock can settle down a bit.
• MasTec (MTZ 110): Infrastructure and construction names are quietly doing very well, and MasTec is focused on areas (involved in 5G, clean energy, oil and gas and power transmission) that are quickly building out and should help earnings ratchet higher as its huge and growing backlog is worked off. See more later in this issue.
• Nvidia (NVDA 427): Nvidia is probably the flag-bearer of this bull move, being positioned well to be the “picks and shovels” provider to all the big AI “miners” out there. Growth is just about to take off, and while the stock has had a big run from its lows, it’s shown no inclination of giving up any of its gains.
• Samsara (IOT 29): The valuation is extreme, but it’s becoming clear that Samsara will post rapid and reliable growth for many years as its software solution gains traction among some gigantic firms. See more below.
  

Other Stocks of Interest

Samsara (IOT 29)—Samsara has a story we really liked a few months ago, but like so many promising names, the stock gave up the ghost in the spring—but now, after being in the wilderness for a while, it’s showing very rare upside power that suggests bigger things are in store. The big idea here is similar in a sense to Procore (written about in the last issue) in the sense that Samsara is a cloud software stock that’s making hay by focusing on a giant area in need of vastly improved efficiencies and lower costs. The company targets clients that have huge amounts of physical assets, which can be anything from big farming operations to equipment rental firms to truckers to state- or city-based transportation departments. And Samsara’s platform helps these outfits save tons of time and money using Internet of Things data (hence the stock symbol): It offers top-notch vehicle telematics and GPS tracking, which is used to boost driver efficiency (less idling time, etc.) and improve safety (in-cab alerts and safety training) that results in fewer accidents and, eventually, insurance and even worker comp costs; allows drivers and managers to better and more easily comply with regulations; preemptively alerts firms as to which machines need servicing (instead of waiting for something to go kaput), which reduces downtime and long-term costs; and even helps clients better monitor warehouses and distribution facilities for safety and productivity. There’s an AI angle here, too, as the firm has been using machine learning to parse the mounds of data it collects on its platform to improve results; in the latest earnings presentation, it said Iron Mountain (the big document and information storage firm) has seen a 54% reduction in safety events, a 97% reduction in no-seat-belt usage and a four-month payback period on its various subscriptions with Samsara. There’s little doubt, then, that the solution works, and the firm is seeing more clients sign on and, importantly, big clients expand their usage—in the April quarter, annualized recurring revenue (ARR) rose 41%, but among its largest clients, that metric was up 53%, with 60% of net new ARR coming from current customer expansions. The bottom line and free cash flow should be about breakeven this year, which isn’t ideal but is headed in the right direction. (Note that there’s an Investor Day next week (June 22), so we’ll see if any long-term forecasts are released.) As we wrote above, the stock wobbled in the spring after a nice run (including a 27%, two-week drop), but has taken off on the upside since earnings, flashing a rare “double skyscraper” signal, where a stock explodes higher on two straight weeks of overwhelming volume. We’re not chasing it here, but IOT is on our watch list.

First Solar (FSLR 193)—This can be a weakness or a strength, but we tend to keep an eye on stocks and sectors that (a) have great potential and (b) have already shown leadership qualities, even if they’re not “hot” right this second. Solar stocks in general, and First Solar in particular, are classic examples—there’s little doubt things are going the sector’s way, with both organic and government-induced demand likely to remain red hot. And some recent guidance on the solar tax credits from the green energy bill that passed last summer should help that along—long story short, the bar for claiming the credit should be easier than expected, which should result in a torrent of subsidies for potential First Solar expansion (management had hinted that if subsidy guidance was encouraging, they could go ahead with a new plant) and U.S. production. Of course, this isn’t just about direct subsidies—as of the last quarterly report, and despite a sharp increase in panel output during the next couple of years, the firm’s massive backlog (90% of which are firm purchase commitments, with the other 10% requiring substantial cancellation penalties if clients back out) extends out to the 2026 to 2029 time frame! Despite this, the top brass said the pipeline of potential bookings is still soaring as solar deployments go wild across the globe,. Put it together and if management can make the right moves, First Solar is going to grow like mad at the very least and potentially be a huge cash cow in the years ahead. The numbers here have always been lumpy, but that’s starting to change, with earnings expected to reach $7.50 per share this year, $12.50 per share next and some see $20 or so in 2025 (we wouldn’t bank on any 2025 estimate, of course, but it shows you the earnings power here). As we’ve written before, FSLR blasted off in the middle of last year after the green energy bill and has had a big, big move—but now we see the stock in a three-plus-month rest period, with some downs and then a massive up (on the tax credit news in May), followed by some more retrenchment. The stock is on our “back burner” watch list—probably not something we’re jumping on next week, but a little more seasoning and a resumption of the major uptrend could mean this liquid leader is back in gear.

Confluent (CFLT 34)—We’ve been looking for the next big player in the Big Data theme, especially with the AI boom likely to accelerate the utility firms can get from the data they collect, and Confluent might be it. The story starts with Apache Kafka, which is an open-source data processing platform created at LinkedIn and used by 150,000 firms and more than three-quarters of the Fortune 500—but, of course, open-source means free. Still, making the most of Kafka can require expertise, which is where Confluent comes in—the creators of Kafka at LinkedIn went on to found Confluent, building a solution that makes it simpler to connect data sources and create a real-time data streaming offering that’s integrated with all of a firm’s apps, software and the like, allowing for up-to-date actions and insights. The firm does have a legacy on-premise offering, but the growth today is obviously in the cloud, and that’s where Confluent shines, allowing clients to have programmers build apps and new releases instead of managing infrastructure, and Confluent’s solution works with all of the big cloud operators. A big part of the success (and something management went into detail on in the early-May conference call) is that the company has rethought many things with data streaming, infrastructure, storage and networking to provide a drastically lower cost (for both clients and Confluent), which has kept demand strong even as many firms pull back on spending given economic constraints. The details and technical terms can give you an ice cream headache, but the big idea is that, in the company’s words, its platform is morphing into the central nervous system of a client’s giant tech infrastructure, with all software and apps connected to the real-time data offering. In Q1, total revenue growth was 38%, though that masks things a bit—the old self-managed portion of the business made up half of sales but grew just 16%, while Confluent’s cloud offering made up 42% of business but grew 89%, while remaining performance obligations (all the money that’s due to the firm under contract) was up 35% and was 4.3x last quarter’s revenue total; the bottom line should hit breakeven soon, too. The stock itself was one of the 2021 IPOs that was crushed in the bear, but it spent months bottoming out and, just a few weeks ago, completely changed character—CFLT rallied seven weeks in a row before finally hitting a speed bump. It’s super volatile but we’re intrigued.

Don’t Underestimate Long-Term Momentum

There’s no doubt the market and individual stocks have generally gotten a lot more volatile in recent years, and that’s especially true when looking back decades—whether it’s because of computerized trading, a string of “never-before-seen events” or something else, the fact is that things can move a lot in a relatively short amount of time. Of course, the news is the same way, with dramatic headlines based on whatever’s happening today or this week.

What’s interesting, though, is that even though volatility is up, we’ve found that long-term measures of the market remain the most reliable out there. Yes, they’re slower to give signals, but they are usually effective at capturing most of the upmove (or staying out of most of the downmove) and they’re far less likely to give false signals. Simply put, you shouldn’t underestimate the market’s longer-term momentum.

The poster child for this is our Cabot Trend Lines, a version of which has been in every single issue of Cabot Growth Investor (we launched in 1970). The indicator itself has outperformed the market, but much more important to us is they keep us on the right side of the major trend—our studies show that they’re positive for about 80% to 90% of the time in a bull move, and negative 70% to 75% of the time in a bear move. Indeed, last year’s signal (a sell in January 2022) came just a few weeks after the S&P’s top, and so far, the latest signal (a buy in January of this year) is looking very promising.

Then there’s a study we touched upon a couple of weeks ago: Not only are the big-cap indexes holding above their longer-term moving averages (what the Cabot Trend Lines are based on), but those moving averages themselves are starting to rise, which is another sign of growing long-term momentum—the S&P’s 200-day line has begun to trend up after tagging 52-week lows last year. Going back to the 1930s, the index was higher every time a year later by an average of 14.4% when this has happened.

And two weeks ago, we saw another similar sign involving the RSI Index, which is an overbought/oversold measure that moves between 0 and 100. Normally, we’re not fans of that measure (it probably does more harm than good with individual stocks), but this proved interesting: When the S&P 500 hits at least an 18-month low (which it did last year), the next time the slow-moving weekly RSI Index goes above 60, it’s almost always confirmation of good things—of the 11 times it’s happened since 1970, over the next nine months, the S&P 500 has an average max gain of 18.5%. (Hat tip to Mark Ungewitter for the indicator—follow him on Twitter @mark_ungewitter.)

Now, none of this means much when looking at the next two or three weeks, but from a big-picture point of view, all of this is encouraging—after transitioning from a steep bear market to more of a sideways phase the past few months, the long-term momentum factors above suggest we’re now switching to a real bull phase. That’s good for stocks, of course, and should provide opportunities in leveraged long index funds like SSO (2x the S&P 500), QLD (2x the Nasdaq 100) and maybe even UWM (2x the Russell 2000, which is starting to catch up).

We’re Bullish on Construction Stocks

If you look at the fundamentals, it should be a terrible time to invest in anything construction related. After all, the economy is supposedly hitting a recession later this year, interest rates remain elevated, the residential housing market has cooled off and pockets of commercial real estate look awful. And yet we’re seeing a variety of stocks in the sector act great.

We’ve written about residential homebuilders before—it turns out the earnings power of these firms remains huge and the bear market discounted a far worse downturn than what’s happening in the real world. There are many, but Toll Brothers (TOL) is one of the best looking out there and is a good example—after a huge earnings ramp the past two years, the bottom line is expected to fall just 2% this year (and come in at nearly $11 per share!), and even that will likely be conservative.

Then there are infrastructure plays. Old friends Martin Marietta (MLM) and Vulcan Materials (VMC) are good examples—they both dominate the construction aggregates industry, which are the crushed stone, gravel, sand slag and more that is needed for just about every construction project in the country. Neither is super-dynamic, but both gapped on Q1 earnings and continue to act well.

Then there’s MasTec (MTZ), which is an infrastructure play, but not exactly the roads and bridges kind: The firm used to have a heavy focus on oil and gas projects, and that’s still a decent part of its business, but now it has its hands in communication infrastructure (5G towers and small cells), clean energy projects (carbon capture, hydrogen, etc.), power transmission projects and more. Sales and earnings are choppy, but the bullish writing is on the wall here, with a large and growing backlog that has analysts expecting big bottom-line growth ahead. And the stock looks great, with six straight above-average volume weeks. MTZ is on our watch list.

Cabot Market Timing Indicators

One of the market’s big bugaboos of late has been the narrowness of the advance, but now that’s changing: Both our Cabot Tides and Two-Second Indicator have joined the bullish parade, and things have broadened out among individual stocks, too, with more leaders letting loose on the upside. Things can always change, but there’s no doubt the evidence has gone from iffy to very good in short order.

Cabot Trend Lines: Bullish
The market’s romp higher has kept our long-term Cabot Trend Lines firmly in bullish territory—as of this morning, the S&P 500 is above its 35-week line by 8%, while the Nasdaq stands a huge 16% above its own trend line. As we wrote earlier in this issue, we’re also seeing these long-term moving averages themselves begin to turn up, which historically bodes well in the months ahead (though, near-term, some retrenchment is possible). All in, it’s looking more like a “real” bull trend is underway.

Cabot Tides: Bullish
After a lot of narrowness, the market has broadened out nicely, and that helped our Cabot Tides flash a buy signal last week—all five indexes (including the S&P 600 SmallCap, shown here) are now solidly above their lower, rising moving averages. Granted, it’s not a perfect picture, with small-caps and similar indexes still well south of their February peaks. But we pay more attention to trend, and right now, the market’s intermediate- and longer-term trends are pointed up—until proven otherwise, the odds favor higher prices ahead.

Two-Second Indicator – Bullish
Our Two-Second Indicator rounds out our bullish set of measures—starting at the beginning of last week, the number of new lows on the NYSE fell below 40 and the readings have stayed subdued ever since (now nine straight days), which is enough for an all-clear signal. That doesn’t mean the market won’t throw some shenanigans at us (possibly another bout of rotation, etc.), but the broad market becoming healthy is an overall good thing.

The next Cabot Growth Investor issue will be published on June 29, 2023.