Cabot Growth Investor Issue: June 27, 2024

Just a quick housekeeping note. With the 4^th of July holiday next Thursday, I’m going to send out the next Cabot Growth Investor update one day earlier than normal. Look for it next Wednesday, July 3.

Tedious and Trendless—For Now

When it comes to the toughest environments to navigate, most people instantly think of the big bear markets, like 2008 and even 2022, when many popular growth stocks fell by 70% over many months. Don’t get us wrong, we certainly don’t wish for those environments—we want up markets as much as everyone else—but in terms of positioning the portfolio, such horrid environments are easy to handle: You hold tons of cash and wait it out, which is exactly what we did in those two prior wipeouts.

While obviously not nearly as bearish, today’s type of environment is far trickier in terms of what actions to take. Outside of a few mega-cap names, the vast majority of stocks are trendless, strength only lasts for a week or two before being sold into and news-driven moves and rotation are the norm—thus raising the odds of being “wrong” when buying or selling and bringing a lot of volatility with little net progress to most portfolios.

Chances are, if you own, say, 10 stocks, half are giving you issues one week before finding some support … and then the other half start to wobble the following week. That’s no surprise given our split market timing indicators, where neither the Cabot Trend Lines (bullish), Cabot Tides (neutral) or Two-Second Indicator (negative) are in agreement. Said another way, it’s tedious and trendless out there; the frustration-to-profit ratio is elevated.

Of course, as we’ve written many times, that narrowness is more descriptive than predictive—and we’re open to anything going forward. Shown below is a chart of the equal-weight Nasdaq 100 (every stock is worth 1% of the index), which, to us, is a pretty good representation of what we’re seeing out there: It’s made no net progress since early March or since late May, with plenty of whippy daily ups and downs … but it’s also not bad, and in fact is perched just shy of new high ground.

Translation: Most of the market (including growth stocks) is effectively still in the rest phase that started in March—some names are a bit better than that, but few are running away on the upside—and it’s a coin toss as to whether this proves to be a multi-month launching pad … or a near-term top that requires more consolidation before the next big upmove.

What to Do Now

We’re as anxious as anyone to put some money to work, and we do have a few names on our watch list that are enticing (PINS is one of the best looking names out there; see more on that later in this issue). While the market could show its hand at any time, but until it does, we think less is effectively more—thus, we’ll again stand pat in the Model Portfolio tonight, where we’re holding on to a 30% cash position, as well as and batch of names we think can really run if the market cooperates.

Model Portfolio Update

You wouldn’t know it looking at the big-cap indexes, but for the broad market and most growth stocks, the chop-fest continues, with lots of rotation and up-and-down action. For the most part, as trend followers, we’re looking for sustained moves that last a couple of months or longer, and right now, there aren’t many areas doing that—many are sideways, while others are one and a half steps forward, one step back. As we wrote on page 1, in a sense most of the market and even the growth arena is still in the correction/consolidation phase that kicked off in March.

Throw in the fact that the market remains very divergent and we continue to think our current stance makes sense—holding a chunk of cash as cushion and being selective on new buying, but also giving our remaining names some room to gyrate given the environment.

With that in mind, we haven’t been doing much of late as the portfolio (like the market) is mixed, with some names under pressure (though not cracking), some looking fine and others meandering. We do have a couple of names we like, but we’ll again hold off here, remaining patient as we wait for the market to show its hand as the second half of the year gets underway.

CURRENT RECOMMENDATIONS

AppLovin (APP)—APP has been a poster child for the market’s environment of the past few weeks—a generally strong name that saw selling on strength for a few weeks and then was hit hard on fears surrounding Apple’s advertising attribution changes … and continued to wobble around even as many analysts came to defend the firm, saying that the change shouldn’t affect business … but has now found some support, with shares perking back into their prior range. Net-net, APP is seven weeks into a reasonable launching pad, and if the market cooperates, we think it can have another run—outside of the Apple brouhaha, one analyst said the firm’s AI investments into its Axon engine should keep the firm ahead of peers for years, leading to higher budget share (and advertiser returns) from AppLovin. Given that the stock is in the middle of its range, we’ll stay on Hold, though a couple of good sessions could be very bullish. HOLD

Cava Group (CAVA)—CAVA is definitely stronger than most stocks out there—it’s been holding north of its 25-day line for weeks—though it too has seen selling on strength (95 has been a tough nut to crack) ever since news broke that closely-held shares were up for sale a few weeks back. There is risk here given the stock’s big run so far this year … but it’s also a bull market, and Cava strikes us as rare merchandise, with Mediterranean one of the fastest growing (but also underserved) restaurant categories out there, and with proven management that’s danced this jig before. Put it together and big investors are still likely looking to build positions given the huge runway of growth ahead. We’ll stay on Buy, though further wobbles given the market environment are possible near-term. BUY

CrowdStrike (CRWD)—CRWD officially was added to the S&P 500 this week, and so far the stock has held up just fine, not standing too far off new high ground. At a conference earlier this month, the firm’s CEO had a Q&A session with analysts and he revealed and reiterated some interesting tidbits: 15 of the top 20 banks in the world are clients; the number of customers using eight or more products rose 95% in the latest quarter (indeed, the CEO went on about how the firm’s platform is enabling huge growth as clients take more and more products after their initial buy); and CrowdStrike is rapidly penetrating downstream, too, with its Falcon Go offering giving small businesses an easy antivirus/malware solution for just $5 per month, per device (it’s rare to dominate with big firms but also have offerings appeal to the small fry, too). Big picture, our view that CRWD is an emerging blue chip and one of the liquid leaders of the bull move has proven correct—and if the market was super-strong here, we’d have it rated Buy. But given the environment out there, the near-term is more of a coin flip, so we’ll stay on Hold a bit longer and see how the action post-S&P addition plays out for a few more days. HOLD

On Holding (ONON)—ONON has been all quiet on the news front, but that hasn’t prevented the stock from getting caught up in the market’s surf—following its nice breakout and upside follow through, shares have been hit relatively hard, slipping six points from their highs. So far, it’s acceptable action, and par for the course given up-and-down environment out there; shares are north of their 50-day line and their breakout level. That said, our antennae are up, as a decisive break into the low- to mid-30s could actually have us cutting bait, though a strong rebound off this support area would be a great sign that the fresh uptrend has legs. Overall, we remain optimistic because the evidence (overall chart, fundamentals) is encouraging—hold on if you own some, and if not, we’re OK starting a position here, though stay flexible in case the stock’s character changes. Of note, Nike reports tonight, which could have an impact on ONON and the entire group. BUY

PulteGroup (PHM)—We’ve given a lot of thought to PHM this week, and we have two competing views. On one hand, big picture, the stock’s rest period since March isn’t abnormal, and given the long-term fundamentals here (huge housing shortage, elevated prices, a likely easier Fed coming up) and the rare power seen late last year, the next big move is probably up. (The 40-week line, which is at 102 and slowly advancing, could kickstart the advance eventually, as it did last October.) On the other hand, though, this is the longest stalling out period PHM (and the group) has seen since its major low in 2022—and it’s coming as Treasury rates have actually backed off and as the odds of a Fed rate cut (or cuts) this year have grown. Right here, the higher-high, higher-low pattern of the stock during the past few months is intact, so we’re hanging on, but while we’re OK giving PHM a couple of points to find its footing, any major selling from here would raise the odds of a more meaningful top. We’re holding but watching closely. HOLD

Pure Storage (PSTG)—PSTG hit an air pocket of late, sliding sharply since last week’s holiday session—though, like almost everything else, it hasn’t cracked any meaningful support and today’s bounce was good to see. Overall, it’s tedious, of course, but the major trend is up for the stock and there’s a cementing perception that some big storage deals from AI and hyperscalers are coming down the pike. A drop toward the post-earnings low (upper 50s) would be iffy, but right here, we’re holding onto our stake—and are fine grabbing a few shares if you’re not yet in and have a chunk of cash on the sideline. BUY

TransMedics (TMDX)—TMDX remains in good shape, testing new highs a handful of times in recent days before easing back afterward. One factor regarding the company that doesn’t get enough credit in our view if the firm’s move into logistics, including having its own fleet to transport organs; initially feared as a money drag (it does have lower margins than the firm’s medical devices that actually prolong the life of organs), adoption has proven to be rapid, with $14.5 million of logistics revenue in Q1, up 58% from the prior quarter (!) and making up 15% of total revenues. And, despite the lower margins from that segment, management is “extremely confident” that they can boost gross margins for the company as a whole (which have already been moving higher) in the next 12 to 18 months. We’ll stay on Buy, though as with everything else, the next near-term move is up in the air. BUY

Uber (UBER)—There have been worries surrounding Tesla’s Autotaxi reveal in early August and rising labor costs in some states (giving gig workers more benefits, etc.), but it’s starting to look like a lot of that been discounted by UBER’s March-May decline. More than likely, whether the stock’s correction will give way to a new advance will come down to the Q2 report (likely out in late July); a better-than-expected second half outlook could refocus investors on the firm’s huge EBITDA and free cash flow story that should continue to ramp for many years ahead as rides, delivery and ancillary businesses like advertising do the same. As for the here and now, UBER is up four weeks in a row off its lows and is holding north of its 50-day line—a good first step, though we need to see more to conclude the path of least resistance has turned up. HOLD

Watch List

• Arista Networks (ANET 348): ANET was a decent winner for us a few months back, but it spent about four months bobbing and weaving as some uncertainties about its potential AI-induced demand ramp. Those seem to be clearing up now, and the stock is showing strength. See more below.
• First Solar (FSLR 249): FSLR is fine overall, but has become subject to the sell-on-strength pattern out there—rallying from 200 to 305 and then back down to 245. It’s still worth watching, and if it steadies itself, could be ready to resume its upmove. Earnings estimates here continue to rise (up 76% and 55% this year and next, respectively).
• Freshpet (FRPT 129): Like so many things, FRPT is in an overall uptrend, but hasn’t really gone anywhere since early May as it chops around. We very much like the story here, but trading volume can be an issue.
• Halozyme (HALO 52): HALO has held its large recent gains, which is a win, and is even starting to show signs of follow through, bolstered in part by FDA approval of a label expansion for an Enhanze-enabled drug (from Argenx). More and more, it’s looking like big investors are thinking the firm’s giant earnings forecasts will come true.
• Pinterest (PINS 44): PINS has always had a unique offering and thanks to some smart investments and top-notch execution, growth is accelerating and profits are exploding. See more later in this issue.
• Robinhood (HOOD 23): Much of the market is stuck in neutral and bitcoin/crypto is down—but HOOD remains in generally good shape, with a low-volume dip finding buyers this week. It’s a glamour name with big potential if the bull market re-accelerates.
  

Other Stocks of Interest

GE Aerospace (GE 160)—We recently wrote up GE Vernova, which was one of the spin-offs from the prior entity and looks like a blue chip in the green energy infrastructure fields. GE Aerospace is another (it kept the original symbol), and it has an outstanding long-term growth story and is positioned to be one of (if not the) liquid leader in the aerospace field. The company has the industry’s largest propulsion/engines business for both commercial (about three-quarters of the total business) and defense areas, and demand from both is expected to grow nicely in both the short and long term. And as with many players in the sector, a big draw here is the recurring income that normally follows—the firm says each engine leads to service business that lasts more than 20 years and brings in three times the amount of revenue as the initial sale! (About 70% of total revenue is included in the service category.) While the defense business can be lumpier, it’s likely sales there will remain strong given the hot spots in the world, the still-giant U.S. defense budget and some advanced products (hypersonics and other new-age wartime offerings) that are in demand. All in all, the attraction here is that GE Aerospace is a leader, the industry is set for major growth and the firm’s numbers should show steady, reliable growth and big free cash flow for many years to come. In an Investor Day earlier this year, the firm said it sees revenues growing in high single digits through 2028 (faster this year and in 2025, so the outlook is likely conservative), while operating profit grows in the low double digits and free cash flow comes in at $5 billion this year (north of $4.50 per share, greater than the $4.05 earnings expected this year) and likely grows in the mid-double digits from there. There were a lot of moving parts earlier this year with the spin-off, but as the long-term outlook came into focus, GE had a huge, smooth run as high as 170 at the end of April before finally running out of gas—but, interestingly, the stock hasn’t given up much of its gains, instead marking time for eight weeks. GE may need more time to rest after such a big run, but the story, numbers and chart all suggest big investors will keep building positions over time. It’s not a lightning-fast grower, but we’ve long like the aerospace field and GE should be a magnet for institutional money as the growth story plays out.

Arista Networks (ANET 348)—We rode Arista to solid gains following the market low late last year, though admittedly, we did get knocked out of our final batch of shares during the market’s April correction. Even so, that doesn’t mean we took our eyes off the stock: While the firm has been the dominant networker of our time, teaming up with hyperscaler giants (Meta and Microsoft are giant customers, making up around 40% of revenue combined last year!) to boost their data center and cloud capabilities, the latest upgrade cycle has mostly played out—which has investors focused on AI-related opportunities that are coming. However, in our view, there were two reasons why the stock stalled out for a few months: First, Arista’s AI story was likely to come in 2025, and even then, the firm expected “only” $750 million in AI-related revenue (less than 10% of all revenue) … though now that we’re about to plow into the second half of the year, the payoff is likely closer to the horizon (and being discounted by the market). More important were worries about whether the AI buildout would be mostly based on Ethernet (Arista’s specialty, though others play here, too) or other standards, with competition from Infiniband (sponsored by Nvidia; we’re talking networking products here, not GPUs) a worry. To be fair, management here (and many analysts) were adamant that Ethernet would turn into the AI standard of choice due to lower costs and real-world performance, and now there’s more evidence that’s the case—Arista itself revealed in May it was working (and won deals) on some mega-projects, and last week, the management of chip behemoth Broadcom said in its conference call that it expects “all mega-scale GPU deployments next year to be on Ethernet,” which was taken by the market as a bold statement. Now, analysts still see earnings growth as just OK (up 14% this year, up 13% in 2025), which goes back to the timing issue—but more seem to be coming around to the view that Arista is likely lowballing its outlook and the tsunami of AI spending is going to hit Arista’s shores in the months ahead. ANET tagged 293 before earnings in mid-February, and in mid-June, it was at 291, four months of no progress—but now the stock has moved out to higher highs after the Broadcom news. Could yet another dip come, extending the up-and-down consolidation? It’s possible, but with the AI writing most likely on the wall here, it’s looking like ANET may finally be changing character.

United Rentals (URI 621)—With the market showing a few signs of rotation during the past couple of weeks, we spent some time looking at various ideas that have good stories and could benefit if money shifts away from the hot and obvious AI-type names (chips, etc.) and into the broad market. One is United Rentals, a firm with a long-term growth story but is also heavily tied to the economy: United is the hands-down leader in construction equipment rentals, with 15% of the entire market (next closest peer has 11%, and 3rd place is down at 4%) and a fleet that’s one million units strong, is valued at $21 billion and includes forklifts, truckers, compressors, physical storage assets and aerial lifts and work platforms; just about all of the business is geared toward non-residential and industrial construction projects (not housing). Long term, United has seen amazing growth by gradually taking share and because the trend toward renting (much less expensive than buying) is firmly in place, and the firm’s higher-margin specialty segments (like trench safety, power, HVAC, mobile storage, etc.) are growing faster than the rest of the business (now nearly 30% of revenue). A couple of years ago, the question was how far earnings would fall due to the rate hikes and a possible economic recession—but instead, the economy hung in there and the company’s bottom line kept powering ahead, with analysts looking for $44.50 per share this year (up from $32.50 two years ago!), while free cash flow is very solid (likely $32 per share this year) and the firm has aspirational targets for 2028 that would see cash flow up another 40% from this year. The stock made no net progress from November 2021 to October of last year (23 months), then had a big advance before stalling out in March. The action since then has been tedious along with much of the broad market, but the overall action (19% correction over four months) isn’t abnormal, and URI has found support north of its 40-week line. It’s not a pure growth title, but we think the stock can do well if it breaks free of this consolidation in the weeks to come.

Don’t Forget About the Cabot Trend Lines

Like just about any worthwhile indicator, our long-term Cabot Trend Lines have been tweaked over the years (they originally followed the Dow Industrials and Transports back in the day), but the bottom line is that a version of them has appeared in every issue of Cabot Growth Investor since our first, back in October 1970.

While not a precise timing tool, they’re our most reliable indicator, giving us a big-picture answer as to whether it’s a bull market—or not. We simply compare the market’s two most prominent indexes these days, the S&P 500 and Nasdaq, and compare them to their 35-week moving averages. While there are a couple of rules to prevent whipsaws, the gist of the indicator is simple: If both indexes are above their 35-week lines, the major trend is up, and if both are below, the major trend is down. Simple.

Because of that long-term focus, though, we probably write less about the Trend Lines than most other indicators for the simple reason that … there’s usually not much to talk about. Signals come once a year on average and, even in the very volatile period of recent years, that pattern has played out. The last three signals were a buy in June 2020, a sell in January 2022 and a buy signal in January 2023. Since that last green light, there were two tests when things got hairy (March 2023 and October 2023), but support held, and the market’s obviously done great during this period.

Like all trend-following measures, there can be some whipsaw action (as mentioned above, we do have some rules to prevent those, but nothing is perfect), but over time, the Trend Lines do what they’re supposed to do—keep us on the right side of the major trend. From a time perspective, the indicator has been bullish about 80% to 85% of bull market periods, while it’s been bearish for about 70% to 75% of bear periods (lower because of some quick, sharp market breaks that only last a couple of months).

Now, we don’t advise using the Trend Lines as an index trading system per se—but even testing that out, it comes out ahead. For example, going back to late 2000, if you theoretically bought the Nasdaq on green lights and held cash during sell signals, you’d have 28% more profit (about 22% more in your account) than just buy and hold, and you would have done that with far less risk, being out of the market about 30% of the time (nearly seven years) of that entire stretch. You can play with those numbers (maybe you could have earned a little income on your cash during the bear phases, etc.), but the larger point is that simply keeping in gear with the major trend puts you ahead of the game.

We write about this today because we’ve been harping a lot on the market’s recent action, which has been very sloppy, choppy and narrow; as a whole, growth stocks and most of the market hasn’t really gone anywhere since early March, and for every stock that perks up another one has hit a pothole. With that evidence, near-term risk is elevated in our view, which has us holding some cash.

However, equally important is that the long-term trend is firmly up, and when combined with numerous bullish studies of unique market action, it’s important not to get too worried or negative—we could always raise more cash if, say, the market breaks, but until proven otherwise, the odds still strongly favor higher prices in the months ahead.

Dancing to Its Own Drummer

Pinterest (PINS)

Pinterest has always had a unique story, being the hands-down most popular “visual discovery engine” (in the company’s words) that millions of people use to get ideas for everything from decorating, style, gifts, recipes and more, and with everyone encouraged to build their own whiteboards of ideas, it’s been a differentiated place for advertisers and users alike.

It’s always done a good business, but most of that was in getting people to peruse and curate ideas—but starting in the second half of 2022, the top brass here began investing in AI and changing things around so that it also became a go-to e-commerce destination, with users actually buying and not just looking at ideas.

If you’re interested in reading about all of the firm’s innovations, go read the Q1 conference call transcript, where management does a deep-dive of things they’ve come up with—for this write-up, suffice it to say that Pinterest’s moves in advertising (links to a specific page on an app, direct links to an advertiser’s buy page, page optimization), measurement (accessible data for advertisers to integrate and act on) and AI (including ad campaign creation and intelligent bidding) has been a hit for both users (user growth is accelerating; Pinterest is one of the only firms whose user base is getting younger, with 40% of the total now made up of Gen Z) and businesses (including an advertising deal with Amazon) that’s resulted in accelerating revenue growth (up 23% in Q1), solid revenue per user expansion (up 19% in the U.S./Canada in Q1) and triple-digit earnings and EBITDA growth in recent quarters. And there should be more to come: In last year’s Investor Day, the top brass said it thought EBITDA margins could leap over 30% within three to five years, which is double what was seen in Q1.

What we like here is that the firm has a unique offering, and after years of good-not-great performance, the top brass looks to be on the cutting edge of truly monetizing it. PINS was up (November-February) and down (February-April) the past few months, but the Q1 earnings gap was fantastic, and the stock has been nosing higher despite the sluggish action in the broad market. PINS is near the very top of our watch list. WATCH

Cabot Market Timing Indicators

The story remains the same as we wrap up the first half of the year—the big-cap indexes are in nice uptrends, but unfortunately that’s thanks to just a handful of stocks. Most of the market is meandering sideways, the broad market is unhealthy and few names are hitting new highs. Big picture, the odds favor higher prices down the road, which is important, but given the trendless, tedious action, we’re holding some cash and being very selective until big investors return to the buy side.

Cabot Trend Lines – Bullish
There are a fair number of warts on the market right now, but our Cabot Trend Lines are still solidly bullish—coming into today, the S&P 500 (by nearly 10%) and Nasdaq (about 13%) are solid above their respective 35-week lines—and as we write earlier in this issue, that means a lot, telling us the odds still favor nicely higher prices in the months ahead. Of course, that doesn’t preclude some potential rough sledding near-term if the sellers step up, but big picture, it’s important to keep your optimist’s hat on.

Cabot Tides – On the Fence
Normally, the market’s intermediate-term trend might be neutral for a couple of weeks before things clear up—but this is an unusual situation, as three of the five indexes we track (including the S&P 400 Midcap, shown here) continue to meander within multi-month ranges, which keeps the Cabot Tides on the fence. We have seen a little bit of outperformance among some growth indexes (our Growth Tides), which is a ray of light, but at day’s end few sectors or indexes are in sustained intermediate-term moves.

Two-Second Indicator – Negative
Our Two-Second Indicator is clearly negative, with 20 of the past 24 trading days bringing greater than 40 new lows—even as the S&P and Nasdaq remain near new high ground. Granted, the readings aren’t expanding in a huge way; we’d be more alarmed if we saw big readings (say, 150 to 200) of new lows most days (so far, the max has been “only” 93), so it’s possible the readings could dry up if big investors return. But right here, there’s no doubt the broad market is languishing.

The next Cabot Growth Investor issue will be published on July 11, 2024.

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