Cabot Growth Investor Issue: May 16, 2024

Selling Pressures Vanish

While investors can attack the market from a million different angles, the fact is the market moves based on the law of supply and demand—selling pressures vs. buying pressures. Thus, when stocks are in a sustained uptrend, there’s no doubt that buyers are active, and the reverse is true during sustained downtrends.

However, at market turning points, that’s not always the case. Sure, sometimes at market low points, you will see a rush of buying, with huge-volume moves in many stocks and indexes that drive prices up; that’s just what happened last November, for instance. But just as often, the turn comes because selling pressures vanish—resulting in a gradual push higher initially, with stronger buying pressures showing up later.

After a 6% (S&P 500) to 10% (many growth funds and indexes) correction, that’s how things have played out this time: We can’t say big investors are going wild on the buy side, but the selling pressures have vanished, which has led to a steady improvement in the evidence in the past three weeks.

It started with an intriguing short-term breadth thrust (three straight days where NYSE breadth was at least 3-to-1 positive while the S&P 500 was north of its 200-day line) that’s relatively rare and usually portends good things. And that’s been followed by both our Two-Second Indicator and Cabot Tides rejoining the longer-term Cabot Trend Lines in bullish territory—
helped along by a dip in Treasury rates, which began falling two weeks ago (after the jobs report) and actually cracked some intermediate-term support yesterday (after the inflation report).

As for growth stocks, the evidence there has improved, too, with our Growth Tides also back to positive territory; the iShares Momentum Fund (MTUM), shown here, is a good example of that. However, there’s no doubt that, similar to MTUM, many names are right back into resistance, and overall growth has lagged the big-cap indexes since the prior peak.

When we put all of it together, the overall, longer-term uptrend looks to be resuming, which is the most important factor—and is why we’re putting more money to work tonight. That said, we advise doing so in steps, as growth stocks remain a bit sloppy given that buying pressures remain sporadic.

What to Do Now

Continue to get more constructive on the market. We began to put some money to work last week, starting a half-sized position in TransMedics (TMDX) and averaging up on Cava Group (CAVA). And tonight, we’ll continue to extend our line, buying half-sized stakes in Toast (TOST) and Pure Storage (PSTG). Meanwhile, having held our resilient performers during the correction, most have rebounded nicely—we’re restoring Buy ratings to AppLovin (APP) and CrowdStrike (CRWD). All told, our cash position will be around 23% after tonight’s moves, and we’ll look to extend our line if more growth stocks get moving.

Model Portfolio Update

The past couple of weeks haven’t been overly powerful—but they have been positive, with the steady upward movement enough to gradually turn our market timing indicators back to green lights. That’s obviously a good thing and is the reason why we put a bit of money back to work last week and are putting more into potential leaders today.

That said, we’re growth investors, and the lack of power seen in the rest of the market has been seen even more among growth areas, with things like our Growth Tides and Aggression Index (more direct measures of how growth stocks are faring) definitely improving but not exactly lighting up the sky, while also lagging the major indexes.

As we write about later in this issue, that action isn’t necessarily predictive (it doesn’t portend bad things); it’s simply a sign that big investors aren’t exactly diving headfirst back into these names. And we’re following that lead, picking our spots and stocks carefully. That said, we’re not going to lose sight of the forest for the trees—the overall bull market remains intact, our market timing indicators are positive, most of our stocks are doing well and we’re not having trouble filling up our watch list.

After tonight’s buys of Pure Storage and Toast, we’ll have about a quarter in cash, which we’ll look to put to work (ideally via averaging up in some of our newly-bought half-sized stakes) should the rally continue.

CURRENT RECOMMENDATIONS

AppLovin (APP)—AppLovin’s business remains in fifth gear, with its big Q1 report easily surpassing expectations as its game business stabilizes and its Axon advertising engine continues to gain share—and, importantly, the top brass made it a point to say there’s no reason Axon can’t be expanded into other sectors, which would greatly broaden its potential. Shares have hesitated this week mostly because a fund of KKR, which owns a bunch of APP, sold 17.5 million shares on the market, which could weigh on things short-term. (The fact that AppLovin didn’t buy back some shares on the offering, as they did in a similar instance earlier this year, was taken as a small negative, too.) Still, APP remains well above its moving averages (25-day line is down near 75), so we’ll restore our Buy rating, though further wobbles in the days ahead certainly wouldn’t be surprising. BUY

Cava Group (CAVA)—CAVA is part of what’s suddenly become a super-strong restaurant sector, with many younger cookie-cutter plays heading higher. (See more on that later in this issue.) Cava still has earnings coming up (May 28), which is always a risk, but there’s no doubt the stock’s support near the 50-day line during the market dip and quick rip back to new highs is a good thing. Fundamentally, the firm just opened a new production and packaging facility in Virginia that can make the restaurant’s dips, spreads and other offerings—along with its first facility, the company now has the capacity to support at least 750 stores (up from 325 as of three weeks ago), and as these operations get busy, margins should improve further. The stock is as volatile as can be, but we added a bit more to our stake last week (bought an extra 3% position) and are sitting tight. If you don’t own any, you can start small here or on dips, though, again, earnings will be key. BUY

CrowdStrike (CRWD)—CRWD has been a lot like the market, not making any huge waves but gradually improving its positioning—so much so that it notched all-time closing highs this week! Granted, the relative performance (RP) line isn’t free and clear yet and earnings are still upcoming (June 4), which will be vital, but so far, everything we’ve thought going back months seems to be on track: CRWD quacks like a liquid growth leader, with rapid, reliable growth that should play out for a long time to come, bolstered by a more threatening cyber landscape and a best-in-class offering that’s being tied in with many big players (such as last week’s announcement that the firm expanded its partnership with Google Cloud). Given the improving evidence for the stock, we’ll restore our Buy rating, though you might consider keeping new positions on the small side with earnings still to come. BUY

DraftKings (DKNG)—DKNG’s story hasn’t changed in recent weeks, and the numbers have actually gotten stronger, with management hiking its 2024 estimates after Q1 topped expectations. Even better is the fact that business is truly firing on all cylinders (active user count and revenue per user were equally responsible for Q1’s 53% revenue hike), and the top brass is keeping costs contained despite fears of another turf war following ESPNBet’s launch late last year—in fact, more than half of this year’s revenue increase is expected to fall to the bottom line. That said, the stock itself is OK but not fantastic—back above its 50-day line but no higher than it was in mid-February. Of course, that seems to be the stock’s character (two steps forward, one step back), so we’re being patient, but would focus new buying on names that are under stronger accumulation. HOLD

Nutanix (NTNX)—Maybe it’s because the story and product line can be a bit of an ice cream headache (hyperconverged infrastructure doesn’t exactly roll off the tongue), but Nutanix isn’t talked about much. Still, that doesn’t bother us, as the stock continues to perform well, nosing to new price and relative performance (RP) highs this week. Like a bunch of growth names, the firm still has earnings coming up (the quarter didn’t finish until the end of April; the report is due May 29), but the stock’s evidence remains excellent, and there doesn’t look to be much standing in the way of many quarters of solid sales, earnings, recurring revenue and cash flow growth as it lands and expands deals with more big players. We’ll stay on Buy, though as with everything else, a near-term wobble wouldn’t shock us. BUY

PulteGroup (PHM)—PHM’s correction ended after the firm’s quarterly report, which easily surpassed estimates, again displaying the firm’s earnings power even in a higher mortgage rate world—and giving investors hope that its elevated earnings can go much higher if and when rates come down. That latter scenario looks to be on track thanks to this week’s inflation reading, which drove rates lower and helped PHM notch new price highs yesterday. Expect continued news-driven movements (often based on economic readings or Fed speeches that might affect rates), but the path of least resistance is up. BUY

Pure Storage (PSTG)—We wrote about PSTG as one of our Other Stocks of Interest in the prior issue, and today we’re going to start a position in it as shares are showing some power. While there are many storage players out there, Pure Storage has always had the latest and greatest offerings, mostly because it’s solely focused on flash products, which is where the industry is headed. (Management said last year it thinks all industry sales will be flash-based within five years.) Moreover, the top brass has been innovative with various subscription offerings (its Evergreen line of products), with annualized recurring revenue now making up about 45% of total revenue. All of that is to the good, but now investors are thinking the AI buildout will start to include a big pickup in storage orders, as all of the machine-generated data being produced will put into datasets to “train” the large language and AI models—and the fact that this firm’s flash drives take up less space and use less power means big savings for clients. Indeed, the CEO in February talked about landing an eight-figure deal (>$10 million) with “one of the largest specialized graphics processing cloud providers for AI.” To this point, Pure’s numbers have been funky (partly due to the transition to a subscription model, where revenues are recognized over time), but key metrics are plowing ahead (remaining performance obligations up 31%, recurring revenue up 25%, free cash flow larger than earnings) and growth is expected to accelerate going ahead. Shares lifted off from a huge base after earnings at the end of February but then sat around for another two-plus months as the market consolidated. But now, as the selling pressures have eased, PSTG has taken off on good volume. The firm still has earnings coming in a couple of weeks (May 29), so we’ll start with a half-sized stake (5% of the portfolio) and look to average up if it remains strong. BUY A HALF

Toast (TOST)—TOST was another name we wrote about in the last issue—it’s best known as a new-age payments operation, but it’s really much more than that, effectively being a one-stop shop for restaurants to take care of various aspects of their business, including payments as well as back-office solutions, analytics, scheduling, mobile/takeout/delivery order processing, marketing tools, tips management and much, much more. We like that the opportunity is huge (it has 112,000 of about 860,000 restaurant locations in the U.S. as clients, and that says nothing about the U.K., Canada and Ireland, where the firm is beginning to get up and running). And growth has been consistent, with sales, payment volumes and the client base up 30%-plus in Q1, while EBITDA is scaling nicely (leading to a nice boost in EBITDA guidance after Q1 results were reported). Shares broke out on the report last week, though there is still an Investor Day upcoming (May 29) later this month, so we’ll start with a half-sized stake today (5% of the account)—if the breakout fails, we’ll cut the loss, but if it gains steam after the event, we’ll look to fill out our position. BUY A HALF

TransMedics (TMDX)—While many glamour stocks started this rally out slowly, TMDX was an exception, actually finding strong buying in early April and then staging a powerful breakout on earnings. And, of course, that move was backed up by great numbers (triple-digit revenue growth) and an even better story, as the company is well on its way to revolutionizing transplants here in the U.S., and eventually overseas. The stock is volatile and extended, but early in a potential fresh rally phase, we like to go with names showing strength (ideally after rest periods), and this stock has that in spades. We started with a half-sized position last week and will sit with that tonight. BUY A HALF

Uber (UBER)—UBER has been the weak link in the portfolio, with the market, worries about Tesla’s Robotaxi unveiling in August and the Q1 report (solid numbers but guidance was a bit soft) all keeping the buyers on the sideline. Our patience isn’t unlimited here, and by a couple of metrics (20% decline from the highs; shares are approaching their 40-week line, now at 61 and rising, which is also near the prior major peak in 2021), buyers should show up soon if all’s well. Deep down, we continue to believe that business remains excellent, with booming free cash flow (something like 67 cents per share in Q1 alone) likely to re-attract big investors once this selling is over, while the stock’s big breakout last November should portend a larger advance. We may trim our position further if the stock languishes, but right here we’ll grit our teeth and sit tight. HOLD

Watch List

• Core & Main (CNM 61): Core & Main isn’t going to make many headlines, but we think the long-term infrastructure story here will lead to consistent double-digit growth and big cash flow. Shares have been resting for eight weeks after a big run; earnings are due June 4.
• Eli Lilly (LLY 772): LLY is higher priced and has been bouncing around since mid-February, but it’s only taken back a max of 30% of its post-October run and stands 3% from new high ground. Meanwhile, earnings estimates are moving nicely higher.
• Natera (NTRA 109): NTRA reported another great quarter, with sales growth accelerating again (now 27%, 43% and 52% during the past three quarters), though to be fair, a lot of that is due to higher pricing. The stock gapped up nicely and remains in a strong uptrend.
• On Holding (ONON 37): Retail remains the strongest growth area today, and after a very tedious year-long consolidation, ONON might be changing character after Q1 results confirmed the rapid growth story remains intact. See more below.
• Samsara (IOT 41): Samsara has been an impossible stock to hold, with a four-steps-forward, three-and-a-half-steps-back type of move during the past year. So why is it on the watch list? Because the story oozes long-term, reliable growth and, after yet another failed breakout attempt that led to a retreat in April, IOT has stormed back to new highs. Earnings are due June 4.

Other Stocks of Interest

Onto Innovation (ONTO 224)—Chip equipment stocks have never been among our favorite investments, mostly because they’re what we call down-the-food-chain operations—demand for their wares will be among the first to fall (and sometimes plunge) when there’s any whiff of a slowdown in the semiconductor space. That said, occasionally, there’s a firm with a new product that serves a new growth area within the chip sector that does well; Axcelis Tech (ACLS) was a good example last year, with a new device meant for silicon carbide chips (big for EVs) that helped the stock more than double in eight months. And now we have Onto Innovation, a firm that’s been around for years and does a good business in metrology and process control—i.e., machines that detect any tiny blemishes during chip production. Growth hit a bump last year (partially due to China sales restrictions), but Onto is just starting a big growth wave mainly due to its Dragonfly system, which appears to be a better inspection mousetrap for AI chips that have more connections and requirements so they can perform their exacting workloads. That alone was enough to get sales (up 15%) and earnings (up 28%) back on the upswing in Q1, and when you combine Dragonfly (which saw sales rise 30% from Q4!) with an expected pickup in other areas of its business, Onto’s top brass expects continued growth this year (with increased margins) and, looking down the road, possibly having everything kicking into gear in 2025 as orders flood in—indeed, Wall Street sees the firm’s bottom line rising 32% this year and another 26% next year, but we’re guessing those will prove low. Now, to be fair, ONTO isn’t in the first inning of its overall advance, having a big run (along with the chip sector) during the past year. But as the advance becomes more selective, we’re impressed with the action during the recent downturn, with shares shaking out in April but storming back to new highs before and after earnings last week. Near-term wobbles are possible, even likely, but the strength and story point to higher prices down the road.

On Holding (ONON 37)—Later in this issue we write about some of the hot cookie-cutter restaurant stocks out there, as investor perception seems to have turned up in a big way. That said, already owning Cava, we’re not anxious to dive into a second restaurant name given that we run a concentrated portfolio. (Owning two good-sized positions in those fastballs would be hard to handle.) However, when it comes to retail in general, we’re intrigued, as there are tons of firms with great growth and stories out there, but whose stocks haven’t been able to kick into gear. On Holding, a Swiss firm, is a name we’ve been watching for over a year because it quacks like another Nike or, if you want to be more modest, Under Armour—the firm’s running shoes continue to rapidly gain popularity and take share, and there’s actually some science behind it (not just a fad), with a more cushion-y impact and a spring-ier liftoff that’s proven to be a hit. Indeed, many racers have moved over to On’s offerings, including the winner of the past two Boston Marathons. From there, the company has been expanding its product line, with tennis and training footwear catching on quick, while it’s also moved into apparel and accessories, too—again, aiming to follow in the footsteps of other athletic gear winners. As alluded to above, growth here has been solid for a while but the stock hasn’t really been able to break free, but that might be changing now: This week, On said that Q1 currency-neutral revenue lifted 29%, with shoe sales up 29%, apparel up 25% and accessories up a big 43%, while margins expanded and EBITDA was likely up in the mid-30% range. The top brass also reiterated that 2024 would be a solid growth year (currency-neutral revenues up 30% or more), and big investors might finally be stepping up to the plate—while it’s not quite free and clear and has been a bit wild, ONON reacted strongly to the report and stands near the top of a year-long range. (The big-volume shakeout and recovery seen in March is another encouraging sign.) We’re putting the stock back on our watch list.

Southern Copper (SCCO 120)—Normally commodity and heavy cyclical names don’t kick into gear until later in a bull move, but this hasn’t been an ordinary cycle, with inflation elevated, the economy strong and many other fundamentals helping the cause. In the case of copper, you have a combination of many factors that have the bulls running: First, there’s China, where tons of smelters are cutting production, and this came after a closing of a big copper mine in Panama. Second is the emphasis on the electrification trend (green energy), where copper plays a big role because of its conductivity, which is boosting demand in the U.S. and Europe. And, on a macro basis, you have investors anticipating an easier monetary environment, with a weaker U.S. dollar almost always a good thing for commodities. The end result is that copper broke out on the upside in March and has enjoyed a persistent run since then—and just as importantly, leading copper names like Southern Copper did the same and continue to act great, as a few big investment houses seeing an even tighter supply/demand situation ahead. The company is one of the world’s largest copper producers with mines in Mexico and Peru, with some of the industry’s lowest costs and longest runway of future output. The prior numbers here don’t matter that much—Q4 and Q1 saw sales and earnings decline—but Wall Street sees the bottom line lifting 20%-plus this year and next, and that could easily prove conservative if the copper bull market continues. As for the stock, we love that the breakout in March came from a very long consolidation (dating back to early 2021!) and shares have acted in a near-perfect fashion since, with a brief rest the past few weeks as the 10-week line caught up and then another round of buying. Commodity stocks aren’t the core of what we do, but it looks like a longer-term uptrend has gotten underway.

Cookie-Cutter Restaurants Coming to Life

We’ve written many times before that, in the market, timing is everything—the same company with the same underlying story and similar numbers can see its stock languish for months if not longer, but when investor perception changes, things can change in a hurry as big investors start to accumulate shares.

We’re seeing that happen now with a few younger, cookie-cutter stories, mostly in the restaurant field, which are joining the positive action of some bigger-cap names (like Chipotle). Our favorite of the bunch, of course, is Cava (CAVA), which is super-volatile but remains strong as earnings approach (May 28).

But there are two others that have caught our eye: Sweetgreen (SG) is a name we’ve written about before (see the April 4 issue of this year)—it’s been doing great business by offering healthier salads and warm bowls (popular among the lunchtime work crowd and at the mall) but it’s now broadening the menu, offering more protein-focused plates and, in the Q1 conference call, confirming that steak options are coming nationwide, which helps with dinner sales. Moreover, thanks to an acquisition last year, it’s testing so-called Infinite Kitchens where customers make their own meal (with the help of food dispensers), potentially slashing costs. (Management has said automation in general could be a huge part of its plan during the next few years.) And, of course, the cookie-cutter aspect (25 new openings this year, up 11%) is strong and should play out for a long time to come. The stock went ballistic on earnings last week and has been holding the gains.

Then there’s Dutch Bros. (BROS), which we’ve been keeping an eye on since it came public in late 2021. The firm is a quick-service (often drive-through) beverage shop, but this isn’t just a coffee outfit—most revenues come from cold beverages, including a lot of customized offerings, such as its own energy drink and, just this year, a protein coffee (protein from certain milk) and boba offerings that have proven to be very popular. The store expansion plan is humongous here (count up 22% in Q1; firm has 876 locations, aiming for 4,000-plus down the road!), though costs and same-store sales have been choppy, which kept the stock under wraps. But it appears BROS changed character last week after the Q1 report (comparable sales up 10%, earnings of nine cents beat by eight cents, big increase in margins), when it rebounded off support on its third heaviest volume week ever.

To be fair, all three of these names—CAVA, SG and BROS—could use more sponsorship, as fund ownership (352 for CAVA and fewer than 300 for SG and BROS) is a bit lacking, which can lead to the wild moves (up and down) all of them have seen of late. But if the action of the stocks is any clue, many funds have been buying in since the start of the quarter and many more will hop onboard if the respective management teams continue to execute. All three act like fresh glamour leaders.

Descriptive vs. Predictive Action

As we wrote on page 1, there’s no doubt the market’s overall evidence has improved in a big way of late—but there’s also little doubt that growth stocks are still lagging, with many doing OK but not exactly powering ahead. Our Growth Tides are positive but not yet powerful, and our Aggression Index (shown below) is in the same boat.

However, an increasingly common question—one I got when I briefly appeared on Cabot’s Street Check podcast last Friday—is what does this all portend. Is the so-so growth stock action relative to defensive and other stocks a bearish sign? Does the up-and-down action signal distribution, sort of like what we saw in late February or early March?

My answer: Not really. While some stuff obviously has predictive value—including the two market studies we mentioned on page 1 today—sloppy growth stock action a few months into a fresh uptrend isn’t a red flag. If anything, it’s somewhat common.

Take a look at the Nasdaq in 2013, which was a great year for growth stocks (Model Portfolio was up 40% that year). But after running up nicely from the November lows to the February highs (about 14% in total), things began to get messy, with a lot of churning and a couple of sharp dips, including one that nose-dived below the 50-day line in April. (Sound familiar?) But from there, the Nasdaq took off and outperformed everything, rallying hugely (with some corrections along the way) by year-end—and growth stocks led the way.

We’re not saying 2013 is an exact comparison to this year, but the point is that the recent so-so growth stock action is descriptive, not necessarily predictive—right now, it means putting money to work in steps and holding a little cash ... but being ready to pounce should big investors pile in.

Cabot Market Timing Indicators

Depending on what you were looking at, the market fell between 6% to 10% during its late March/April swoon and then initially bounced in just a so-so fashion. But what the rally lacked in power in made up in persistency, with our market timing indicators returning to bullish territory one by one. Growth stocks aren’t necessarily lighting up the sky just yet, but all in all, there’s no doubt the overall evidence is in good shape.

Cabot Trend Lines: Bullish
Our Cabot Trend Lines haven’t changed their positive tune since January of 2023—by our measures, the longer-term trend has been up since then, and it remains so today, with both the S&P 500 (by 11%) and Nasdaq (by 12%) actually hitting new highs this week and having plenty of cushion above their respective 35-week moving averages. Of course, there’s always a chance something goes wrong (maybe if interest rates spike again), but it’s best to go with what’s in front of us and respect the longer-term uptrend.

Cabot Tides: Bullish
It hasn’t been the most powerful move, but the steady improvement in our Cabot Tides during the past three weeks has returned them to positive territory—most indexes we track (such as the NYSE Composite, shown here) nosed above their 50-day line a couple of weeks ago, held that area and have continued higher since then. Granted, our Growth Tides are lagging a bit, but even they’re back in positive territory. All in all, the market’s intermediate-term trend has turned back up.

Two-Second Indicator: Positive
Our Two-Second Indicator signaled an all-clear last week as the broad market put on a good show—today, in fact, looks like it will be the 15^th straight day of sub-40 new lows, a very good sign for the market. Thus, while the buying pressures have been hit and miss (especially with growth stocks), the broad selling pressures (which this indicator measures) have dried up nicely.

The next Cabot Growth Investor issue will be published on May 30, 2024.

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