Cabot Growth Investor Issue: May 18, 2023

Keep it Simple

Usually whenever a trend gets mature, you start seeing investors getting into the arcane and complex. In a long uptrend, that can play out with stock selection—instead of sticking with solid leading names, investors tend to dig into speculative names and, when sentiment gets bubbly, come up with reasons why the advance will continue. During long bear phases, you’ll see people trading different patters (weak stocks but near support, etc.) and emphasizing tertiary evidence.

And we’re starting to see the same thing play out now, during this tedious sideways phase. This week we’ve seen a study about the past few decades of mid-May performance (looking for help from seasonality); a look at a 40-year cycle of interest rates and how that means they should head higher from here; a look the short-term divergence between junk bonds (six-week low) and the big-cap indexes; and, of course, the usual barrage of economic and (now) debt ceiling analysis.

Don’t get us wrong, these things come from smart people, and we enjoy some of it for perspective. But at day’s end, you’re almost always better off keeping it simple—trust us, we’ve gone down the rabbit hole a few times over the years, but it never proved better than just sticking with the rubber-meets-the-road evidence.

Today, the top-down evidence is about as neutral as can be: The longer-term trend is still positive (Cabot Trend Lines), the intermediate-term trend remains sideways (Cabot Tides) and the broad market is negative (Two-Second Indicator). One version of our Aggression Index (equal-weight Nasdaq 100 vs. consumer staples) is contained within its multi-month range, as are many other measures.

For individual stocks, the evidence is worse off—not bearish per se, but as we write below, the meat grinder environment is in full effect, with plenty of air pockets on good news and few stocks letting loose on the upside.

The thing to remember here is that the situation is very much on the fence … so much so that a good or bad few days from here could really change the outlook. We will say the past two days have been intriguing, with a few stocks starting to move. Even so, we see no reason to jump the gun, especially given the chop-fest that exists with growth stocks; if things get going, there should be plenty of names to hop on.

What to Do Now

Because of that, we’re content to hold an outsized amount of cash, though as we’ve written many times, we’re not opposed to a nibble or two in names that have shown strong buying. Since the last issue, we sold our half-sized stakes in Axon (AXON) and On Holding (ONON)—but tonight, we’ll start a half position in Uber (UBER), which finally looks ready for a sustained advance. That will still leave us with a huge 68% in cash, which provides us plenty of cushion but also plenty of buying power should things improve.

Model Portfolio Update

If you look at the overall evidence, it’s not great, obviously—the intermediate-term trend is mostly neutral, with an iffy broad market. That said, you also have a stubbornly positive long-term trend (our Cabot Trend Lines) and a lot of potential leaders that continue to set up, with a few actually pushing higher.

However, when you get down to doing some buying, it’s a meat grinder; most of the time, buying just results in your money getting shredded. Basically, individual stocks are trying to walk through a minefield, with few really going up (the number of new highs is pathetic), and many getting nailed … and of those that act well, most usually hit some pothole within three or four weeks. Said another way, the juice generally isn’t worth the squeeze, with potential profits of pennies and nickels while risking dimes.

To be clear, we think the odds favor the next big move being up; there are numerous studies that tell us that, and the fact that our Cabot Trend Lines remain positive amidst a tidal wave of pessimism bodes well down the road. We’re also intrigued by the action of the past two trading days, when some stocks have stretched higher.

But the above is the reason why we’re still holding lots of cash. After selling small stakes in AXON and ONON during the past two weeks, we’re adding a half-sized position (5% of the account) in Uber (UBER) tonight, but that still leaves us with 68% on the sideline. As always, we’ll put money to work quickly if leaders truly emerge, but we’re not jumping in a big way until the meat grinder environment changes.

CURRENT RECOMMENDATIONS

Academy Sports & Outdoors (ASO)—ASO’s action has frankly been very disappointing, with a gradual but persistent slide—and then, on Tuesday, a big-volume plunge as retail stocks as a whole gave up the ghost. It was certainly unpleasant, but the 20%-ish top-to-bottom slide isn’t completely surprising given the environment, and ASO has bounced decently since. It’s a close call for us—clearly the action isn’t what we’re looking for, but we did sell a third of our stake at much higher levels; there’s little doubt the fundamental story is on track; and we’ve seen more and more stocks and sectors get hit for a few weeks before rebounding. All in all, we’re sticking with ASO right here—any more weakness and we’ll let our remaining shares go, but we think giving it a couple points of wiggle room makes sense. To this point, this looks like a good support week, though we’ll see how tomorrow goes. HOLD

Axon Enterprises (AXON)—AXON is one of many stocks that looked proper and was acting well, released solid earnings numbers and had a good outlook—but still had its share price crack intermediate-term support after the report as sellers swarmed, forcing us to sell our half position. To us, the Q1 report was as solid as they come, with sales (up 34%), earnings (up 96%) and many sub-metrics showing excellent growth, and with the top brass nudging the 2023 outlook higher. Because of that, and because we have seen some wild shakeouts in recent weeks, we are keeping an eye on AXON—shares have bounced a bit and are holding near the 200 level during the past week; if the market and the stock can power ahead, maybe last week was one big shakeout. Still, as of now, the stock itself and environment as a whole are iffy at best, so we cut bait last week and are holding the cash. SOLD

On Holding (ONON)—As with most of our names, nothing has changed with our view of On Holding fundamentally—it definitely still quacks like a future leader, with the Q1 report (sales up 80%, earnings tripled, both topped estimates) showing demand is huge. There were reportedly worries that the top brass didn’t hike estimates enough and that inventories rose a bit, but both are easily explained away (conservative guidance; management forecast the Q1 rise in inventories last quarter and said they’d fall back by year-end). Despite all of that, the meat grinder environment saw the stock fall sharply after the report—the first day was unpleasant but acceptable, but Wednesday’s plunge through the 50-day line and poor close was too much for us. We’ll still keep a distant eye on ONON going forward—like we wrote above, the fundamentals are definitely still there for big investors to get heavily involved over time; plus we’ve seen some intriguing snap backs of late—but at this point the trend has cracked and we cut bait in yesterday’s special bulletin. SOLD

ProShares Ultra S&P 500 Fund (SSO)—You can argue about what it means or what it might lead to, but the fact is a handful of mega-cap stocks are keeping the big-cap indexes like the S&P 500 above the waterline—and, today, actually testing the upper end of the multi-month range. That’s why we’re OK giving our remaining position in SSO a chance, especially given that our Cabot Trend Lines are positive and numerous studies based on market action tell us higher prices are more likely than not down the road. Of course, we’re watching things closely like everyone else; a drop three points would be a yellow flag, make the past few weeks look toppy and could have us selling ... but the opposite (a rise of two or three points) would have SSO and the S&P 500 breaking out on the upside and could have us adding exposure. We won’t anticipate what’s to come—right here, we’ll continue to hold on. HOLD

Shift4 (FOUR)—FOUR took a one-two punch in April (on a short seller report) and in early May (after earnings), but none of that changed the fact that business is great and getting better—management actually hiked its outlook after the Q1 report, and analysts see earnings up more than 60% this year and another 25% to 30% in 2024, with big free cash flow, too. (We’re not valuation buffs, but the forward P/E ratio of 28 is hardly insane.) Just looking at the story, numbers and potential, our thought that Shift4 can morph into an emerging blue chip down the road hasn’t changed at all. And now we’re starting to see FOUR respond a bit, holding support near 60 despite some bad sector action (PayPal has been clobbered of late) and starting to bounce. We have a small position left after two partial sells so we’re willing to give the stock some rope; the longer it can hold up, the greater the chance that the overall uptrend will resume. HOLD

Uber (UBER)—We wrote about Uber’s story and the latest quarterly report in the last issue (in Other Stocks of Interest), so we won’t repeat ourselves here. We took a swing at the stock earlier this year, but was forced to purge the name when it was dragged down by the market, but we think a few things have changed. First, another quarter of improving, better-than-expected cash flow always helps the cause and confidence of big investors. But second, one of the issues that dented UBER in February/March was its peer Lyft, whose stock was hammered. Now, though, Lyft still looks terrible, but Wall Street is seeing Uber as in a class by itself—which, in a way, means the potential for growth is larger, not just from the ride sharing and delivery businesses expanding over time, but from Uber grabbing more and more market share, too. There aren’t many strong, liquid growth names in the market today, but UBER is one and we think it can be a liquid leader. After a powerful liftoff before and after the Q1 report, shares have held firm. We’ll add a half-sized stake tomorrow (5% of the account). BUY A HALF

Wingstop (WING)—After a great earnings report, WING saw (what else) selling on strength, but that’s OK—while tedious, the stock saw just one above-average volume decline (the day after its earnings pop) and is trying to find some support near the 200 level and its 25-day moving average. Earlier this month the firm opened its 2,000^th location, and one thing we’ve liked about the company for years is that they’re thinking big, aiming to have 7,000 restaurants around the globe eventually and to be a top 10 global restaurant brand. And with same-store sales soaring (19 straight years of gains in this metric, which was up a whopping 20% in Q1), the store economics continue to improve—the average domestic restaurant pulled in $1.7 million of revenue (annualized) in Q1, up from $1.6 million a couple of years ago and the top brass believes it’s headed to $2.0 million down the road. If you don’t own any and want to nibble on this pullback, we won’t argue with you, but officially we’ll stay on Hold given the market environment. HOLD

Watch List

• Axcelis (ACLS 145): ACLS was clearly one of the early-year growth leaders, and after a good-sized earnings shakeout, the stock has blasted back to new highs just as the chip sector is beginning to percolate. See more later in this issue.
• Celsius (CELH 133): CELH boomed ahead after the Q1 report last week showed the Pepsi partnership was bearing fruit. We’re not chasing it at this point, but a reasonable rest period could have us starting a position.
• DraftKings (DKNG 24): DKNG’s Q1 report was terrific (revenues up 84%, EBITDA breakeven to come in Q2, two quarters ahead of prior expectations). To be fair, growth will slow some acfrom here, but similar to Uber, it’s likely cash flow will have plenty of upside ahead. The recent pullback has come on next-to-no volume.
• Duolingo (DUOL 152): DUOL snapped back beautifully from its selloff thanks to a great earnings report that not only topped estimates, but management completely dispelled any notion that AI would upset its business—if anything, it was an early mover to integrate AI into its offerings. Shares are acting very well.
• Inspire Medical (INSP 303): It’s hard to trust anything in this market environment, but it’s looking more and more like INSP has changed character, with a steady post-earnings march upwards that led to new price and (unlike earlier this year) relative performance highs.

• Las Vegas Sands (LVS 61): LVS has fallen back into its base—par for the course these days—but we still see a decent setup if the stock can find its footing. Fundamentally, all signs point toward more big cash flow and earnings gains ahead as Macau travel picks up.

  
  

Other Stocks of Interest

Snowflake (SNOW 184)—The time factor (as Jesse Livermore put it) is a huge factor in the market—companies that have great numbers and stories may have seen their stocks flounder for the past year or two, but when the market’s time is right, that same stock may see a massive advance. We’re thinking Snowflake, with its new-age cloud data platform, could be next in line to get going … if the market settles down and earnings (due out May 25) please investors. The firm’s story has always had liquid leader written all over it: Snowflake’s offering gets rid of the so-called data silo issue, allowing clients one place to collect, govern, securely share (inside or outside the company), hide, report and even sell (there’s a growing marketplace) any type of data (structure, unstructured, etc.)—and with unlimited storage and computing power, too. And that means clients can easily build off the data (think improved automated customer service “chats” online) and use it in any number of ways. The technology details are stuffy, but big picture, Snowflake allow firms easier access and more productive use of their ever-increasing data loads, and because it charges on a usage basis (typically ahead of time), clients get what they need and Snowflake gets mounds of deferred revenue. The customer base is a who’s who list of huge outfits from a variety of sectors (Capital One, JetBlue, Adobe, HubSpot, Okta, Pacific Life, Warner Music, NBC Universal, Instacart, Urban Outfitters, Novartis, Anthem, etc.), and growth has been rapid for many years—in the quarter ended in January, revenue lifted 53% while remaining performance obligations (all the money that’s due to the firm down the road) was nearly $3.7 billion, up 38%, as total customers (up 31%) and larger customers (up 79%) sign up and expand their usage. (It has 579 of the Forbes Global 2000 as clients.) To be fair, growth is slowing, both because of Snowflake’s size (revenues should approach $3 billion this year) and the economic environment, but sales are still expected to rise 40% this year (likely conservative) while free cash flow is clearly positive and growing at the same rate (should be north of $2 per share this year)—and, long-term, the top brass is on record saying it thinks it can reach $10 billion of revenue in calendar 2028. To us, the story oozes rapid and reliable growth for many years, and now the stock is trying to shape up: SNOW bottomed last June, tested and held the 120 to 130 area many times in the months that followed and, since February, has etched a reasonable 14-week structure. A gap on earnings would be very intriguing.

NEXTracker (NXT 39)—Solar has a lot of hubbub surrounding it, but the fact is that only one stock—First Solar (FSLR)—has really had a big run since the green energy bill passed Congress last summer. However, for the first time since then, some names are percolating, and one that’s caught our eye is recent new issue NEXTracker. The story is simple to understand and similar to that of Array Technologies (ARRY), which we’ve written about before: NEXTracker is the global leader in solar tracking technology, which basically moves solar panels gradually throughout the day so that they’re capturing as much sunlight as possible—and thus producing as much energy as possible. NEXTracker claims to have a better, patent-protected mousetrap (more than 350 patents dealing with its mechanical structures, its software and its electronics and controls), including the fact that each row of panels can be controlled independently. Beyond the product itself is the firm’s reliable, global supply chain (it expanded its U.S. supply chain two years ago, now with 10 facilities that have deals in place for huge amounts of components; 50 manufacturing partners in 16 countries overall) and partnerships with big utilities (the firm’s focus is on utility-scale solar installations) that help it win deals across the globe and in varying environments. Big picture, the firm thinks the solar tracker market opportunity is 682 gigawatts from 2020 to 2030 (about $70 billion in total), and given that NEXTracker supplied 17 GW last year, the potential is huge. In the March quarter, revenues grew 18% while EBITDA more than tripled off a small base, with backlog booming 90%—and management guided for about that same thing for the year ahead (16% top-line growth, 36% EBITDA and earnings growth). Not surprisingly, this new stock is wild, but after meandering between 28 and 36 for its first two and a half months, shares have leapt to new price and relative performance highs. We’d like to see it settle down a bit, but we think NXT could join FSLR among the leaders in the group.

MasTec (MTZ 99)—“The infrastructure boom” has been a phrase tossed around for years, but rarely with much market-altering punch—while spending on various projects has gone up and down, few names in the broad infrastructure group have really had big moves. But today, whether it’s due to the economy overall, some huge state and federal spending bills or something else, we are seeing many infrastructure stocks show strength, and MasTec is one of the best of the bunch. The firm used to be very heavy in oil and gas-related projects, and those are still an important part of the pie, but communications, power delivery and clean energy projects now combine to make up two-thirds of revenue, which means business is far less cyclical. The numbers here are very solid, bolstered by new orders and a handful of acquisitions in recent quarters—in Q1, revenues were up a solid 32% and the bottom line topped expectations, while the more important 18-month backlog totaled $13.9 billion, up 31% from a year ago and 7% from the prior quarter, with more growth in that metric coming. But beyond the numbers is the sheer multi-year opportunity coming: In communications, the 5G revolution (as well as some grants via the federal infrastructure and green energy bills) will require adding to current cell towers and building and connecting tons of new small cells; in power delivery, the need to upgrade infrastructure and connect new sources of power is giant; and clean energy and oil and gas are obviously in demand, with everything from traditional projects to carbon capture, hydrogen-related equipment and more. There are still some supply chain issues that are limiting business a bit and things can be a bit lumpy quarter to quarter, but there’s no question management and Wall Street are expecting good things; analysts see the bottom line rebounding 50% this year and rising another 35% in 2024. As for the stock, it had a great off-the-bottom bounce last fall and has mostly meandered sideways the past few months—but did tighten up near the 40-week line and has begun to perk up after earnings. It’s not going to double in a month, but if MTZ can get moving, we think it can have a steady, sustained run.

The Market Is a Bad Teacher (Don’t Forget to Think Big … Eventually)

There is a great interview in the old book The New Market Wizards by Jack Schwager (there are a few books in the series, all are highly recommended) where a trend-following trader named William Eckhardt was being interviewed—and towards the end of it, he talked about how the market is a bad teacher, that, in his words, “does behave very much like a tutor who is trying to instill poor trading techniques; most people learn this lesson only too well.”

We generally agree, and if you’ve been around a while, you see it play out each market cycle. For instance, by late 2021, what had the market taught investors? To buy the dip (especially in leading tech stocks), that the Fed was on the bulls’ side, that the post-pandemic economic boom was set to continue and to remain patient with your stocks even if they hit speed bumps. In truth, under the surface, more and more names were topping out that year, and all those lessons learned by investors contributed to big losses.

Today, though, it’s the opposite: Strength has been sold repeatedly in the past year, so taking quick profits is the smart play, if you play at all. The headlines are filled with economic and political worries, so you better not hold stocks for long. And the future looks sour, too, so the odds favor further tough times ahead.

Obviously, right now, we mostly agree with the market’s current set of lessons and beliefs—hence our big cash position. But, eventually, the majority will be caught off-guard again just as a new bull is launched. We’ve seen it play out many times over the years, and it will happen again without any doubt.

Shown below are a select few stocks and what they looked like coming out of big bear markets or otherwise severe corrections. eBay (EBAY) in 2003, Baidu (BIDU) in 2009, Meta/Facebook (META) in 2013, Shopify (SHOP) in 2017 and DocuSign (DOCU) in 2020 are just a few of the dozens of stocks we bought at various turning points when the news was bad and everyone had low expectations—and you can see that these leaders didn’t just break out but they kept running without any pullback for weeks.

So, today, given the endless negativity out there, our message is (a) be cautious and patient today, but (b) be an optimist longer-term, thinking big and hunting for revolutionary new ideas (including possibly some in the chip space—see below). Thinking big is one of the underrated keys to making big money once the tide truly turns up.

Semiconductor Stocks Remain Intriguing

Chip stocks were clobbered in 2022, but they were also the leading growth-oriented sector in the months after the October bottom in the major indexes—you can see in the chart below the VanEck Semiconductor Fund (SMH) snapped back viciously late last year and ran nicely higher through January.

After that, there have been some ups and downs, and some good-looking names have been hit hard—but the group as a whole hung in there, as did some potential leaders. And now it’s starting to look like the group may be starting another intermediate-term run.

In terms of chip producers, Nvidia (NVDA) remains the liquid leader in the group—and one of the few liquid leaders in the entire market. It’s had a giant move in recent months, so air pockets can’t be ruled out, but it does seem like a way for big investors to play the AI boom and other technology infrastructure trends.

But we’re just as interested in two equipment makers. One is ASML Inc. (ASML), which we mentioned earlier this year and are still keeping an eye on—the firm effectively has a monopoly on super-high-end (extreme ultraviolet) lithography machines that allow chips to be etched with more and more circuits, which is key for just about every fast-growing end market. It’s a big outfit, but after a modest dip last year, earnings should race ahead this year and next, and the stock testing the top of a tight, quiet 15-week consolidation.

Then there’s Axcelis Technologies (ACLS), which remains on our watch list and is the chip name we’re most intrigued by. While some other EV-related names have fallen off, ACLS is an equipment name that looks to have something special for silicon carbide chips, the growth of which should be a sure thing for many years to come. Earnings estimates are solid (up 20% this year, up 17% next) and the valuation isn’t crazy (24x trailing earnings)—and it’s hard not to be impressed with the powerful rebound all the way to new highs. We still think the firm could be “the next” Applied Materials of sorts for the silicon carbide chip boom that remains in its early stages. WATCH

Cabot Market Timing Indicators

As we wrote on page 1, our indicators (the ones here as well as other key metrics we follow) are about as neutral as can get, with individual stocks providing their own challenges. We remain cautious with a few small positions as we patiently wait for decisive turn higher.

Cabot Trend Lines: Bullish
The Cabot Trend Lines are an important piece of our market timing system, and we remain encouraged that they’ve been stubbornly positive during the past four months despite all the bad news, with both indexes (S&P by 5%, Nasdaq by 11%) holding solidly north of their 35-week lines—and, interestingly, those 35-week lines may begin to turn up themselves soon. This indicator is one of the biggest reasons to keep your eyes peeled for any upside change in the market’s character.

Cabot Tides: Neutral
Our Cabot Tides are still mixed and neutral, with the same situation in place as we’ve seen the past few weeks—big-cap indexes are holding up well, but broader measures (including the NYSE Composite Index, shown here) are weaker—not awful, but floundering. Things have been so quiet that a few big days could propel the next intermediate-term move, but right now, sideways is the path of least resistance.

Two-Second Indicator: Negative
Our Two-Second Indicator has actually worsened over the past couple of weeks, with the number of new lows on the NYSE picking up steam even as some indexes test multi-month highs. (The Nasdaq is also seeing new lows at elevated levels, too.) Like everything else, these readings could change in a hurry if big investors turn bullish, but it’s clear the sellers are still doing damage to many areas of the broad market.

The next Cabot Growth Investor issue will be published on June 1, 2023.