Cabot Growth Investor Issue: May 2, 2024

Remain Patient—and Prepared

In the last issue, we wrote about the market’s split outlook: The churning over many weeks and the intermediate-term breakdowns starting in early April were enough to tip the market into a correction … though, when looking at the big picture, the vast majority of evidence suggested higher prices once the downturn finished up. And to this point, just about everything we’ve seen has backed up that point of view—arguing for caution and patience right now, but also being prepared to buy once big investors start looking ahead to brighter days.

Right now, our Cabot Tides are still negative by a bit, with the major indexes moving around a lot (the Nasdaq’s daily range has averaged 1.8% during the past two weeks!) but unable to get over resistance just yet. More important to us, our Growth Tides (see more later in this issue) are actually lagging some of the major indexes, as most growth stocks consolidate their prior upmoves.

Moreover, it’s hard to ignore things like our Aggression Index (negative), interest rates (trending up) and, more anecdotally, the repeated selling on strength seen in many names, even after buoyant earnings reactions. Right now, then, it’s safe to say the buyers and sellers are still mostly fighting it out, with the bulls unable to really get things moving on the upside.

Big picture, though, the correction is progressing normally, at least to this point—from high to low, for instance, the S&P 500 has given up 27% of its big October to March run, while the Nasdaq has given up a smidge less than 33%, both pretty normal, with the same type of action seen among most leading names. Indeed, our Cabot Trend Lines remain firmly bullish, while we’re also seeing some encouraging action from the broad market (Two-Second Indicator), too.

Moreover, the correction has begun to get investors uncomfortable, which is a good thing. We see that in many near-term sentiment surveys (Investors Intelligence and AAII are both showing the fewest bulls since last October, a good contrary sign) as well as interest rate policy: Whereas many investors were thinking (hoping?) the Fed might give them five or six 2024 rate cuts earlier this year, those expectations have been steadily chopped, with futures markets now pricing in just one cut by year-end.

What to Do Now

Given all of the above, we think the Model Portfolio is in the proper stance—hanging on to some generally resilient (and usually profitable) holdings, but also sticking with a good-sized cash position as individual stocks wade through the minefield of a market correction and earnings season. The day after our last issue, we sold the rest of our position in Arista Networks (ANET), but we’ve stood pat since then—and will continue that tonight, holding 44% in cash while fine-tuning our watch list for the next upmove.

Model Portfolio Update

While there’s been a lot of movement during the past couple of weeks, nothing has really changed with the evidence: The intermediate-term remains down (at the very least, it’s not up) for the market as a whole and for growth stocks, most of which are correcting after huge multi-month runs. Thus, we remain cautious, holding plenty of cash, though we’re also trying to give our remaining names a chance to hold up and resume their overall advance.

Beyond the portfolio, most of our focus right now is on earnings season—it’s a good bet the growth titles that show some upside power will be in pole position to lead the next market upturn whenever it gets underway (especially if we’re talking about fresher names), while those that are hit hard will likely languish, all else being equal.

That’s basically the game plan here—patience for as long as the sellers remain in control and watching our stocks for signs of cracks ... but also keeping our head up so we’ll be on the next rally phase, which will come eventually. We’re not ruling out a small move (buy or sell) in the near future, but tonight we’ll stand pat with our cash position at 44%.

CURRENT RECOMMENDATIONS

AppLovin (APP)—APP had a tough pullback when the market keeled over last month, but unlike most stocks, it found support north of its 50-day line and has been holding above that support area for the past few days; an analyst upgrade today, based on an industry survey that shows the company gaining share, helped the cause. Earnings are out next Wednesday (May 8), which will obviously be a big event—analysts see revenues rising 36% (bolstered mainly by Axon, its AI advertising platform) with EBITDA of $495 million (mostly from Axon), up around 80% from last year. A drop meaningfully south of the recent low (in the 65 area) would be a red flag and tell us the post-February breakout action has failed. Still, right now, we’re optimistic that AppLovin is a new leader, and any tidings in the conference call about Axon expanding beyond mobile gaming (say, into connected TV) could be big. We’ll stay on Hold and see what comes. HOLD

Arista Networks (ANET)—We let our remaining shares of Arista go nearly two weeks ago (the day after we published our last issue) when the stock dipped below support. To ANET’s credit, it has bounced a bit, and like everything else, earnings next week (May 7) will be key. That said, the big-volume decline and mundane earnings outlook for the next few quarters isn’t our favorite combination. Bottom line, we think there will be better names to own when the bulls retake control of the market. SOLD

Cava Group (CAVA)—CAVA certainly has the look and feel of a new leader, though it’s also a bit out of control—after testing and holding the 60 level during the worst of the selling two weeks ago, the stock (along with some growth-y restaurant peers) soared back to new high ground … only to give up a chunk of that move this week after some sour earnings news in the restaurant sector (especially from Starbucks on Wednesday). We’ll see how it goes, but net-net, CAVA is still well off its recent lows, the overall uptrend is intact and, of course, the growth story is hard to beat. We’re not anxious to average up given the volatility and the market environment, but if you don’t own any, we’re OK with a nibble on CAVA here. Earnings likely won’t be released until late May. BUY A HALF

CrowdStrike (CRWD)—CRWD has been quiet on the news front of late, though it is hitting the conference circuit this month ahead of earnings on June 4. The overall story here remains the same, with a best-in-class cybersecurity platform leading to outstanding sales and free cash flow growth as firms of all sizes move to protect their ever-growing technology and data. Indeed, just this morning the company announced that Amazon is replacing many point solutions and standardizing on CrowdStrike’s Falcon platform, while CrowdStrike itself is deepening its ties with Amazon Web Services. And it also said it’s partnered up with Tata Consultancy Services, one of the largest IT services firms in the world, which will offer and get clients up and running with Falcon. (Outside of the tech field, there are rumblings that the huge February hack of UnitedHealthcare’s technology unit, Change Healthcare—which handles 50% of all U.S. medical claims (!)—is only going to accelerate cybersecurity spending in that sector.) As for the stock, it’s been tedious but has remained north of its February lows as it attempts to round out a new launching pad. We’ll continue to hold our remaining shares. HOLD

DraftKings (DKNG)—DKNG is set to report Q1 results tonight after the bell, with analysts looking for revenues of $1.12 billion and an earnings loss of 17 cents (though much better results when it comes to EBITDA). Really, the report will probably tell the intermediate-term tale: DKNG hasn’t made much progress since the start of February and is standing just above key support, so we don’t have much rope left here if the sellers pounce in the days following the report. Even so, the major trend is up for both the stock and business (with the bullish multi-year outlook released late last year still in effect), so we’re holding onto our position and will see what the report brings. HOLD

Nutanix (NTNX)—NTNX is hardly super-strong, but given the damage seen among growth, software and now AI stocks, we think the action has been solid—to this point, in fact, the stock has only given up just over one-quarter (27%) of its entire October-March advance at its recent lows, which is among the best out there among leading titles. (As a comparison, NVDA has given up as much as 37% of its run, and as mentioned earlier, the Nasdaq gave up as much as 33%.) Of course, good-looking stocks can go bad in a hurry in a weak environment, so we’re certainly not declaring victory, but the action so far is clearly resilient. Fundamentally, the move to a subscription (recurring revenue) model adds reliability to the results, which is a good thing, and we’re thinking the company could be gaining more business than expected from VMware as that firm’s clients look to diversify after Broadcom’s acquisition. Long story short, we’ll stay on Buy, though we favor keeping new buys on the small side given the market. BUY

PulteGroup (PHM)—There’s no question interest (and mortgage) rates are going to impact perception of Pulte’s stock, but so will the firm’s actual results—and after another great quarterly report that featured strong orders and backlog, earnings estimates have again been bumped up: In early 2023, the outlook for 2024 was for just $7 per share of earnings, while by November, it had risen to $11.25, and now analysts see nearly $13, and that could prove conservative even if the housing market remains tricky—and the bottom line could go much higher than that if rates actually come down in a meaningful way. As for the stock, PHM is in the middle of its range, is holding most of its earnings bump from last week and is near the 50-day line, all of which is encouraging. Continue to hold your shares. HOLD

Uber (UBER)—UBER was already pulling in with the market and growth stocks, and it looks like the much-hyped Robotaxi service from Tesla—a fleet of autonomous vehicles that compete with traditional taxis, as well as Uber and Lyft; the big unveiling is set for early August—has dented investor perception a bit more. We’ll see how it goes, but autonomous competition didn’t come out of nowhere (Uber’s top brass has been working on their own autonomous offerings for a while), and we doubt that Uber’s market share will tumble (not to mention its business in grocery, drug store and other delivery, as well as ancillary services like advertising) after spending years building it up. Of course, what really counts is the stock itself, which is where our focus is: So far, it’s pulled back a maximum of about 20%, which is acceptable, but if all’s well, we’d expect buyers to show up soon. Earnings, due out next Wednesday (May 8), will be key. HOLD

Watch List

• Boot Barn (BOOT 104): BOOT has a terrific underlying story that has been masked by some post-pandemic effects—but that drug is easing and we think perception has a lot of room for improvement. See more below.
• Core & Main (CNM 58): Core & Main won’t be the fastest horse, but the firm’s long-term reliable infrastructure story should keep buyers interested. Shares have been resting above their 10-week line for six weeks.
• Datadog (DDOG 125): DDOG is 12 weeks into a 15% consolidation, with earnings due May 7—a big beat and positive reaction would obviously bode well, and longer term, we’re optimistic the stock can become a magnet for institutional money given its leading position in many observability areas.
• Eli Lilly (LLY 754): Lilly reported great results this week, with the outlooks continuing to be hiked on the backs of super-strong demand for weight-loss drugs. See more later in this issue.
• Natera (NTRA 94): NTRA is just a stone’s throw from virgin turf as big investors hesitate to let go of their shares. There’s no set date yet for earnings, though they should be out relatively soon.
• Robinhood (HOOD 18): HOOD is getting heavier, but we continue to think that, should this bull market rev up again (which the odds strongly favor), that business will do well. Earnings are due May 8.
• Toast (TOST 23): Payment companies continue to crank out excellent results—but the stocks haven’t been able to get going (even MasterCard was hit hard this week). We’re not going to jump the gun, but Toast has a very solid short- and long-term setup on the chart, a steadily growing business and a catalyst in the form of earnings next week (May 7). See more below.
• TransMedics (TMDX 124): TMDX reported another fantastic quarter earlier this week, with sales (up 133%) and real earnings (35 cents per share!) obliterating estimates, causing the top brass to meaningfully hike the full-year outlook—and helping the shares gap to new highs. Impressive.

Other Stocks of Interest

Boot Barn (BOOT 104)—Boot Barn has had one of our favorite underlying growth stories in the retail field (with a terrific cookie-cutter aspect to it as well), but in our view, it’s been masked by lingering after-effects of the pandemic … but that may be changing soon, helping investor perception. Business-wise, the firm is the top player in a large and growing niche: Boot Barn offers a variety of apparel and accessories that are geared toward western- and country-style living, as well as work-wear for blue collar employees; obviously, business is strongest in the southern U.S., but this is a $40 billion-plus market and it’s growing in popularity alongside country/southern entertainment (Nascar, country music) and the rural living lifestyle. What we like best here is the cookie-cutter aspect of the story—the store economics are fantastic, with new stores bringing in $3 million of revenue in their first year of operations and paying back the initial opening investment in just one and a half years, both of which are close to the best we’ve read about in the industry. Because of that, Boot Barn has been expanding quickly, likely ending March with just under 400 stores (up 15% from a year ago), and on its way to 900 within eight years (about a 10% to 12% annual increase from here). All of this is great, but as mentioned above, it’s been masked by the after-effects of the pandemic: Back in 2022, when rural and outside living was the antidote to virus-induced cabin fever, Boot Barn’s business went wild, with same-store sales that year rising more than 50% (yes, you read that right), and they amazingly held flat last year at those elevated levels. But now we’re finally seeing things fall off somewhat—that metric was down nearly 10% in Q4 and was likely down 7% for the fiscal year ended in March, which has dragged down earnings (off 10% to 15% last year), with more weakness coming in the first half of 2024. However, after that, analysts expect good things—positive and accelerating sales and earnings growth—and we think the stock might be starting to look over the horizon, focusing on the very bullish underlying story: BOOT didn’t get join the market rally until February, but it’s been under solid accumulation since then, barely flinching during the market’s recent wobbles and hitting 27-month price highs last week. Earnings are due May 15—a positive reaction (and a more supportive market environment) would get our attention. BOOT is on our watch list.

Toast (TOST 23)—Maybe we’re gluttons for punishment, but having been around the market for a while, we’ve seen a steady stream of new payment firms (often with new technologies and offerings) come into favor and embark on huge, often multi-year runs as business expands at a rapid, reliable rate quarter after quarter. What’s been interesting is that we’re seeing that fundamental pattern repeat itself in a few names, but the stocks themselves have remained challenging (our latest foray into Shift 4 (FOUR) proved to be a dud despite fantastic numbers). However, we’re still keeping an eye on the group, with Toast offering a great, straightforward story with solid growth—and a stock that’s set up to run if earnings (due May 7) are pleasing. What we like here is that Toast is basically a one-stop shop for restaurants, which is an enormous sector (860,000 locations in the U.S. alone), providing clients with everything they need to thrive, whether it involves operations (point of sale solutions, kitchen displays, catering, invoicing, etc.), financing (loans and advances), marketing efforts (gift cards, loyalty programs, email marketing), mobile storefronts (online ordering, takeout, delivery), team management (payroll, scheduling, tips management) and even supply chain and accounting services, too. While there’s competition (including from Shift4), Toast was built from the ground up for the restaurant sector and has a pristine reputation in the industry (about 20% of new clients come from word of mouth!), which is a big reason it’s continued to take share—at year-end, 106,000 locations were using its wares (up 34% from a year ago), while gross payment volume of $33.7 billion lifted 32% in Q4 and total annualized recurring revenue (consisting of both payments and subscriptions) came in at $1.2 billion, up 35%, yet that’s only about 8% of the firm’s serviceable U.S. market, never mind the much larger opportunity overseas. Earnings are still in the red, but EBITDA is beginning to accelerate higher and it’s basically a sure bet that Toast is going to get a lot bigger over time. Beyond earnings next week, there will be an Investor Day on May 29 that could move the stock as well. Shares have been repelled by resistance in the 26 area numerous times dating back to last spring, but if TOST can get moving from its eight-week zone, it should lead to a sustained run.

Pure Storage (PSTG 51)—Pure Storage is a name that appeals to us for a few reasons. First is the fact that it’s the leading new-age player in the storage sector, which is gigantic and ever-growing: Pure is an all-flash provider of the latest and greatest storage offerings that use far less power, are more reliable, have top-notch performance and take up less space, and thus have a much lower total cost of ownership than others. (Management thinks hard disk storage drives will be a thing of the past within five years.) The second angle here is the business model itself, with Pure’s move toward more subscription offerings (storage as a service), led by its Evergreen product line, allows clients to always have the most up-to-date cloud storage arrays. Both of those have led to a steady improvement in the underlying business—Pure ended January with around 12,500 clients (up 14% from a year ago), including 60% of the Fortune 500, and while about half the business is traditional one-time sales, half is now recurring subscription revenue, helping to drive metrics like remaining performance obligations (all money owed to it in the future) up 31%. (Overall revenue growth has been lagging, actually falling 3% in the latest quarter, due to lumpy one-time sales and the effects of the transition to subscriptions, where revenue is realized over time.) That leads us to the third reason Pure appeals to us—AI, with the company’s offerings very attractive to big firms because they use less power and take up less space, both of which is vital in a data center and will become more key down the road. Overall, the top brass sees total revenue growth gradually accelerating from here, while earnings and cash flow pick up steam—and the AI kicker should help things, too. The stock gapped up nicely at the end of February, leaving behind a long consolidation, and it’s spent the past eight weeks correcting and consolidating. Earnings here aren’t out for another three weeks, but any powerful move into the upper 50s (along with a more supportive environment for growth stocks) should prove very bullish.

“Growth Tides” More Important than Ever

For whatever reason (possibly because a few mega-cap names make up such a huge weight in the big-cap indexes?), the relationship between the major indexes and growth stocks, which used to be very tight, has weakened somewhat in the past decade or two—in recent years, we’ve often seen growth stocks dance to their own drummer over weeks and, occasionally, months. In other words, there are many times when the major indexes look good but growth stocks are churning (we saw a lot of that in February and March), and there are other times that the market was just OK or chopping around ... but growth stocks were lighting up the sky.

That leads us to market timing, which is something we’ve been doing successfully for more than 50 years—we wrote about some key timing indicators (including one version of our Cabot Trend Lines) in our very first issue in the fall of 1970, and we continue to follow that tradition today. Over time, though, we’ve always aimed to make the indicators we follow as insightful as possible when it comes to the action of growth stocks.

For instance, a couple of years ago we came up with our Aggression Index, which gives us a clearer view of whether big investors are truly playing offense (buying the Nasdaq) or defense (consumer staples). Then, last year, we began writing about our Growth Tides, which follows the same rules as the overall Cabot Tides but examines growth-oriented indexes and funds that more closely track the leading and glamour growth titles we focus on.

We’re writing about the Growth Tides today because they’ll have a big say in how we handle our portfolio in the coming weeks. Below are three of the growth indexes we look at on a daily basis: The Renaissance IPO Fund (IPO), the equal-weight Nasdaq 100 (QQQE) and the iShares Momentum Fund (MTUM).

To this point, all three of these measures (along with other growth indexes we follow, like the IBD 50) began to top out in March, weakened in early April and broke down in the middle of the month. The rally since the low has been decent, but to this point, you can see none of these have come close to recapturing their 50-day lines—which is needed to signal the path of growth stocks has turned back up.

Our message here is simple: While we’re obviously not ignoring the major indexes, the action of growth indexes like these is more important than ever to us, as they’ll signal when big investors are putting money back to work in the names we traffic in.

Trends Go Longer and Farther than Most Anyone Expects

Eli Lilly (LLY) and Novo Nordisk (NVO)

My old boss Timothy Lutts coined the above phrase as far as I know, and it’s absolutely true. If you study history, you’ll find that big, powerful trends will often seem mature and run into more than their fair share of doubters, shorts and skeptics—only to keep chugging higher and higher as the fundamentals improve (and often top even the most bullish assumptions) and investor perception does the same.

We’ve been thinking about this week when it comes to Eli Lilly (LLY) in particular; along with its peer Novo Nordisk (NVO), they own the super-popular diabetes and (more importantly) weight-loss drugs, known as Zepbound (for Lilly) and Wegovy (for Novo), which have shown great results in trials and, now, in practice, with benefits that go beyond just looking and feeling better, but also involving various other health benefits from weight loss, too.

Even as many already think this class of drugs could be the biggest sellers of all time, it appears that demand is even stronger than most anticipated, despite limited supply. In Lilly’s Q1 report Tuesday morning, the firm saw Zepbound bring in $517 million in its first full quarter of sales, while Mounjaro (the same drug, officially marketed for diabetes but has been prescribed for weight loss, too) saw $1.8 billion of revenue, more than triple its year-ago figure—all while supply fell short of demand in a big way. Nevertheless, Lilly hiked its earnings outlook on the news, expecting the second half to see more supply come online while demand remains giant. Novo Nordisk also saw bullish fundamental results, with the top brass nudging up expectations for the year.

That has us watching the stocks to see if, even after good runs, they can continue higher as the humgonous growth story plays out. So far, there’s many positive signs: For LLY, which is the stronger of the two, the stock was only able to pull in 10% during the recent market weakness and then pop higher on its own report earlier this week. Today, though, did see some sloppy action (reports of falling prices), but even so, LLY is about 6% from all-time highs and has shown very little meaningful selling.

The story is well known, of course, but if the stock can hold up and eventually stage a fresh breakout, we think it’s poised to have another run. WATCH

Cabot Market Timing Indicators

The market has been up and down during the past couple of weeks, but its overall position hasn’t changed, as the indexes and growth stocks remain in a corrective mode, though the still-bullish longer-term view hasn’t changed, either. Thus, we continue to advise patience while the sellers do their work—all while working on your shopping list for when the bulls return.

Cabot Trend Lines: Bullish

Our Cabot Trend Lines remain positive, with the big-cap indexes exhaling, but remaining clearly north of their key moving averages—as of this morning, both the S&P 500 and Nasdaq stood a solid 6% above their respective 35-week lines. As a reminder, we’d have to see both indexes close two straight weeks below their trend lines to receive a sell signal, so that’s not on the horizon right now. Bottom line: The long-term trend remains clearly up.

Cabot Tides: Bearish

Our Cabot Tides, however, are still on the bearish side of the fence, with all five indexes we track (including the S&P 500, daily chart shown here) below their moving averages after being rejected near resistance earlier this week. That said, it’s a relatively close call, and a positive couple of days could change the landscape, though growth stocks are still lagging. As usual, we won’t anticipate what’s to come—right now, the intermediate-term trend is down (or, at least, not up), telling us the market’s correction continues.

Two-Second Indicator: On the Fence

Our Two-Second Indicator has improved nicely and is actually approaching a fresh all-clear signal, with four straight days of fewer than 40 new lows. That’s obviously encouraging, and it goes along with the view that, while the current correction could go further near-term, it’s unlikely the market hit a major top in March/April. There’s still repair work to do, but the broad market’s resilience is a plus.

The next Cabot Growth Investor issue will be published on May 16, 2024.

Copyright © 2024. All rights reserved. Copying or electronic transmission of this information without permission is a violation of copyright law. For the protection of our subscribers, copyright violations will result in immediate termination of all subscriptions without refund. Disclosures: Cabot Wealth Network exists to serve you, our readers. We derive 100% of our revenue, or close to it, from selling subscriptions to our publications. Neither Cabot Wealth Network nor our employees are compensated in any way by the companies whose stocks we recommend or providers of associated financial services. Employees of Cabot Wealth Network may own some of the stocks recommended by our advisory services. Disclaimer: Sources of information are believed to be reliable but they are not guaranteed to be complete or error-free. Recommendations, opinions or suggestions are given with the understanding that subscribers acting on information assume all risks involved. Buy/Sell Recommendations: are made in regular issues, updates, or alerts by email and on the private subscriber website. Subscribers agree to adhere to all terms and conditions which can be found on CabotWealth.com and are subject to change. Violations will result in termination of all subscriptions without refund in addition to any civil and criminal penalties available under the law.