In tonight’s Cabot Growth Investor, we dive into all our stocks and highlight our current batch of ideas (including an intriguing recent IPO with a great cookie-cutter story) and discuss the good and bad of mental versus in-the-market stops.
Cabot Growth Investor 1368
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Long-Term Trend, Growth Stocks Remain Bullish
Our founder, Carlton Lutts, used to tell a story that highlighted one the challenges of the stock market. The tale was of an analyst back in the 1960s, whose boss came over and said he needed a detailed report on Boeing, which was a major growth stock back then. The analyst nodded his head and asked his boss, “Do you want a bullish report or a bearish report?”
Partly, Carlton’s point was that Wall Street will sell you whatever it can, which is true. But his larger message was that there are always conflicting pieces of evidence with any investment. Earnings might be growing nicely, but the valuation is elevated. Last quarter’s report was somewhat soft, but there’s been insider buying. Business has been good for a while, but we may be nearing the end of the upcycle. And so on.
The principle applies to the overall market as well, even if you follow just a handful of timing indicators like we do. You’ll often see the intermediate- and longer-term trends in disagreement, along with opposing action between leading stocks and the broad market. Then there are sentiment measures and the action of the stocks in your own portfolio.
When there is conflict, where should your focus be? To us, the top factors are the action of leading growth stocks (especially the stocks you own or are watching closely) and the longer-term market trend. These are the most rubber-meets-the-road indications of whether the environment is favorable for our methodology.
And right now, both of those factors remain in great shape! Our Cabot Trend Lines remain firmly bullish, as they have been for 13 months, and growth stocks continue to act great, even after last Wednesday’s big selloff. The Model Portfolio, helped by some good luck through earnings season, is up 17% for the year, so something is clearly working.
But what about the neutral intermediate-term trend and the recent flareup in the number of new lows (see page 8)? They certainly count, too, which is why we did a little selling last week and are holding 21% in cash.
Overall, the way we’re thinking about it is: There’s risk out there given the lack of progress in most indexes and the wobbles in the broad market—hence we have fewer Buy ratings in the portfolio and some cash on the sideline. But the elevated risk isn’t enough to ignore the other major positives, which is why we advise you to remain heavily invested.
[highlight_box]WHAT TO DO NOW: Remain mostly bullish, though as always, keep your eyes open for changes (either bullish or bearish). Last week, we sold half our stake in ProShares Ultra S&P 500 Fund (SSO), booking a nice profit, but we’re sitting tight with our other positions. Details below.[/highlight_box]
Model Portfolio Update
We’ve had a good amount of movement from the market since our last issue, including last Wednesday’s huge selloff and the sharp snapback since. But we haven’t taken much action; we sold a portion of our winning SSO position and moved three stocks to Hold.
That leaves us with just over 20% cash, which seems appropriate.
Our next move is to simply listen to the market and go with the flow. If the major indexes can get in gear on the upside and growth stocks remain in favor, we’ll look to get fully invested. But further bouts of intense distribution, which could coincide with a Tides sell signal, would have us backing off.
Current Recommendations
BUY—Alibaba (BABA 123)—BABA reported another terrific quarter last Thursday morning, with revenues soaring 60% and the gains broad-based: The core commerce segment grew 47% (making up 82% of total revenues), cloud computing expanded 103% (5.6% of the total), and the other pieces of the pie also expanded at triple-digit rates. Earnings were up 37% from a year ago and other metrics like cash flow (and sub-metrics like user growth) were excellent. The stock had a big shakeout after the news (see page 7 for more on surviving these kinds of retreats), partly because the market was in its big selloff last week, but found support above its 50-day line and has since pushed to new all-time highs. Like the market itself, some consolidation could be in order after the recent volatility, but BABA’s trend is clearly up. Sit tight if you own some, and if you don’t, try to buy on dips of a couple of points.
HOLD—Facebook (FB 150)—We placed FB on Hold last week mostly because of the shift in our market timing indicators, but also because the stock has had a good run this year—it was up from around 115 to a pre-earnings peak of 154 (about 34%)—but has since encountered three big-volume days of selling. Still, we can’t say the big picture has changed; the stock found support at its 50-day line during last week’s selloff, the major uptrend is intact and the fundamental growth story (analysts see earnings up 39% this year and 24% next, and they’re almost always conservative on these guesstimates) has a long way to run as it grabs more and more eyeballs for its various services. (Facebook has a deal to livestream 20 major league baseball games this year, and has partnered with ESL for other live sporting events.) If you own some, sit tight.
BUY—Netflix (NFLX 158)—Netflix has been relatively quiet on the news front, though one analyst nudged up his price target this week on anticipation that the Season 5 rollout of House of Cards will attract new subscribers and grab some good press. But our thoughts on Netflix go well beyond the firm’s next content release. With so many people dumping their cable subscriptions (one research outfit estimated that 2.05 million TV subscribers left last year, with another 2.11 million to cut the cord in 2017), Netflix is becoming more and more of a staple of people’s entertainment consumption. And that’s just the U.S.! Internationally, the firm had 45 million paid subscribers at the end of March, up 41% from a year ago, with another 2.8 million expected to sign up in the current quarter. Thus, despite the high valuation, we think NFLX has a long way to run if management continues to make the right moves. The stock dipped with everything else last week, but held above its 25-day line and has bounced back. We’re staying on Buy.
HOLD—ProShares Ultra S&P 500 Fund (SSO 88)—We decided to book partial profits in SSO last week, selling half our shares as our market timing indicators turned mixed. To be clear, we hope it’s a “bad” sale and that the market kites higher from here, which will not only help our remaining shares of SSO but, mostly likely, our strong stocks, too. But given the evidence—the S&P 500 (and hence SSO) hasn’t made any progress in nearly three months, and this was our largest position by far—we thought it best to take some chips off the table (the profit taken on the partial sale was nearly 2% of the portfolio’s equity), while giving the remaining shares more rope in order to play out the overall bull market.
HOLD—Shopify (SHOP 92)—SHOP had some very wild action last week, gapping down as low as 81 on Thursday morning after it announced a 5.5 million share offering (representing about a 6% dilution to the overall share count) in the midst of the market’s sharp decline! But that dip didn’t crack the stock (believe it or not, it only brought it down to its 25-day line) and buyers quickly pushed it back up to around the 90 level. (See page 7 for more.) It’s possible the share offering will be the catalyst that will finally push SHOP into a deeper correction … but it’s also possible that last week’s shakeout could lead to a lower-risk entry point if the stock calms down. Long-term, we remain very bullish; one nugget that few investors are talking about is that, while the company didn’t give an exact number, Shopify confirmed that it added at least 50,000 clients in the first quarter, which means its total customer count has grown at least 30% in the past six months alone. Given the stickiness of Shopify’s platform, it’s unlikely many of these firms will ever leave, and instead will expand their usage in the quarters to come. Bottom line, we think SHOP is a major leader of the current bull market, but will keep watching for a better entry point for new buyers.
HOLD A HALF—Tesla (TSLA 310)—TSLA has been fading a bit in recent days, but net-net, it’s not much changed over the past six weeks and is still above support in the 290 to 295 range. We’re still optimistic because nothing has changed with the major story: Tesla is significantly ramping production to meet demand for the Model S and Model X, and management recently affirmed it will start production for its Model 3 in July and begin deliveries this year. And note that expectations aren’t very high—many analysts see just a couple of thousand Model 3 deliveries all year, and the huge short interest (31.4 million shares, or about a quarter of the stock’s trading float) suggests that many are betting against the company. From here, we’ll play it by the book—a decisive break of 290 or so would have us taking a small loss on our half position and moving on, but a renewed push above 327 or so would likely signal a new upleg has begun, and could have us filling out the rest of our position. Hold for now.
BUY—Universal Display (OLED 114)—OLED has been chopping sideways for the past three weeks, which is completely normal following its gigantic earnings gap. Encouragingly, other players in the organic light emitted diode field are also reporting huge demand, confirming Universal Display’s results. There will always be risk that big customers get skittish or run into production issues and delay product rollouts, but the upside here remains huge as flat panel TVs and smartphones transition to OLEDs in the years ahead, which would catapult earnings for the next two to four years. We think the stock’s relatively tight trading in the mid-110s is a positive sign, especially given the market’s recent action. Hold on if you own some, and if you don’t, you can start a position around here.
BUY—Veeva Systems (VEEV 61)—VEEV doesn’t get a lot of press, but the stock has been very strong in recent weeks, including some large upside volume during the past week. It’s all good to see, but the real test will come following earnings, which are due out tomorrow (May 25) after the close; analysts are modeling $152 million in revenue and earnings of 18 cents per share, though the level of bookings and cash flow from operations will also be key. (Beyond the numbers, any hint that the firm is making further progress selling its software outside of life sciences would be big.) Given the stock’s run and our profit cushion, as well as the very long runway of growth, we’re willing to take some heat following earnings, though a complete meltdown (15% or more) would probably tell us the growth story has faltered. For now, we’ll stay on Buy, but will update you if we have any changes.
HOLD—XPO Logistics (XPO 53)—Since XPO’s post-election rally ended in early December, the stock has moved from 50 to 42, then back up to 53, back down to 45, up to nearly 56, down to 50 and now up to 53. The higher highs and higher lows are fine, but we’re eager to see the stock enter a sustained uptrend (as opposed to three-week spikes), which would tell us big investors are consistently adding to their positions. We’re willing to be patient a little longer, especially given the firm’s excellent free cash flow.
Watch List
Five Below (FIVE 52): FIVE has notched 10 straight up weeks (including a push to three-and-a-half year price highs), a sign of persistent accumulation. Earnings are due out June 1; if they please investors, we’ll be looking for a lower-risk entry point.
Nvidia (NVDA 139): NVDA is not early in its advance, but we’ve learned to respect huge-volume, earnings-induced rallies from big, liquid growth stocks, and that’s just what NVDA has experienced. Demand for its chips is strong, and Japanese giant Softbank has taken a $4 billion position.
PayPal (PYPL 51): We’ve tried our hand with PYPL a couple of times with little to show for it, but now it appears to have (finally) morphed into a liquid leader. See page 6.
Zillow (Z 44): Z is meandering in the low-40s following its huge liftoff during April and early May. See page 6.
Other Stocks of Interest
The stocks below may not be followed in Cabot Growth Investor on a regular basis. They’re intended to present you with ideas for additional investment beyond the Model Portfolio. For our current ratings on these stocks, see Updates on Other Stocks of Interest on the subscriber website or email mike@cabotwealth.com.
Floor & Decor (FND 37) — When the U.S. housing market is in gear, materials suppliers can get up a head of steam and that’s exactly what Floor & Decor, the hard flooring specialist that just came public on April 27, is doing. Floor & Decor has the potential to be a category killer in the wood/tile/stone flooring category, as the company’s 72 warehouse stores average 72,000 square feet, usually much bigger than competitors’ locations, which appeals to professional customers looking for a one-stop shopping experience. The company has another advantage in its global direct sourcing model that keeps materials costs low. Floor & Decor has grown revenue by at least 30% per year since 2013, and management projects over 400 stores in the long run. It’s a potentially very big cookie-cutter story.
PayPal (PYPL 51) — PayPal (or, as Tesla investors know it, “Elon Musk’s first company”) is a payment firm that lets people and merchants around the world make and receive secure payments and exchange money on any platform on any device. The company is remarkably consistent in its expansion, with four years of revenue growth in the teens and projections of 19% earnings growth in both 2017 and 2018. Since its spinoff from eBay in July 2015, PYPL has mostly been in a choppy sideways phase. But the stock started to pick up speed in the middle of April and gapped up on huge volume on April 27 after a well-received Q1 earnings report. Investors like the company’s habit of making deals with major players that avoids damaging competition.
Wayfair (W 65) — Wayfair is trying to bring the furniture business into the internet age, offering over seven million products from 10,000 suppliers through wayfair.com and other websites. While the company has grown revenue by leaps and bounds (50% in 2016, 71% in 2015, 44% in 2014), it hasn’t booked a profitable quarter and doesn’t expect earnings to turn positive at least through 2018. The good news is that investors gapped W up from 51 to 62 —a new all-time high—following earnings in early May and the stock has been holding onto those gains. The furniture category has lagged far behind other merchandise sectors in gaining acceptance online, but Wayfair is making inroads. Any more evidence that the company can turn profitable (and fend off Amazon) could lead to big gains.
Zillow (Z 44) — Just as most people have Googled themselves at some point, most homeowners have Zillowed themselves, searching the company’s site for the estimated value of their biggest asset. In the long run, Zillow’s ability to bring motivated home buyers and apartment seekers together with real estate professionals, property managers and mortgage lenders should keep growth humming—sales should rise 25% this year, while cash flow soars 50%. The stock pushed out to new all-time price highs in early May, after nine months working on a base under resistance at 40, and this pullback looks like decent entry point. As long as the U.S. housing market stays strong, Zillow should be just fine.
Mental Stops vs. Stop Loss Orders: The Good and Bad of Each
It seems like nearly every investor these days uses some form of stops, including us. But recently, the question has come up whether it’s better to use mental stops (which are executed by the investor if a stock closes below a certain level) or stop-loss orders with your brokerage firm (which automatically knock you out if a stock touches a certain level during the day)?
Like most things in the market, there are good and bad points to each. But the general difference is simply that mental stops tend to do better with a methodology that’s a bit longer-term, while in-the-market stop-loss orders are often better for shorter-term, more active strategies that emphasize avoiding much drawdown.
In Cabot Growth Investor, where we have an intermediate- to longer-term viewpoint (and are trying to develop some big long-term winners), we prefer mental stops. The best aspect of them is that they help you avoid the occasional shakeout during earnings season or when the market goes haywire, which it inevitably does a few times per year.
We saw two examples of this last week. On Thursday morning, Shopify (SHOP) announced a share offering that, along with some early-morning market panic, caused the stock to plunge 10% at the open! Many were likely kicked out of their position on the move, though the stock has bounced back since.
Alibaba (BABA) was another example. In the early morning of the same day, the firm released a solid quarterly report but the weak market open caused the stock to plunge seven points in the first few minutes before rallying to close the day in positive territory. (It’s popped to new highs since).
Of course, mental stops aren’t without their bad side, either. Sometimes a stock drops to your stop during the day … and then just keeps dropping for the rest of the day, leaving you with a bigger loss than you planned on. In those situations, in-the-market stops are more fruitful.
In our view, the real key to using stops is twofold. First and foremost, decide which method (mental or stop-loss orders) you like better, and then apply that to all your stocks—don’t use mental stops for some holdings and stop-loss orders for others.
The second key is to add some common sense. If you use mental stops like us, realize that sometimes (like on a truly horrible earnings reaction), it will be better to take action intraday instead of waiting for the close. We’ve made that very adjustment this year. Conversely, if you have stop-loss orders in place, it’s probably best to pull them just before a company reports earnings and then use some judgment depending on how a stock reacts.
Stops are an important part of any selling strategy, but you should put some thought into them. We usually prefer mental stops, but have also added some contingencies for when a stock (or the market) completely implodes, which can allow us to get out a bit earlier (and at higher prices) than otherwise.
Bottoming Action Doesn’t Mean Buyable
Another question we’ve been getting a lot recently involves some former big-name losing stocks that have shown some life; Twitter (TWTR) is a good example, with the stock surging from 14 to nearly 20 during the past month on hopes for a turnaround.
Our take: The fact that TWTR held support in the 13-14 range for more than a year and then surged higher on big volume probably means the stock has bottomed after a multi-year, post-IPO decline. That’s a good thing.
But that doesn’t mean we’d be buying TWTR here. Both sales and earnings fell last quarter, earnings are expected to fall 40% this year, the relative performance (RP) line is only up four weeks from its low, and there’s a bunch of overhead resistance above 20.
That doesn’t mean Twitter can’t eventually morph into a new leader and live up to its promise. But the point is to always look for the best of the best (both fundamentally and technically) when it comes to new buying—just because a stock has likely bottomed doesn’t necessarily mean it’s ripe for buying.
Cabot Market Timing Indicators
This remains a bull market and growth stocks are still in good shape, but the short- to intermediate-term outlook is up in the air, with most indexes treading water and the broad market not in the best of health. We remain bullish but are holding some cash as we wait to see how things play out.
Cabot Trend Lines: Bullish
Our Cabot Trend Lines continue to stand above the market’s day-to-day volatility, as both the S&P 500 (by 4.7%) and Nasdaq (by 8.5%) closed last week well above their respective 35-week moving averages. It’s not the sexiest indicator or one that you’ll brag about at cocktail parties, but the Trend Lines are very reliable, and continue to tell us we’re in an overall bull market.
Cabot Tides: Neutral
The market has snapped back very nicely following last Wednesday’s dip, and the Nasdaq is still in a clear uptrend. But we’re calling our Cabot Tides neutral, as the other four indexes we track (including the S&P 600 SmallCap, shown here) have been marking time for months. We’re waiting to see a decisive breakout (or breakdown) from most indexes as the sign the intermediate-term trend has turned up (or down).
Two-Second Indicator: Unhealthy
The Two-Second Indicator is technically negative, having recorded seven straight days of greater than 40 new lows through last Friday. Granted, the readings weren’t huge (most were just above 40) and this week, the number of new lows has dried up nicely. But after the broad market took a hit, we’ll want to see a few more days of sub-40 readings before assuming the sellers have left the building.
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Send questions or comments to mike@cabotwealth.com.
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All Cabot Growth Investor’s buy and sell recommendations are made in issues or updates and posted on the Cabot subscribers’ website. Sell recommendations may also be sent to subscribers as special bulletins via email and the recorded telephone hotline. To calculate the performance of the portfolio, Cabot “buys” and “sells” at the midpoint of the high and low prices of the stock on the day following the recommendation. Cabot’s policy is to sell any stock that shows a loss of 20% in a bull market (15% in a bear market) from our original buy price, calculated using the current closing (not intra-day) price. Subscribers should apply loss limits based on their own personal purchase prices.
Charts show both the stock’s recent trading history and its relative performance (RP) line, which shows you how the stock is performing relative to the S&P 500, a broad-based index. In the ideal case, the stock and its RP line advance in unison. Both tools are key in determining whether to hold or sell.
THE NEXT CABOT GROWTH INVESTOR WILL BE PUBLISHED JUNE 7, 2017
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