In tonight’s issue, we dive into some education, revealing a long-term chart pattern that bodes well (including one stock that’s at the top of our Watch List now). We also give you all our latest thoughts on the market and our recommended stocks, and present the usual crop of new ideas if you have some cash on the sideline.
Cabot Growth Investor 1381
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Follow the System
There has always been—and will always be—a lot of judgment involved when it comes to investing in the stock market. Deciding which stocks to buy, when to sell and how to manage your portfolio will be different for you than for other investors based on how you interpret various factors. There’s no question, then, that your decision-making ability affects your results.
But we think even more important than individual decisions is the Cabot growth investing system, which lays the groundwork that allows you to be in a position to make good decisions. It puts the odds in your favor over time by keeping you heavily invested during major uptrends, defensive during major downtrends and focused on stocks that, historically, have the best chance of producing outsized results. That system is the big reason why Cabot Growth Investor has beaten the market handily since I took over at the start of 2007, nearly 11 years ago.
One of the biggest benefits of having a time-tested system is that you can lean on it when the market does something unusual; instead of relying on emotions and predictions (both are which are usually counterproductive), you instead turn to the system’s rules and tools.
Following the system is particularly helpful during weak spots in the market, when you have to decide whether to sell a particular stock or raise cash in the portfolio. But it’s also useful during the current environment, as the market’s eerily smooth advance (at least in the major indexes), hunky action from growth stocks and iffy broad market has many wondering if a shoe or two is set to drop.
Could we be nearing a top in the market or in some growth stocks? Sure, it’s possible, as things have come a long way from a year ago. For some stocks that are extended in both the short- and long-term, taking partial profits could make sense.
But the Cabot growth system makes it a point not to try to pick tops (or bottoms) in the market or individual stocks for the simple reason that trends (in both directions) often go far longer than most investors expect. Thus, today our best advice is to keep your feet on the ground and be prepared should the sellers appear—but until then, follow the system, which says to remain heavily invested in leading growth stocks.
[highlight_box]WHAT TO DO NOW: Until the evidence changes, you should stick to your bullish guns. Since the last issue, we’ve made no changes to the Model Portfolio, where we remain near fully invested.[/highlight_box]
Model Portfolio Update
The Model Portfolio continues to crank ahead, and we’re up more than two and half times the S&P 500 so far this year. Of course, bull markets make geniuses of us all, but we’re enjoying the good times while they’re here.
That said, investing is a contrary business—when the market is in the dumps, you should be looking for signs of bottoming action and new leadership, and today, when things are marching higher, it’s important to keep your feet on the ground and look for abnormal action. That’s not to say you should react to every short-term wiggle or selloff, or that you shouldn’t be looking out for new leadership; we’re very high on Splunk, for example, after last week’s earnings report. (See more later in this issue.)
Still, while we’re keeping a close eye on the broad market, all of our stocks are acting well enough, so we’re standing pat in this issue.
Current Recommendations
HOLD—Alibaba (BABA 191)—We’ve been too jumpy with BABA in recent weeks, switching it back and forth from Buy to Hold a couple of times as the stock gyrated up and down. Taking a step back, our simple thought is this: BABA hasn’t decisively made it out to a new relative performance (RP) peak in three months, though the action so far this week has been encouraging. Fundamentally, we still think Alibaba has a ton of growth ahead of it (analysts see earnings up 23% this quarter and 30% next year, both of which are likely conservative), and the firm continues to stretch its tentacles into some offline areas (it took a $2.9 billion stake in China’s largest hypermart, which is a combination of a supermarket and department store). If you own BABA, we advise holding, but we wouldn’t be buying it until it shows more strength.
BUY—Autodesk (ADSK 127)—ADSK has crept higher since we added it to the portfolio near the start of November. The stock’s intermediate-term future will probably be determined by earnings (due out November 28)—analysts are looking for revenues to rise 5% (the first rise in two and a half years as the firm’s new subscription model takes hold) and a loss of 13 cents per share, though just as important will be total subscriber additions and any update to its long-term cash flow goals (currently $6 per share in 2020 and $11 in 2023). A drop all the way back to the mid-110s would be a red flag, but with the stock acting fine, we’ll stay on Buy, though you should keep any new positions small ahead of the report.
BUY—Exact Sciences (EXAS 59)—EXAS has caught its breath in recent days, partly due to a valuation-driven analyst downgrade last week. (We also saw some bearish options activity picking up last week, so some investors are betting on the stock retreating further.) Even so, the rest looks normal on the chart, and a dip into the mid-50s wouldn’t be surprising. The company itself is certainly a believer that it has a ton of growth ahead of it: Exact Sciences is in the process of upping its production capacity at one facility from one million to 2.5 million Cologuard tests annually, and it just broke ground on another facility that will eventually boost total capacity to 4.5 million tests annually. That compares to an expected 570,000 tests this year! If you don’t own any, you can start a position here or on dips of a couple of points.
HOLD—Facebook (FB 182)—On a price chart, FB remains in fine shape; if you own some, the stock is a solid Hold. (Remember that, unlike on Wall Street, hold actually means hold to us.) But whether it’s because of fears of slowing growth next year (mostly due to higher spending) or the fact that the stock is so well known, FB isn’t a leader right now—the RP line is no higher today than it was in late-July, which means the stock hasn’t been outperforming the market. Eventually, we think the stock will kick into gear, but we want to focus new buying today on stronger situations.
BUY—Five Below (FIVE 58)—FIVE stretched its legs late last week, hitting new all-time highs near 60 before pulling back a bit following an analyst downgrade (based on valuation) this week. Earnings will be released on November 30 (next Wednesday), with sales growth of 23% and earnings of 13 cents per share (up 30%) expected. That said, all eyes will be on fourth-quarter guidance (current estimates: $484 million revenue, $1.08 earnings), as Q4 (ending January) usually provides the bulk of Five Below’s annual profits. With the stock acting fine, we’ll stay on Buy, but our usual advice applies—keep new purchases small ahead of earnings.
BUY—Grubhub (GRUB 67)—GRUB remains very much under control, pushing steadily higher since its bullish earnings reaction a month ago. Given the company’s best-in-class scale (four times the size of its largest competitor), it’s beginning to attract more big fish, both in terms of restaurants (150% growth in the number of restaurants on its platform from a year ago, including many national chains that signed on and let the company take care of the delivery service) and ancillary deals—last week, the company inked a deal with InterContinental Hotels that allows diners to earn rewards points when using Grubhub. Buying volume has been a bit slack this month, so see if you can grab shares on dips into the lower 60s.
BUY—PayPal (PYPL 78)—PayPal made a big move last week, agreeing to sell its consumer credit portfolio to Synchrony Financial for more than $6 billion, which will lessen PayPal’s credit risks and free up a ton of cash to invest in other, higher-yielding areas. While the move will play around with the company’s numbers in the short-term, investors generally like the move, thinking it will raise the ceiling on PayPal’s potential growth and free cash flow down the road. The stock popped on the news and continues to look fine, but shares remain extended to the upside in the short-term (the 50-day line is below 69) and intermediate-term (PYPL hasn’t had a correction in seven months). We don’t see any major warning signs, so we’ll stay on Buy, but aim to buy shares on pullbacks.
BUY—ProShares Ultra S&P 500 Fund (SSO 103)—After a nice rally in September and much of October, SSO (along with the S&P 500) did a nice job consolidating that move by chopping mostly sideways and remaining mostly above its 25-day line before today’s rally pushed it to new highs. We still view SSO as a great way to get a foothold in the overall bull market, so you can buy some here or on dips of a point or two if you’re not yet in.
BUY—ServiceNow (NOW 128)—Like the S&P 500, NOW has done a nice job tightening up during the past month, hovering between 123 and 129 after a volatile earnings reaction in late October. ServiceNow is an institutional favorite, with more than 1,000 mutual funds owning shares, so it’s not going to be a go-go stock. Yet with fast, foreseeable growth coming (30% revenue growth through 2020, free cash flow of $6 per share or more), those big investors are likely to continue supporting the stock. You can buy some here if you’re not yet in. Be aware that cloud software giant Salesforce.com (CRM) reports results after the close tonight (November 21), which could push/pull NOW in the days ahead.
HOLD—Shopify (SHOP 111)—It’s not out of the woods yet, but we’re growing increasingly optimistic that SHOP has another leg up in it, partly due to the chart (it’s done a nice job of holding support and, over the past few days, rallied about halfway back up its recent trading range) and partly due to the still-enticing business (including a deal to bring UPS’ delivery services to clients that use Shopify’s platform). That doesn’t mean the stock is ready to get going right now—there’s still resistance to chew through and our gut says SHOP probably needs more time to come out of the public’s eye—but it’s encouraging. If you own some, continue to hold with a mental stop in the upper 80s.
BUY—Universal Display (OLED 185)—OLED remains a moonshot, rallying straight up from 135 in late October to as high as 185 today. There’s nothing new with the story, but it’s obvious that big investors are thinking Universal is going to rake in the money as smartphones, TVs and even lighting products move to organic light emitting diode displays. While the stock is obviously extended, the run isn’t necessarily near an end; in fact, given the huge-volume, post-earnings liftoff, our guess is that the next pullback will be buyable. If you own some, sit tight, and if not, look for a dip of a few points to buy a small position.
Watch List
Diamondback Energy (FANG 109): We’re still watching energy stocks, which have been out of favor forever but are showing some very intriguing technical action. FANG is one of our favorites, though there are others (both explorers and oil service firms) we’re keeping a close eye on.
Planet Fitness (PLNT 31): PLNT is consolidating its big earnings move in fine fashion. We love the story, though the stock’s low trading volume isn’t ideal.
Pulte Group (PHM 33): Homebuilders remain very strong, with PHM one of the big-cap leaders in the group. A knockout-type of move could provide an entry point.
Splunk (SPLK 84): We’ve always liked SPLK’s story and growth numbers, and now the stock has blasted off and entered what should be a sustained advance. See our writeup on SPLK in Coiling Consolidations.
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.
DXC Technology (DXC 99) — DXC Technology was formed by the merger of the enterprise services division of Hewlett Packard with Computer Sciences Corp., and the company is a giant in the global IT world, with over 6,000 clients in more than 70 countries and a market cap of $28 billion. The expected synergies from the merger are expected to add up to $1.5 billion within a year and should drive earnings above $7 per share this year, and rising 20% for a few years to come. DXC came public in April 2017 and has soared from 68 to 98, stair-stepping higher with gaps up in August, October and again on November 8. Free cash flow should be even larger than earnings, which, in a company this size, makes it a perfect choice as a conservative growth stock.
Ollie’s Bargain Outlet (OLLI 47) — Ollie’s Bargain Outlet, “Good Stuff Cheap,” is a retail discounter with 247 stores in 20 states in the eastern half of the U.S. The company’s strategy is to concentrate on offering a treasure-hunt shopping experience on heavily discounted closeout merchandise in a warehouse environment. Ollie’s has the scale to buy whole product offerings and uses its long-standing relationships with manufacturers, wholesalers, brokers and distributors to get good deals and pass on the savings. Management has produced three years of revenue growth in the high teens, and sees an opportunity for an eventual string of up to 950 Ollie’s stores. With the retail sector beginning to pick up, OLLI, which is up from 28 in January, has been trading sideways since August, and with earnings due on December 6 after the close, there’s the potential for a breakout if the news is good.
ON Semiconductor (ON 22) — ON Semiconductor was already a fair-sized chip maker when it bought Fairchild Semiconductor in September 2016 for $2.4 billion in cash. The merger has produced a string of quarters with huge revenue growth. But even more impressive has been the earnings results this year, with EPS up 100% in Q1, 267% in Q2 and 2,000% in Q3. The chip industry is notoriously cyclical, and it’s not early in the cycle’s uptrend, but many stocks—including ON Semi—are acting very well. ON has made great strides since it bottomed at 7 in February 2016, but the stock reset itself with a long flat stretch from February 2017 through August. Since its low at 14 in July, ON has pushed to near 22. There’s still plenty of momentum here.
ProPetro (PUMP 18) — With crude prices up significantly from June lows, investors are looking at the oil patch again and liking what they see. One attractive possibility is ProPetro, a Midland, Texas-based well services company that’s a pure play on fracking in the Permian Basin region. ProPetro has 16 equipment fleets in operation (including four that came into service in Q3) and a 17th planned for early next year. The company’s services are optimized for the Permian drilling environment and business is picking up quickly. After a couple of years of losses, analysts see earnings turning positive in 2017 and growing by 173% in 2018. PUMP is still a young stock (IPO was in March 2017), but it’s surged to new highs recently. We like it.
Coiling Consolidations: A Bullish Long-Term Chart Pattern
Splunk (SPLK)
We’ve written a couple of times in recent months about the huge number of multi-year breakouts we’ve seen in 2017; many stocks did nothing from 2014–2016, only to leap above their ranges this year, which is a very bullish clue. Indeed, many stocks that met these criteria earlier this year (like Alibaba (BABA) and PayPal (PYPL)) have had solid runs.
The good news is we’re still seeing some of these long-term breakouts among growth stocks. One that got going last week—Splunk (SPLK), which is the King of Big Data software—also had a very bullish long-term chart pattern we call Coiling Consolidations. Here’s a chart lesson you can chew on while you’re eating leftovers this weekend.
When examining the weekly chart, you’ll often see a stock repeatedly attempting to form launching pads over many months or even years. At the beginning, those bases will be wide and loose, with lots of big selling volume. Gradually, the trading ranges will become shallower, until finally the stock forms a very tight, proper consolidation, signifying that the weak hands are gone. This often happens right before the breakout.
PayPal (PYPL) was a classic example earlier in the year. Notice how its consolidations went from very loose (28% deep in the months after its IPO), to decent (19% deep during mid- to late-2016), to tight (15% deep) to extremely tight, when the stock closed seven weeks in a row right near 43 before breaking out. It’s this gradual grinding action that wears out the weak hands over time.
Splunk (SPLK), which just got going last week, looks like another example. After a huge plunge from 106 in March 2014 to 30 in January 2016, the stock rallied to the mid-60s last August, which is where our analysis begins. The first base lasted 36 weeks and was very choppy; there was huge-volume selling during the consolidation and, the two times it tried to break out, volume was light, telling you buyers were nowhere to be found.
The next consolidation was too sharp—the stock fell 22% in just five weeks, with four of those weeks coming on very heavy volume. The RP line, too, even approached multi-year lows.
However, the action since September brought a change in character. First, SPLK gapped up on earnings, though it was again rejected by resistance in the upper 60s. But the next dip was mild, both in terms of the pullback (just 10%) and the volume (no big selling weeks). Shares bounced back to their highs, and last week brought the “real” breakout, with SPLK surging 18% on eight times average volume.
Of course, the fundamentals are also vital, and Splunk has an excellent story and growth numbers. The company is all about machine data, which is digitally-derived data that provides a definitive record of how customers and others act online. Think of an e-commerce firm knowing who clicks where, when and how often, and how long they stay on each page. It’s valuable stuff if you can harness it, given the amount of it and the fact that it is often captured in different formats.
Splunk’s software has proven to be the best at helping clients mine and get the most from their reams of machine data to boost customer experiences, improve security and drive more sales. Indeed, despite the stock’s lack of progress in recent years, business has been good, with revenues rising between 30% and 43% each of the past six quarters. And earnings (up 70%) and free cash flow (more than 30 cents per share in Q3 versus 17 cents of earnings) are both rising nicely. Analysts see next year’s bottom line rising 47%, and management believes sales can rise from $1.16 billion today to $2 billion in 2019, with profits rising faster than that.
All told, SPLK’s story, numbers and chart are aligned and pointing to higher prices. We’re not opposed to buying some right here, though with our Model Portfolio basically full, we’ll keep it at the top of our Watch List.
Cabot Market Timing Indicators
The bull market remains alive and well, with growth stocks leading the way, and we’re riding many of the best performers higher. There are a couple of cracks in the armor (broad market, complacent sentiment) that we’re monitoring, but we’re primarily focused on the trends of the indexes and growth stocks, both of which look fine.
Cabot Trend Lines: Bullish
We’re now coming up on 19 months in row with our Cabot Trend Lines on a Buy signal, and the indicator remains firmly in the bull camp today. Even after two modest down weeks, the S&P 500 closed last week 5.0% above its 35-week line, while the Nasdaq finished a strong 7.8% above its own 35-week line. As we’ve written recently, a correction wouldn’t be surprising, but until proven otherwise, the odds favor higher prices in the months ahead.
Cabot Tides: Bullish
Our Cabot Tides actually raised our eyebrows during the middle of last week, as two indexes we track fell below their lower (50-day) lines and the S&P 400 Midcap (shown here) approached its own 50-day line during the day. However, close doesn’t cut it with our indicators, and the bounce in the indexes during the past few days has kept our Tides bullish. The fact that the longer- and intermediate-term trends are both pointed up is reason enough to remain heavily invested.
Two-Second Indicator: Unhealthy
The Two-Second Indicator continues to tell us the broad market is unhealthy, with the number of stocks hitting new lows regularly numbering greater than 40 on the NYSE (and the figures have been elevated on the Nasdaq, too). We haven’t taken action based on these readings as growth stocks remain in favor, but these readings do raise the odds of either a market dip or same rotation out of growth stocks and into beaten-down names. It’s something to monitor.
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Send questions or comments to mike@cabotwealth.com.
Cabot Growth Investor • 176 North Street, Post Office Box 2049, Salem, MA 01970 • www.cabotwealth.com
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 DECEMBER 6, 2017
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