In today’s issue, we talk about some of the clues to identifying abnormal action, which earlier this year led us to sell a couple of stocks that have since been hit hard, while holding onto some leaders that are beginning to re-emerge. It’s an art as much as a science, but we think the discussion will help you hold your highest-potential holdings through tough corrections.
Cabot Growth Investor 1388
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More Good Than Bad
After waterfall declines in early February, the major indexes began to bounce on February 9, and kept bouncing for the next two weeks. After a little hesitation, we saw enough strength early this week for our Cabot Tides to flip back to positive, which was our sign to start putting money back to work.
Is this a pound-the-table Buy signal? We wouldn’t go that far, for a couple of reasons. One is the nature of the correction: Brief, V-shaped bottoms (straight down and then straight back up) are often less reliable and/or lead to choppier action. They can definitely work out well, but such a short decline and immediate snap back doesn’t leave much time for big investors to reposition their portfolios and investor sentiment to turn negative, which provides a better foundation for a sustained market advance.
Another reason comes from the Tides themselves. Such “whipsaw” buy signals are more easily reversed if the market dips. Indeed, it wouldn’t take much more selling from here to reverse the recent signal.
Despite those cautionary signs, there’s more good than bad in this market. Starting with the major indexes, the strength of the recovery itself is a good sign—the S&P 500 has recovered as much as 75% of its decline, while the Nasdaq regained 90%! Even the worst performing index (NYSE Composite) regained as much as 60% of its losses. No guarantees, of course, but such a strong snap back increases the odds that (at the very least) the low is in.
More important to us is the action of growth stocks. They look great! In fact, it’s difficult to narrow down our list of potential new buys because so many are showing excellent relative strength. Going along with that is the growth-oriented Nasdaq, which is clearly the best-performing index we follow. We’re not seeing a ton of low-risk entry points—V-shaped patterns are the norm, which isn’t surprising given the market—but the action in general is still a big plus.
Put it all together and we’re optimistic, but we don’t advise jumping in with both feet. In the Model Portfolio, we did some new buying this week, and will be looking to be “pulled” into a heavily invested stance via further market strength and continued bullish action from growth stocks.
[highlight_box]WHAT TO DO NOW: Do some buying. In the Model Portfolio this week, we bought a new position in HubSpot (HUBS) and averaged up in Shopify (SHOP), which brings our cash position down to 27%.[/highlight_box]
Model Portfolio Update
Volatility was muted for just about all of 2017, but it’s clearly back this year, both in the market and individual stocks. As always, we rode the bucking bronco, raising as much as 42% in cash during the market’s plunge, but this week we put about a third of that to work, leaving us with 27% cash.
We’ll obviously continue to follow our indicators and our system, but we’re also not leaving our brain at the door—V-shaped recoveries in the market can work, but even when they do, they often lead to choppy conditions. Thus, we’re viewing this less as some major new Buy signal and more of a resumption of the uptrend, which means it’s still vital to look for the right setup and situation.
Long story short, after doing some buying this week, our next move will really come down to individual stocks—a bunch of tight setups and upside follow-through could have us getting fully invested, but barring that, we’re content to wait and see how things handle themselves.
Current Recommendations
HOLD—Alibaba (BABA 186)—Alibaba continues its shopping spree, buying another chunk of Ele.me (which translates to “Hungry Yet?”), a Chinese food delivery outfit that should boost Alibaba’s last-mile delivery capabilities. The company is also considering a $500 million stake in an Indian news aggregator and purchased another 15% slice of a big Chinese furniture chain. That said, the next few quarters will be driven by BABA’s core e-commerce activities, which are strong. As for the stock, it remains range-bound—the recent bounce was decent, but not spectacular, with the stock and its relative performance (RP) line rallying halfway back before this week’s slippage. We’ll continue to follow our game plan—a drop below the 200-day line and its recent lows (below 165 or so) would be bearish, but a good-volume move above 200 would tell us the stock’s major uptrend is resuming. Right now, we advise standing pat.
HOLD—Facebook (FB 178)—FB’s recent action looks a lot like BABA’s, with a quick plunge during the market’s correction and a bounce about halfway back since then. Bigger picture, we are tossing around the idea that Facebook may have matured to the point of being more like, say, a Google—i.e., a fine company, but a stock that usually doesn’t dramatically underperform or outperform the market. After all, when we originally bought the stock back in 2013, Facebook had around $6.5 billion in revenue (vs. $40.6 billion today) and earnings of around 40 cents per share ($6.16 today). Of course, the company now has more legs of growth than back then (Instagram, Messenger, etc.), so it’s possible the firm’s rapid earnings growth could continue. All that said, it’s best not to overanalyze the situation; our goal is to be a bit “dumb” by watching support in the high 160s, holding above that level but saying goodbye if it doesn’t. Right now, you should sit tight.
HOLD—Five Below (FIVE 67)—FIVE is now in its eighth week of building a new launching pad, which is normal action following its breakout from a five-year zone in November and subsequent advance. There’s still no set date for earnings, though mid-March is likely, and investors will obviously be looking for added details on the business. But in its early-January investor presentation, the company gave some bullish statistics, saying it plans to open 125 stores this year (a 20% hike in the store count), believes there’s room for 2,500 in the U.S. long-term (about four times what it operates today!), and said store economics remain best-in-class (payback of initial investment in a year or less). Of course, to support the expansion means more hiring and more distribution centers (one will open next year, another in 2020), but there’s no indication that spending will crimp earnings growth at all. We’re not opposed to nibbling here if you don’t own any, but officially, we’ll stay on Hold until we see a bit more strength.
BUY—Grubhub (GRUB 99)—GRUB has motored as high as 100 in recent days thanks to follow-on buying after the firm’s terrific Q4 report. The sales and earnings trends (analysts see earnings up 39% this year and another 31% in 2019) are obviously key, but we’re also keeping an eye on the bigger picture—with just 2% of all U.S. takeout orders going through Grubhub, the potential is enormous, and we wouldn’t be shocked to see more large operations ink deals. Last week, Grubhub announced an agreement with American Express allowing people to use their membership points to pay when ordering through Grubhub, and use express checkout to get the order completed quicker. Down the road, it’s likely that more big restaurant chains like Cheesecake Factory and Yum! Brands will team with Grubhub. Back to the stock, GRUB is clearly extended, so a pullback of a few points wouldn’t be surprising. Hold on if you own some, and if you don’t, try to buy on weakness.
BUY—HubSpot (HUBS 111)—HubSpot is part of both the strong software sector and part of a theme we think has a long way to run—that of helping small- and mid-sized businesses (many of which were ignored by providers and lenders during the past few years) thrive in the new digital world. HubSpot’s claim to fame is its inbound marketing platform, which avoids the annoying cold calls, email blasts and direct mailings of years past and focuses on less intrusive methods that offer useful content and build loyalty, allowing their clients to attract, convert and satisfy leads. Most important, the platform works, and that’s leading to excellent growth—revenues have grown between 37% and 40% each of the past four quarters, earnings have leapt into the black and the firm’s customer count (41,593 at year-end) was up 48% from a year ago. The stock has been a good-not-great performer during the past year, but has shown outstanding action since earnings and the market’s low, including a string of big-volume up days. It’s a bit extended to the upside here, but we view that as a sign of leadership. It’s buyable around here or on dips; we’ll use an initial loss limit in the upper 90s.
HOLD—PayPal (PYPL 79)—PYPL remains in a consolidation phase—it’s bounced about more than halfway back from its early-February plunge (which was both market- and earnings-induced) but is also sitting above its November high. We still think PayPal has the makings of a MasterCard or Visa for the digital, e-commerce age, and the stock will eventually resume its longer-term uptrend. Thus, we remain patient, though we’re using a mental stop in the high 60s in case something goes wrong.
BUY—ProShares Ultra S&P 500 Fund (SSO 112)—We went back to Buy on SSO earlier this week after our Tides turned positive. And despite the wobbles of the past two days, we’re still OK picking up shares around here given the longer-term positives (Cabot Trend Lines are positive, and don’t forget the many bullish studies we wrote about last month) and the fact that the strength off the February bottom (the S&P 500 recovered about three-quarters of its total decline) meaningfully raises the odds that a low is in. If you already own some, just hang on, but if you’re looking to get a foothold in the market, you can grab some shares of SSO around here.
BUY—Shopify (SHOP 138)—SHOP’s dazzling action came to a halt last week after the company’s medium-sized secondary offering (it represented about a 5% dilution) hit the stock. Even so, we think the stock has regained its leadership status, and the fundamental story remains as strong as ever, with revenues continuing to surge (up 71% in Q4), new client growth excellent (more than 600,000 clients in total) and earnings ramping higher. Put it together, and we advised boosting your position earlier this week—we added a 3% position (that is, 3% of the portfolio) to our stake earlier this week. If you don’t own any, you can buy a modest-sized position around here or on weakness.
BUY—Splunk (SPLK 93)—SPLK popped to new highs just a few days after the market’s low, though it’s chopped sideways since. Overall, the chart is in fine shape, but it’s all going to come down to earnings, which are due tomorrow (March 1) after the closing bell—analysts are looking for revenues of around $391 million (up 28%) and earnings of 33 cents per share (up 32%), but the outlook will be vital, too. Given the fact that the stock just got going from a multi-year base in November, we’re optimistic SPLK has a lot of gas left in the tank, but we’ll take our cue from the stock’s action in the days following earnings.
Watch List
TD Ameritrade (AMTD 58): We got out of ETFC near breakeven when the market began to plunge, but most Bull Market stocks have snapped back nicely, with AMTD being the first to kiss new highs. Analysts see earnings booming 70% this year.
MuleSoft (MULE 31): We don’t want to own too many software stocks, but MuleSoft is solving a big unaddressed problem (technology integration) for companies all over the world. Shares just exploded out of an IPO base on earnings last week.
Planet Fitness (PLNT 37): It’s not quite as fast-growing as we’d prefer (15% to 20% expectations), but Planet’s cookie-cutter (and Amazon-proof) story has years of solid growth ahead of it. And the stock just reacted well to earnings, too.
Proofpoint (PFPT 107): After two years of lackluster, choppy action, the cybersecurity group appears to be getting going, and PFPT (at all-time highs) is a mid-cap leader in the group. Management sees 30%-plus cash flow growth for at least the next three years.
Pure Storage (PSTG 22): We think PSTG has a chance to be the next great storage stock (it seems like there’s one big winner from the group every three or four years), but earnings are due tomorrow (March 1), so we’ll continue to watch.
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.
Diamondback Energy (FANG 125) — While some stocks (like Universal Display (see next section) and Exact Sciences) have cracked further and look broken, FANG has done a nice job of snapping back since we sold it. A great earnings report on February 13 had a lot to do with the stock’s strength, as revenue was up 116%—the fourth consecutive quarter with triple-digit top-line growth—and earnings were up 73%. During the fourth quarter, total production was up 9% over the previous quarter and 79% over Q4 2016. Proven reserves jumped 63% over the previous year. And the company also initiated a 50 cent-per-share annual cash dividend to be paid quarterly. The oil group isn’t as vibrant as it was, which makes us question whether FANG can keep it up. But it’s definitely worth watching, and if you didn’t sell when we did, it might pay to hang on and give it a chance, although we see better opportunities for new buying out there.
Nutanix (NTNX 36) — Nutanix provides an enterprise cloud platform that lets servers, virtualization and storage systems all work in one integrated solution. Nutanix calls it hyperconverged infrastructure (HCI), and it’s proving popular with both users and investors. There’s no hardware involved, just HCI nodes that turn separate resources into one transparent fabric. Nutanix isn’t profitable, and doesn’t expect to be through 2019, but revenue has been growing like crazy: up 90% in 2015, 84% in 2016, 72% in 2017 and 77%, 67%, 62% and 65% in the four most-recent quarters. NTNX skidded from its post-IPO peak of 40 in September 2016 all the way to below 16 in May 2017. So the stock’s return to 38 in January constitutes a huge post-IPO base. Earnings are due out tomorrow, March 1. Keep an eye on it.
Wix.com (WIX 75) — Wix.com specializes in helping users build great websites with ease. The company’s platform doesn’t require knowing code and offers plenty of upsells from its free offering to premium and subscription levels of support that sell for a reasonable $5 to $25 per month. Entrepreneurs and small businesses are the target consumers, and the company boasts 119 million registered users, with 3.2 million signed on for premium subscriptions. The company has turned the corner into profitability, and the quarterly report on February 14 was very strong (sales up 41%, earnings up 129%). WIX ran from 15 in February 2016 to 86 in April 2017, but fell down to 51 in December. With the good earnings news, WIX is back above 75; it’s worth watching to see if it can resume its longer-term advance .
Zendesk (ZEN 43) — Zendesk helps businesses build strong relationships with customers by supplying easy-to-use, cloud-based software that provides technical support, live chat, phone talk and messaging services. And Zendesk’s software consolidates all of these channels into one unified record so a client’s history is always at hand. It’s not revolutionary, but the software suite has been a hit, with revenues growing between 36% and 41% each of the past five quarters, and management sees the top line reaching $1 billion in 2020 (32% annual growth from now until then). Earnings have been less impressive, but should reach the black this year, with free cash flow of nearly 30 cents per share. ZEN, formed a giant post-IPO base from August 2014 to September 2017, broke out to new highs in November and has kept gaining. Cloud software is hot, and ZEN is one of the strongest.
Normal vs. Abnormal Action
During last year’s three-day Cabot Wealth Summit, one of the presentations I gave centered on how to handle the market’s hottest stocks. And a key to that skill was answering the question, “What is normal action during a big winning stock’s major advance?” The answer surprised many people.
After poring through dozens of examples of past winners, we see that even a big winning stock is likely to see a couple of adverse earnings reactions, at least one or two 15% to 25% corrections (if not deeper) and/or multi-month periods of no net progress, the run will include a couple of times when the Cabot Tides were negative (intermediate-term market downtrend), there will almost surely be some analyst downgrades (often valuation-based) and plenty of negative news and rumors about competition.
In other words, the biggest winners experience lots of sour action and bad news on their way to higher highs. It doesn’t always feel good, and that’s why it’s hard to hold onto winners!
But once you understand what’s normal, you have an edge on the vast majority of investors that invest who based on their gut and are heavily influenced by a stock’s recent action.
Take Shopify (SHOP), for instance. The stock broke out of a huge IPO base last January, which was our signal to jump on board. It doubled by June and, after a reasonable consolidation, lifted as high as 124 in September. Then came some weakness in growth stocks and a high-profile attack by a well-known short seller. The result: A sharp 28% correction.
Was the run over? It was possible (we sold some shares during the retreat), but certainly not conclusive—SHOP was still above its long-term 40-week moving average (which we try to use once we have a big winner). And, importantly, the stock began to find support the week after its initial dip. Thus, despite no net progress from June through December, we held onto our remaining shares—and this year, the stock has come alive, regaining its leadership status. (We added more shares to our position this week.)
Obviously, there’s judgment involved when a winner hits the skids. You don’t want to be complacent, but you also need to be sure you’re taking an objective look at the chart and the other evidence. In SHOP’s case, the decline occurred mostly over just a couple of days, the “news” was superficial and obvious, and the decline (while painful) only brought the stock back into its prior base—all reasons to give the stock a chance.
Now let’s compare SHOP’s action to Universal Display (OLED), which we sold in January and has continued to tank. What led us to sell OLED but not SHOP? Two things in particular. First, one of our best sell rules is when you see a stock etch a double top—and then see a huge-volume selloff after the second peak. OLED didn’t quite fit that exact definition (it did poke out to new highs in January) but the move was quickly erased on huge-volume selling.
Second, the selling didn’t abate—on day four, the stock made a huge break below the 50-day line, and kept sliding without any rebound attempt for two weeks! Even the rally in mid-February didn’t change the picture, and last week, OLED got whacked after earnings.
The upshot is that determining the difference between normal (though sometimes painful) action and abnormal action makes a big difference when you’re trying to ride out your winners. Right now, a lot of last year’s winners look abnormal, so avoid them, even if they’re familiar names. Instead, focus on winners (like SHOP) that have resumed their uptrends, and the many other growth stocks have shown excellent action during the past few weeks.
Cabot Market Timing Indicators
Our Cabot Tides flipped back to bullish this week, joining the Cabot Trend Lines (bullish since April 2016!) on the positive side of the fence. V-shaped bottoms are often tricky, so we advise going slow, but the excellent rebound by the major indexes and growth stocks tells us to put some cash back to work.
Cabot Trend Lines: Bullish
Our Cabot Trend Lines are still in fine shape. Following the market’s two-week rebound, the S&P 500 and Nasdaq closed 6.0% and 9.4% (respectively) above their 35-week moving averages last week. We’re always open to changing our mind if the evidence changes, but the stubbornly bullish Trend Lines along with the many bullish studies from December and January (caused mainly by the market’s strength) bode well for higher prices in the months down the road.
Cabot Tides: Bullish
Our Cabot Tides produced a buy signal at the close on Monday, when three of the five indexes (including the S&P 500, daily chart shown here) closed clearly above their lower (50-day) lines. Granted, since then, the indexes have pulled back, and a couple of bad days from here could reverse easily the signal. But for now, we still consider the intermediate-term trend tilted up, given the strong rebound from the lows.
Two-Second Indicator: Unhealthy
Our Two-Second Indicator has improved, but not enough to conclude the broad market is in great health, with a couple of sub-40 readings generally followed by a few over-40 readings. Because of the major recent decline, such on-again, off-again readings aren’t unusual, but we’d like to see the number of new lows dry up consistently should the market continue to push higher.
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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 MARCH 14, 2018
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