Cabot Growth Investor 1467

The overall market remains in good shape, with many indexes actually stretching to new highs this week. But growth stocks are another ball of wax, with many leaders having decisively cracked their uptrends and the Nasdaq itself stuck in no-man’s land even after this week’s bounce.

We’re open to anything, and in fact we’re putting a small piece of cash back to work tonight (buying a half-sized position in a high-potential stock), but we’re mostly going slow and waiting for growth stocks to set up properly. Our cash position will be right around 50%.

Cabot Growth Investor 1467

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Open to Anything, but Playing the Odds
Last year saw a ton of “wow, we haven’t seen this kind of unusual market action in decades!” situations, but instead of reverting back to normal behavior, 2021 has had plenty of tricks up its sleeve as well. The past few weeks has been a good example of that, as growth stocks have cracked their uptrends across the board, while the rest of the market continues to dance to its own bullish tune.

Indeed, today, many indexes leapt to fresh all-time highs, even as the Nasdaq itself is hanging around its 50-day line and most growth leaders are still 15% or more off their peaks!

Now, given the spate of unusual occurrences during the past year, we’re open to anything, including the possibility that this short, sharp (10% on the Nasdaq, 25%-plus on many leaders), scary shakeout was just a passing thunderstorm. According to Ryan Detrick of LPL Financial, the 11 other rapid 10% corrections (occurring in less than one month) generally led to great performance, with the Nasdaq up an average of 21% six months later.

That goes along with our trend-following indicators (both the Cabot Trend Lines and Cabot Tides are still bullish) and our big-picture view that, at day’s end, this is still a bull market that many things (like the blastoff measures from last November) tell us should last for months to come.

However, when you boil it down, our system is all about placing the odds in our favor—and when it comes to growth stocks, the pattern of (a) huge multi-month runs, often since last April or May, (b) skyrocketing investor sentiment amidst a backdrop of excellent news, and (c) a rash of big-volume intermediate-term breakdowns all tell us that the odds favor most growth stocks will likely need some time to build new launching pads and for some new leadership to set up.

Thus, we’re not holing up in our bunker or expecting some great unraveling; in fact, we’re putting a small piece of our sidelined cash to work tonight. But in general, we’re content to go slow and stay cautious, waiting for the market to prove this was one big shakeout or for more legitimate, lower-risk entry points to emerge.

What To Do Now
Given the action among individual stocks, we pared back quickly during the past two weeks, selling three stocks and (late last week) trimming a bit more of both TWLO and ROKU. However, that’s left us with a huge cash position, so tonight we’ll start a half-sized position in DraftKings (DKNG), which will leave us with right around 50% on the sideline.

Model Portfolio Update
We’ve seen some strong rotation and scary shakeouts in recent months, but the action among growth stocks in late February and the start of March was clearly abnormal—just about every growth leader we follow cracked intermediate-term support, with many names cascading more than 30% in a matter of days. We took defensive action, selling three stocks outright and trimming two others.

However, we’re far from pounding the bearish drum—our Cabot Tides are still bullish and the rally in the middle of this week has been a breath of fresh air, so we’re actually dipping a toe back in the water today, adding a half-sized position in DraftKings (DKNG). But, for most growth stocks, this latest snapback is just the first step; now we need to see whether the bounces hold and some real setups emerge.

If that happens, we’ll put some more money to work … but if not, we’ll stand pat, as the vicious selling seen of late could lead to more reverberations down the road. At the moment, we’re content to mostly watch and wait, but we’ll let you know if/when we have any changes.

Current Recommendations

DraftKings (DKNG)—Many big winning stocks are born from entirely new industries, and that’s looking like the case with DraftKings, which is positioned to be one of the leading players in the iGaming (online casino-type gambling), daily fantasy sports and (most important) online sports betting sector. Indeed, the company said this week it has a 30% market share in the online sports betting area in states it operates in and a 19% share in iGaming, and the size of these markets could be enormous—thanks to increasing legalization and cannibalization of illegal betting, DraftKings thinks these two areas could represent a $67 billion market down the road! Of course, that’s a very long-term forecast, but the point is this theme should grow 10-fold or 20-fold going forward, and DraftKings’ positioning (operating in 12 states today, more than anyone else, and ready to expand further as states pass legalization bills) should make it the biggest beneficiary. The company is still bleeding red ink, but management sees 2021 revenue up 50% or so and Wall Street sees years of rapid growth beyond that. The stock is crazy volatile, which is a risk in this environment, but it broke out on the upside a couple of weeks ago, and after being yanked down into the mid 50s, has immediately stormed back to its highs on big volume. Could DKNG fail if the market turns back down? Sure, it’s possible, and even “normal” volatility could see the stock pull in a few points. But this is a huge story and the stock is showing unusual strength in a very tough market for growth stocks, which usually bodes well. We’ll start with a half-sized position, and we’ll use our maximum loss limit (20% or so, which equates to 1% risk in the overall portfolio) to give it plenty of room to maneuver. BUY A HALF.

Five Below (FIVE)—FIVE finally got caught up in the market’s downdraft last week, dipping as low as 172 on Friday before finding support. Yes, the chart is sloppy of late like most things growth-related, but shares are just 6% off their highs and are about two months into a rest area after their strong September-mid-January advance. The future path of growth stocks will be important, but as we wrote last week, so too will be earnings—Five Below is set to report holiday quarter results next Wednesday (March 17), and while the Q4 results will be key (sales up 22%, earnings up 7% is the expectation), more important will be any update on same-store sales trends in February and March as well as the full-year outlook. At heart, we’re optimistic FIVE will be nicely higher down the road given its best-in-class growth story and its two-year breakout last September, and given that we have a solid profit and have already sold one-third of our shares, we’re willing to give our remaining portion room to retreat if necessary. We’ll stay on Buy, but keep any new positions small this close to the report. BUY.

Halozyme (HALO)—We still enthuse about Halozyme’s growth story; despite a so-so Q4 report and outlook, analysts still see earnings up 73% this year and another 68% next year, and those are probably conservative given that the company should ink further deals for Enhanze in the months ahead. But the stock, while acting fine, never really got going in a big way, and it gave up months of gains in a matter of days after earnings and a good-sized, dilutive convertible bond offering. HALO has begun to bounce, and if you still own it and want to use a stop just under 40, that’s fine; in fact, if the stock sets up properly weeks or months from now, we could take another swing at it. But we see the recent selling as clearly abnormal, which should lead to a longer base-building effort. We got out near breakeven last week. SOLD.

Pinterest (PINS)—The strongest growth stocks of the past few months have taken the hardest hits, and PINS certainly was one of those, plunging to nearly 60 last week before finding support. There are some worries out there that, as the pandemic dissipates, much of the online shopping/researching surge we saw last year will do the same. But we think that view is off—growth here was already picking up before the virus, and no vaccine will change the fact that Pinterest has a one-of-a-kind offering that will attract tons more advertisers (and, thanks to improved targeting tools, higher revenues per user) that are looking to influence potential buyers earlier in the process. Back to the stock, we’re not going to pretend the recent action hasn’t been ugly, but interestingly, the stock has had only two big-volume days on the downside, and one of those was actually supporting action (last Friday). We still believe the odds favor PINS will round out a new launching pad in the weeks ahead—though a dip into the mid- to upper-50s could change our mind. Right now, we’re sitting tight. HOLD.

ProShares Ultra S&P 500 Fund (SSO)—The S&P 500 plunged below its 50-day line last Thursday, which caused us to place SSO on Hold, but happily the leveraged long fund has stormed back since and is within shouting distance of all-time highs. Like many of the names we still own, much of the longer-term evidence points higher for SSO; the Three Day Thrust rule, which triggered near the start of November, suggests the S&P should rise another 10% from here in the months ahead. Of course, that’s just one study, but the point is that most evidence suggests that this is still a bull market that, short-term uncertainties aside, is likely to carry higher down the road. We hate to vacillate with our rating, but given the snapback, we’ll return to Buy on SSO—just be aware that near-term volatility is likely. BUY.

Roku (ROKU)—We decided to trim another small piece of Roku late last week (selling one-quarter of our remaining stake), but that was mainly to respect what was going on across all growth stocks. Overall, ROKU’s correction has definitely been sharp and painful, but also not wholly unexpected—even at its lows last week, it was still up nearly 90% from its breakout in September, and the stock has bounced decently since. As with most former high-flyers, we think time is a key issue here, both for the stock to wear out some weak hands (the 40-week line is still down around 255) and for big investors to see that the company’s advertising and revenue-sharing boom is progressing as planned. A break all the way under 300 would be a red flag, as would a situation where ROKU can’t really get off its knees (the bounce so far has been weak). But we’ve already taken three rounds of partial profits out of the stock, so we’re trying not to get too close to its action as it works on its consolidation. HOLD.

Twilio (TWLO)—We also pared back a bit on TWLO late last week (selling one quarter of our remaining stake) given the very weak action—the bounce since then has been decent, but when you see outsized distribution after a big advance, there’s often more selling to come. (That goes for most growth stocks and is why the odds favor some time being needed before that area of the market can really motor ahead.) Still, while it hasn’t seemed like it recently, Twilio remains a rare bird, with a very bullish longer-term forecast (one analyst just initiated coverage on Tuesday, estimating that revenue can grow at in the mid-30% range annually through 2023). Plus, to its credit, the company is using much of the money it’s been raising to good ends; Twilio confirmed it’s invested “up to” $750 million in Syniverse, which will not only help its offerings for business-to-consumer messaging, but could also prove to be a fruitful investment, too (rumors are Syniverse could do a SPAC-style reverse merger in the months ahead). Back to TWLO, the 200-day line down near 300 will be key if growth stocks have another leg down, but we’re encouraged by the recent bounce and, having trimmed our position size, we’re following the same “hold on and give the stock room to consolidate” plan we are with PINS and ROKU. HOLD.

Uber (UBER)—UBER has continued its up-and-down ways, though lately that’s been a good thing, as shares found support twice near the 50 area and have pushed back nicely higher since. Part of the reason may have been some intriguing tidbits from an investor conference this week: Management reiterated that it expects to be EBITDA positive in the second half of the year, which is obviously a good thing; Rides bookings were up 15% month-over-month in February in the U.S. and Canada, with the first week of March showing a 12% bump from February (!); and just as important, the firm has seen no slowdown in its Delivery business despite easing lockdowns, with that business still growing 150% year-over year! As we’ve written recently, we think UBER is an early-stage situation (breakout last November) that is set to see business soar due to the combination of reopening trends and secular growth in the Delivery business. If you wanted to buy a small amount here, we wouldn’t argue with you, but officially we’ll stay on Hold and see how well the stock can hold its recent gains. HOLD.

Watch List

• Diamondback Energy (FANG 84): Both Diamondback and Pioneer Natural (PXD) look like emerging leaders of a new energy bull move. See more later in this issue.
• Dynatrace (DT 54): DT may be forming a base-on-base, with the last five weeks of consolidation sitting on top of the prior seven-month launching pad. Fundamentally, demand for its application performance management platform should remain buoyant for a long time to come.
• Inari Medical (NARI 126): This recent IPO got clobbered during the recent selloff, but Tuesday night’s quarterly report (sales up 144%, earnings well into the black) has pushed the stock to new highs.
• SelectQuote (SLQT 28): Last week was an ugly one for the stock due to the market and a (non-dilutive) share offering, but SLQT is still hanging around its 50-day line and the story (biggest online insurance portal) and numbers (50%-plus earnings growth for many quarters to come) are pristine.
• Wayfair (W 320): You’re not going to find many stocks as volatile (or controversial) as Wayfair, but it’s setting up nicely after a six-month rest and we think estimates could prove very conservative. See more later in this issue.

Other Stocks of Interest
Boston Beer (SAM 1,117)—OK, we’re not big on $1,000 stocks (especially those that trade just 100,000 shares per day), but we have to admit that we’re enticed by Boston Beer, which has an easy-to-understand story and is posting growth that the best medical or Internet company would be jealous of. The company is best known for its Samuel Adams brand of beer, and that’s still a key component of business, but the growth is about the newer brands these days, including Dogfish Head, Truly hard seltzers, Twisted hard teas, Angry Orchard hard ciders and the like. While the virus has hurt restaurant-related sales, that was more than made up for by booming demand for hard seltzers and teas, areas of the alcohol industry that are still in the their early stages of growth; total company sales rose 31%, 42%, 30% and 53% during the past four quarters! And as the economy reopens, even the lagging beer offerings should see a spike in demand. Indeed, management believes all of the firm’s brands will grow in 2021, with shipments rising 40% or so and prices up a couple of percent, too, which should lead to a 50%-ish pop in earnings (shipments were up north of 50% for the first few weeks of the year, FYI). Obviously there’s plenty of competition in the field, but Boston Beer has the leading brands in the industry’s new areas of growth, and a management team that’s proven to pull the right levers. Given the popularity of its offerings, SAM went nuts after last year’s crash, breaking out near 440 in April and zooming as high as 1,100 in October before finally losing steam. The stock tried to get going a month ago, but was briefly yanked back down by the market before beginning to perk up again. We think it’ll be ready to move once growth stocks are.

Snap (SNAP 60)—Like every leading growth stock, Snap has certainly been cut off at the knees of late; from high to low, the stock fell 30% during the recent selling wave before bouncing. But there are a couple of reasons to think the stock will set up a new launching pad in the weeks ahead. The first and most important goes to one of our stock picking principles: If a company sports rapid, reliable growth, and has a long runway of growth (all because of a unique offering and barriers to entry), that gives big investors confidence to build big positions over time. And Snap is one of the few that should have that combination going ahead. At the firm’s recent Investor Day, management surprisingly forecasted “several years” of 50% revenue growth thanks to its core Snap (including ads, lenses, augmented reality and more) and Discovery (news feed) offerings as its ad tools and optimization efforts improve and international user growth picks up. And that actually leaves upside beyond that for newer services like Maps (a cool feature of submitted Snaps in real-time from users, often at sporting events or theme parks, presented via a hotspot-like map), Games and Spotlight (video snaps from users, etc.). Of course, the firm has already been hitting it out of the park (sales up 52% and 62% during the past two quarters), and Wall Street now sees Snap’s top line nearly quintupling from 2020-2024 while earnings begin to ramp up late next year. Another reason for long-term optimism is the fact that the stock only really got going from a giant IPO base (March 2017 to September 2020) last year, so SNAP isn’t a name that’s been overplayed and is a favorite among the chattering class (a good thing). To be fair, more of a rest is likely in order—two-plus weeks down after a multi-month run probably isn’t enough to scare out or wear out the weak hands—but we think SNAP is a name that can lead the next growth stock advance.

Wayfair (W 320)—The growth stocks that ran up right through February (like SNAP) are still early-ish in base-building processes, but those that topped months before (like SAM and Wayfair) are probably more ready to get going if the market ratchets up from here. Wayfair needs no introduction, as it’s long been the “Amazon of home furnishings,” racking up rapid sales growth in a gargantuan market ($1 trillion by 2030!) that’s still catching up to the rest of the world in terms of percent of sales made online (21% last year, vs. 50% in other sectors). Like Amazon in its earlier days, Wayfair had been bleeding money as it expanded, but the pandemic caused a step function higher in its business, with earnings soaring from a loss of eight bucks per share in 2019 to a profit of $5 in 2020 while sub-metrics (active customers up 54%, orders up 47%, repeat customers placed 73% of all orders) surged as well. But that’s where the story gets interesting: Wall Street believes this was a one-time event, with earnings likely to be cut in half this year while sales expand just over 10%, but Wayfair often trashes these estimates (Q4 earnings of $1.24 per share were 38 cents above expectations) and the stock certainly isn’t acting like it’s destined for mediocre growth during the next many quarters—W had a ridiculous run through August of last year, but has now chopped in a very wide range for six months and is showing signs of getting going (very solid price/volume action in recent weeks and some tight weekly closes) despite the growth stock hurricane of late. The stock is extremely volatile, but W is on our watch list.

Precedent Analysis
Energy Looks a Lot Like Housing 10 Years Ago
We’re growth investors, but we’re also students of the market, and that means we’ll occasionally play a turnaround situation—a firm that doesn’t have the traditional growth numbers we look for, but it’s a leading player in a sector that could be emerging from years in the doldrums.

Back in 2011, that turnaround situation was housing, which had been declining for six years and saw many stocks completely fall apart—Lennar (LEN), a major homebuilder, fell as much as 95% from its highs (the ultimate bottom was in 2008) and even in 2011 was still sitting 82% off its summit. But it (and the sector as a whole) began to change character and business showed signs of picking up—we dove into LEN in the Model Portfolio and enjoyed a solid run during the next year or so.

Today, we’re seeing a similar situation play out with traditional energy (oil and gas) stocks—whether it’s explorers (down 89% from mid 2014 through October of last year) or service firms (down more than 90%), the entire group went through the wringer for many years due to debt worries, falling prices, imploding demand and the like.

But similar to the homebuilders years ago, that caused a change in the sector’s thinking—whereas oil companies were all about new basins and production growth a few years ago, today most have slashed expenses, are growing output at a manageable pace and, now that prices are rising, should spin off mountains of free cash flow. Throw in positive momentum on the chart (the sector has been outperforming the market for more than four months, the longest stretch in years) and we think there’s opportunity here, especially after the next pullback in the group.

If you want to keep it simple, there’s nothing wrong with just owning a broad ETF—we prefer the SPDR Oil & Gas Fund (XOP), which focuses on explorers and isn’t too concentrated (top holdings are 3% to 5% of the fund) in mega-cap names. Like most names in the group, the fund has come alive since November and is under extreme accumulation; a pullback of a few points would be tempting.

As for individual stocks, two of our favorite names are Diamondback Energy (FANG), which we wrote about in the last issue, and Pioneer Natural Resources (PXD)—two good-sized explorers that have two things in common that are attracting big investors.

The first is that both were on the offensive even during the prolonged industry bust and last year’s pandemic: Diamondback just completed the buyout of Guidon (from a private equity firm) and should soon finish its purchase of QEP Resources, which together will bring another 80,000 acres in the Midland basin. Pioneer, meanwhile, just completed its takeover of Parsley Energy, which many believed had some of the best acreage in the Permian basin when it was a standalone outfit.

The second factor is what we mentioned above—after years of downtimes, these (and others) explorers have shifted their focus. Instead of taking on tons of debt and expanding production at all costs, these operators have cut costs, boosted efficiencies and, now that prices and demand are back up, are beginning to throw off tons of cash. In 2021, Diamondback is aiming to keep production relatively flat, but believes it will produce $4 per share of free cash flow (after CapEx) even at $40 oil. At $60 oil, that figure should be north of $7.50 per share!

Pioneer is on a similar track—its breakeven oil price is in the high 20s, it cranked out $689 million of free cash flow last year and sees $2 billion of free cash flow this year (more than $9 per share) at $55 oil. (Current oil prices are in the mid 60s, though these firms usually collect a bit less than the market price.)

Both FANG and PXD have had huge runs since the November cyclical stock blastoff (FANG has been down just three of the past 17 weeks!) that look like the initial leg up of a new bull phase. (Interestingly, the initial homebuilder advance lasted 18 weeks before chopping around for a while.) We wouldn’t chase the energy names up here, but a pullback of a couple of weeks would be tempting.

Cabot Market Timing Indicators
From a top-down perspective, the market remains in good (albeit divergent) shape, with most indexes trending up. Under the surface, though, most growth stocks have broken their uptrends, which is likely to require time to fix.

Cabot Trend Lines: Bullish
Our Cabot Trend Lines have come down from the stratosphere during the past two weeks (especially the Nasdaq), but the market’s larger, longer-term trend remains firmly positive—last week, both the S&P 500 and Nasdaq closed 8% or so above their respective 35-week moving averages. There are definitely dents in the market’s armor, but the long-term trend isn’t one of them.

Cabot Tides: Bullish
The Cabot Tides are also still positive, though remain divergent—on the one hand you have the Nasdaq (right around its 50-day line), and on the other you have the four broader indexes (including the S&P 500, shown here), which have either hit or are close to hitting new all-time highs. You can read into all of that if you want, but as usual, we prefer to just go with the main message: Until proven otherwise, the intermediate-term trend remains up.

Cabot Real Money Index: Negative
Our Real Money Index hasn’t shown any giveback despite the recent market selloff, with the five-week sum perched near multi-year highs—a sign of enthusiasm or, at the very least, complacency. This is one of the measures we’ll be watching for signs that investors have pared back because of the recent volatility, but there’s no sign of that so far.

Charts courtesy of StockCharts.com

The next Cabot Growth Investor issue will be published on March 25, 2021.

Cabot Wealth Network
Publishing independent investment advice since 1970.

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Chairman & Chief Investment Strategist: Timothy Lutts
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