November 18, 2021

The market is in the midst of a short-term consolidation, which usually dishes out some pain and offers tedious action, which is what we’re seeing so far—earlier this week, we cut bait with one stock and have tight leashes on a couple of others. Further near-term shenanigans are possible, even likely, so we’re taking things on a stock-by-stock basis, but we’re also not opposed to putting money to work in resilient leaders—which we’re doing tonight, starting a half-sized position in a name we’ve long thought has the characteristics of a future winner.

Market Overview & Model Portfolio Update

Shaking the Trees
We’ve had great weather this fall, mostly dry and mild and some solid foliage per usual. But, as has been the case all year, when the weather turns ugly, it’s rarely been a light drizzle; just a couple weeks back we had a nasty Nor’easter that took down some trees and scattered everyone’s yards with bunches of branches. Nature’s pruning, they call it—taking down the weak trees and limbs and leaving the strong still standing.

That’s basically what we see happening in the current market environment: A correction and consolidation that’s likely to shake the leadership trees, cracking some weaker or later-stage stocks, but leaving most of the leadership intact. It’s not a hurricane or tornado, but it puts enough of a dent in enough stocks to raise the discomfort level among investors—at which point the next rally phase will begin.

We see this scenario playing out via some top-down measures as well as with individual stocks. In our own Model Portfolio, we were kicked out of one stock earlier this week and have a couple others on tight-ish leashes, and even some super-strong performers have begun to hack around as profit takers appear.

From a top-down perspective, one telling stat comes from the number of stocks hitting new highs. When the Nasdaq hit a near-term peak on November 5, a whopping 445 stocks reached virgin turf, while this week’s return to that same level saw a max of 235. That’s far from a red flag, but it confirms what most investors are seeing with their accounts—it’s been trickier the past couple of weeks, and we think it could remain so for a bit longer.

Still, until something really changes, none of the above alters the big-picture outlook: The market’s major trends are up and most leading stocks are in fine shape, so we expect this period of rough sledding to (a) do some more damage and possibly knock us out of another stock, but (b) lead to some solid entry points among many leaders that are simply digesting huge October gains.

What To Do Now
Thus, we’re following the same playbook as usual—holding our strong, resilient names while giving them some room to maneuver, while throwing up some mental stops on those exhibiting flashing iffy action and eyeing to start positions in some new leaders. In the Model Portfolio, we sold CrowdStrike (CRWD) earlier this week after a bad breakdown, but tonight, we’ll add a half-sized stake in ZoomInfo (ZI), which has all the makings of a winner. Our cash position will now be around 21%.

Model Portfolio Update
It’s still a bull market, but there’s no doubt we’re seeing some hesitation following the three-week moonshot off the early-October lows—there have been some earnings-related hits, some news-driven dips and, earlier this week, one of our stocks (CRWD) cracked after being repeatedly rejected by resistance.

Obviously, we’re on the lookout for further abnormal action and, in general, we do think the next couple of weeks will likely be more challenging than the prior three weeks, partially to get sentiment back down. But so far, the market’s hesitation looks very normal following the prior run, so we’re aiming to remain mostly bullish.

Thus, we’re playing it both ways for the time being—if something cracks, we won’t hesitate to sell, but we’re also keeping our eyes open for new buys. Tonight, we’re starting a half-sized stake (5% position) in ZoomInfo, leaving us with 21% on the sideline.

Current Recommendations

Ambarella (AMBA)—AMBA has been caught up in the market’s chop during the past couple of weeks, with a couple of bad days (including one on big volume) when growth and chip stocks have been weak. As always, we’re open to anything, especially with earnings coming up soon (November 30), but at this point the rest period looks normal, with shares still holding north of their 25-day line following the prior big advance. The firm has been all quiet on the news front, but all indications are that its computer vision chips continue to notch design wins, with more and more clients having gone live with products featuring Ambarella’s offerings. With the 50-day line down in the 170 area, further wobbles are possible ahead of earnings, but until proven otherwise, we think the stock’s path of least resistance is up, with the huge September blastoff likely to lead to good things. If earnings weren’t out in less than two weeks, we’d probably be filling out our position, but given earnings (and the recent chop in growth stocks), we’ll stand pat with what we have. If you don’t own any, we’re OK buying a half-sized stake during this consolidation. BUY A HALF

Asana (ASAN)—ASAN has also taken a couple of lumps during the past two weeks, including an ugly-looking reversal yesterday. And as opposed to Ambarella, this weakness is coming after a bit of stalling out—the stock has been stymied by the 140 area multiple times during the past month, and of course this comes after a massive run before that. Because of all that, we do have our antennae up; taking partial profits is an option given the action and the fact that earnings are due relatively soon (December 2). Right now, though, we’re more sanguine: ASAN has certainly earned the right to fidget around after its rally, and shares remain north of their 25-day line despite the recent ups and downs. And let’s not forget that, fundamentally, all signs point to Asana being the leader in the work management software space, which looks like the next must-have app in the cloud software area. We’d like to see shares settle down a bit and/or decisively push to new highs, but right here, most of the evidence remains in fine shape, so we’ll stay on Buy. BUY

Cloudflare (NET)—Like many stocks, we’re 50-50 on the near-term outlook for NET, with shares moving up in recent days on next-to-no volume; combined with the tricky environment, some wobbles are possible. But overall it’s hard to throw darts at the action. The stock actually tagged new highs today and has risen six weeks in a row (could be seven this week) and shown little ability to pull back. It’s clear that big investors are discounting years of 50%-plus growth as hundreds more big companies sign up for the firm’s content delivery and security offerings. Indeed, clients paying Cloudflare at least $100k per year have risen north of 70% three straight quarters, while overall same-customer revenue growth came in at 24% in Q3, yet the firm still has just a small share of its potential market. If the market gets rough and/or NET starts to keel over, we could take partial profits, but our thoughts from the past couple of weeks haven’t changed—NET is one of the strongest growth stocks in the market and showed abnormal power after the October low, so we’ll stick with our Buy rating, though we prefer new buyers aim to enter on weakness. BUY

CrowdStrike (CRWD)—Well, sometimes you’re the windshield, and sometimes you’re the fly, and in the case of CRWD, our timing really couldn’t have been less fortunate—the stock did try to get moving to new highs a couple of times after our entry, but each instance brought in some stalling action. And then, Monday morning, a second analyst opined that growth for the firm’s core endpoint market was set to slow, and competitive pressures (including some new-age outfits that are pricing products well below CrowdStrike) are picking up. And that was enough to crack the stock; the 290 to 300 area looks like an intermediate-term top, with the huge-volume plunge triggering one of our sell rules. The company does have earnings due on December 1, so it’s possible the top brass could clear some things up, but at day’s end, the stock’s overall picture (not just one or two days) has worsened, so we cut our loss (around 12% on the purchase) on Monday’s special bulletin and are moving on to greener pastures. SOLD

Devon Energy (DVN)—Oil prices have been easing a bit of late, dipping to $78 per barrel this week, while natural gas prices (less important for Devon but still a factor) are back in the $4.80 range. Despite that, DVN has not only refused to give back any of its massive late-September surge (31 to 40 in two-plus weeks), but has continued to crawl higher, holding north of its 25-day line. Some of that resilience might be from dividend hunters; Devon will pay an 84-cent-per-share dividend on December 30 to those who own the stock at the close of December 9. (After that payment, we’ll have collected $1.67 in dividends from the stock since our initial buy, or nearly 6% of our cost basis. Doesn’t hurt.) But beyond that, we think investor perception is finally improving given the bullish free cash flow projections even at much lower prices—if oil and gas average $60 and $4 (respectively) next year, Devon is still likely to pay out something like $2.60 per share in dividends, buy back 3% to 4% of outstanding shares and pay off another few hundred million of debt … and of course those figures would mushroom if prices stay up here. We think DVN is a solid buy here or on any weakness. BUY

Dexcom (DXCM)—DXCM isn’t going to be a fastball type of name, but that’s part of the attraction, likely to offer some liquid leader-ish action if all goes well. Nothing has changed here from a fundamental point of view, though something we read this week was interesting: According to one article, up to 40% of all Covid deaths in the U.S. were people that also had diabetes; that’s not likely to dramatically boost demand, but it’s another general wind at the back for the continuous glucose monitor industry. As for the stock, it’s been nosing higher of late—nothing dramatic but it remains in good shape. We’ll stay on Buy a Half, and if shares can push higher (and the market environment remains OK), we’ll look to fill out our position. BUY A HALF

Dynatrace (DT)—DT is a frustrating situation—given that the stock only just emerged from a huge rest period in June and the company’s rapid, reliable growth story (as well as the overall bull market), we’re optimistic shares will be nicely higher in the months ahead. That said, there’s no question the stock is acting funky right now, and one of our portfolio management tools (never let a 20% gain turn into a loss) is at play here; a drop of another couple of points would wipe out our profit. (We also think that news of the CEO’s retirement, while not a complete nothingburger, isn’t likely to impact results going forward.) As always, we’ll follow the system here—a dip below today’s lows would probably have us cutting bait, but we’ll play it by the book and see what comes. If you own some, hang on, but stay in touch. HOLD

Floor & Décor (FND)—At the end of the day, it’s investor perception of a company’s future that drives the stock, usually based on results from the firm or the industry. But other things can help as well—on Tuesday, it was revealed that Berkshire Hathaway started a modest position (817,000 shares) in FND, which obviously puts us in good company in thinking that Décor’s long-term growth story is top notch. As for the stock, it remains OK but wobbly—the post-earnings selloff was a shot across the bow, but so far FND has held its 50-day line, is miles above its prior lows near 114 in early October and is just 8% off its peak. Given the wild action (down, then back up on the Berkshire news), plus the choppy market, we think it’s prudent to remain on Hold, but the longer the stock can hang in here despite some macro fears (rising rates, supply chain, inflation eating into margins), the greater the chance the post-earnings correction will remain contained. HOLD

ProShares Ultra S&P 500 Fund (SSO)—When individual stocks get a bit dicey, the major indexes are usually much more calm, and that’s proven true again so far, with SSO pulling back just a couple of days before meandering back to its highs this week. (That’s also a reason we like to have a leveraged long fund linked to the S&P 500, giving the portfolio a bit of diversity away from Nasdaq-type names.) As we wrote on page 1, we still think the next week or two will be trickier than the last few weeks, with tedious action probably needed to raise the discomfort level among investors; thus, we half-expect another selloff or two or some rotational activity to shake the tree. But having already taken partial profits a couple of times, we’re content to give SSO some rope. If you’re looking to buy (or buy more), we suggest looking for dips into the upper 130s. BUY

ZoomInfo (ZI)—We’ve been watching and writing about ZoomInfo for many months—it’s always had the story (leading go-to-market intelligence platform that does a ton of the leg work for salespeople, saving them huge amounts of time) and numbers (consistent 50% to 60% sales growth, surging earnings and cash flow) of a big winner. And now, after a long setup, the chart is in gear, too, with ZI lifting past resistance near 70 on many days of solid volume (and it’s remained calm and collected in recent days, too). It also doesn’t hurt that sponsorship is picking up steam (473 funds owned shares at the end of September, up from 334 three months before), including some sharp operators. We’ll start with a half-sized position here and, per usual, look to fill out the position if the stock gets off to a good start. BUY A HALF

Watch List

• Affirm Holdings (AFRM 139): AFRM has been super wild pre- and post-earnings—we think it’s still OK, and the growth story is playing out as expected, but we need to see it steady for a bit before jumping in.
• Arista Networks (ANET 133): ANET had been doing OK, but it’s completely changed character since earnings, with Wall Street now expecting accelerating growth next year for the firm’s advanced switches and routing software. See more below.
• Coinbase (COIN 324): COIN pulled in a bit after earnings and, this week, took a small hit as crypto assets faded. But we remain intrigued—it’s a high-risk, high-reward name that has a bright future.
• Snowflake (SNOW 397): SNOW is working on its seventh up week in a row as earnings (due December 1) approach. A modest pullback after earnings could be interesting.

Other Stocks of Interest & Lots of Big IPO Launching Pads

Arista Networks (ANET 133)—Arista Networks was a big winner a few years ago, as its faster/better network switches and software took a ton of share from Cisco. This industry moves in cycles, though; after that wave followed a slowdown, but now the company is on the verge of boom times again—thanks especially to the huge cloud service providers like Facebook and Microsoft (both giant Arista customers) that are building out capacity (including 400G and faster speeds) like mad. In fact, demand and orders are so strong that, in an industry where demand trends can usually be forecast just a quarter or two into the future, Arista is ordering a ton of supplies for over a year from now! There’s more to it just the “cloud titans” as the company’s top brass puts it; enterprise-related sales are strong even outside of the traditionally-strong financial industry. (Arista’s CEO: “I think it’s fair to say Arista has arrived in the enterprise.”) Importantly, too, the company was early on addressing supply-chain issues—they still aren’t selling as much as they could because of supply issues, but have more products on hand than most peers, allowing the company to gain share even more rapidly than before. Indeed, in Q3, sales lifted 24% and earnings were up 22% (costs were up a bit, no surprise), but Wall Street loved the long-term orders Arista talked about, along with its forecast for accelerating revenue growth (30%) in 2022. Analysts see earnings up mid-20% next year, but money managers seem to think that’s too conservative—in fact, after the Q3 report, ANET mushroomed higher in an out-of-character (in a good way) move, and it’s just sat there since despite all the ups and downs in the market and growth stocks (a sign few big investors want out). To be fair, the huge spending cycle won’t last forever, and Arista is reliant on a couple of big customers, but there’s little doubt the next few quarters should be terrific for the company.

Dutch Bros. (BROS 54)—If you’ve been reading us for a while, you know we love cookie-cutter stories—retail firms with a proven product or service that can grow their business many-fold simply by opening up more locations. Such a business model remains powerful, producing rapid and reliable growth, which is the catnip that gets institutional investors piling in. Dutch Bros. has been around for 30 years and focuses on hand-crafted, high-quality cold and hot (82% of drinks served cold) beverages; espresso-based drinks are the core, but there’s also milkshakes, coffees, teas, sodas and an energy drink (its most popular offering). There’s more to it than that: Dutch Bros. puts a big emphasis on culture, with runners meeting drivers before they hit the drive-through window to personalize orders or explain the menu, then take orders via tablets. And the firm reportedly hasn’t expanded as quickly as it could have in the past, opening only company-operated stores since 2017 and promoting from within to keep the fun, hard-working culture intact. Still, that’s not to say that growth hasn’t been massive—total locations were 503 as of September (the new prototypes are around 900 square feet), up from 441 at year-end 2020 and 370 at year-end 2019. Store economics are solid (full payback within two to three years), and the firm is opening new locations like mad, with 33 new ones in Q3 and at least 30 more coming in Q4. Long term, Dutch thinks it can have 4,000 locations in all! Throw in solid same-store sales growth (7% in Q3) and the numbers are excellent—Q3 saw revenues up 50% and earnings of seven cents per share, up 150%, with a lot more of that expected in the years ahead. The valuation is rich ($9 billion market cap!) and the stock is new, but we’re keeping an eye on BROS—this is the type of new, easy-to-understand growth story that could have a good run as the stock becomes better known.

Livent Corp. (LTHM 30)—We don’t think we’ve ever written the phrase “growth commodity,” but that appears to be what you get with firms that specialize in lithium production—it’s a commodity, but one that is a vital input into batteries for electric vehicles, which is obviously an industry that’s set to get a lot bigger going forward. In fact, the impact of EV demand on lithium is almost hard to believe; EV penetration of the auto market should grow nearly eight-fold from 2020 to 2030, which should push demand for some types of lithium (like lithium hydroxide) up 10-fold during that time. (Demand for battery storage, e-bikes and mobile devices also is a plus for the industry.) All of that means Livent Corp. will get a lot bigger in the years ahead: The firm has manufacturing facilities all over the globe, and as automakers look for secure costs (not paying gyrating spot market prices) and supplies, many are likely to turn here. (Livent’s CEO: “We have already agreed to new or expanded lithium hydroxide commitments with several leading OEMs and battery producers [with] prices that are more reflective of current market conditions.”) Indeed, the firm plans to have most of its volumes contracted out on take-or-pay deals, though it’ll keep some lithium on hand for exposure to the spot market. There are certainly execution risks here, with a ton of capacity expansions on track and its own supply-chain issues to address (like most everyone else), but if management executes, who knows how big earnings could get; analysts see sales and earnings up 26% and 187% (respectively) next year with a ton of upside after that if all goes well. The stock is a hot potato, but it’s been very strong in recent weeks and the latest pullback looks normal.

Lots of Big IPO Launching Pads
We have a love/hate relationship with IPOs: On one hand, new IPOs that have great stories and growth numbers will often morph into new market leadership, offering opportunities to get in early on in a sustained run. On the other hand, many never do much of anything, and most take a long time to “grow up” and gain the institutional sponsorship needed for a sustained run. Said another way, IPOs are high risk, high reward—when they hit, it can be a home run, but most IPO buys end up taking a few bucks from your brokerage account and giving you some grey hairs in the process.

However, our studies do show a couple of times when the odds of success are higher when taking a position in recent new issues.

The first is something we wrote about this summer: If you have a liquid stock with great growth numbers that’s faded or gone dead for a few months, two to four straight weeks of huge-volume buying (even if it’s off the lows) will often mark a bottom—and kick off a big advance. It sounds a bit too easy, and again, there are times when it failed. But huge market movers like Netflix and Shopify began uptrends with this pattern, and this year, Snowflake (SNOW) is following suit, rallying nicely back toward its post-IPO highs after the May/June volume cluster. (Note that SNOW has earnings out December 1, which will probably tell the intermediate-term tale from here.)

The second pattern that increases the success rate is all about time. Many IPOs will have nice initial runs soon after coming public, but in the vast majority of cases, those initial pops will die—we call it the post-IPO droop, which almost always comes and wipes away any gains before that. However, if the stock then goes on to etch a multi-month base (giving it time to come under strong hands) and decisively breaks out (especially after earnings), that is another higher-odds play that has been seen from a ton of big winners over time.

Facebook (FB) was a classic example—shares came public (and were super overhyped) in mid-2012. A year later, the July earnings report caused a whopping big gap up that took it above nearly all of its resistance, kicking off a multi-year run. PayPal (PYPL) was another example, with its April 2017 earnings gap effectively kicking off a couple years of great performance (though it’s encountered some longer-term chart damage of late).

The good news is that the increase in IPOs starting a year or two ago have resulting in a growing number of these huge, long-term launching pads, similar to Snowflake—and we’re starting to see some break loose.

One is Unity Software (U), which had a massive correction in the middle of this year but has come all the way back, exploding to new highs following earnings last week. The company boasts a huge valuation ($55 billion vs ~$1 billion in revenue this year) due to its huge story: It has the best-in-class platform for content creators, whether that means online games, 3D modeling of buildings, industrial part designers or dozens of other applications. And its recent buyout of Weta Digital adds movie studio-quality visual effects tools to the platform, too. Sales should grow at 30%-plus rates for years to come.

Another is Coinbase (COIN), which is on our watch list and has an easy-to-understand story: It’s likely to be the Schwab or NYSE of the crypto world, which should be a bullish thing long term (though lead to plenty of wiggles at any given time). COIN is near the highs of its big IPO base, and the recent move of six weeks up in a row bodes well.

Then there’s Airbnb (ABNB), which we wrote about in the last issue—it’s a mix of an industry story (travel could finally be set for boom times next year if the virus’ waves shrink), and of course, there’s a solid overall growth story here, too. The Q3 report was well received (cash flow was much higher than the comparable 2019, pre-pandemic quarter), with ABNB lifting from a tight area and approaching its springtime highs.

There’s also DoorDash (DASH), the new-age delivery outfit that’s looking to deliver anything you want to your door, be it groceries, takeout, prescriptions and even booze. DASH etched a nice-looking eight-week rest after its huge IPO structure and powered ahead after its Q3 report.

To be clear, none of these are sure things—we remember buying into Uber (UBER) last year after its IPO base breakout, only to see the stock peter out afterwards. But our larger point is that at least a couple of them are likely to be new leaders; if all goes well, we could pull the trigger on one or more in the weeks ahead.

Cabot Market Timing Indicators

It’s still a bull market, as our market timing indicators tell us—the action of the major indexes and most leading stocks look fine. That said, there’s little doubt we’re in the midst of a near-term correction and consolidation, so we’re taking things on a stock-by-stock basis.

Cabot Trend Lines: Bullish
Our Cabot Trend Lines have stretched nicely higher of late as the big-cap indexes lifted into new high ground. At the end of the last week, both the S&P 500 (by about 8%) and Nasdaq (by nearly 10%) stood well above their respective 35-week moving averages; near term, such large percentages could lead to some retrenchment, but there’s no question the market’s big-picture trend remains up.

Cabot Tides: Bullish
Our Cabot Tides are still solidly positive, with all five of the indexes we track (including the Nasdaq Composite; daily chart shown here) remaining solidly above their lower moving averages. Similar to the Trend Lines, there is some daylight on the chart, so further dips aren’t out of the question. But with both the intermediate- and longer-term trends pointed up, you should remain mostly bullish.

Cabot Real Money Index: Negative
Sentiment is still a bugaboo for the market—our Real Money Index is now at its highest level since mid-April (when it was coming off the February/March frenzy) as investors have poured money back into equity funds and ETFs during the past five weeks. Sentiment is always secondary, but it’s another reason to be on the lookout for further market shenanigans.

Charts courtesy of StockCharts.com

The next Cabot Growth Investor issue will be published on December 2, 2021.