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Small-Cap Confidential
Undiscovered stocks that can make you rich

May 21, 2020

Enjoy the current strength but be aware of the environment we’re in, and why. Accept that we could see a significant retreat in the prices of many of our stocks in the near term, but that the fundamental reasons behind their current strength should persist despite a retreat, and drive them higher over the coming years.


If you’re wondering whether or not stocks are expensive right now the simple answer is yes, if discussing the types of stocks that we invest in (software, internet, MedTech).

Let’s zero in on software as an example and use the Enterprise Value to Forward Revenue (EV/Forward Revenue) multiple as our guide.

The five-year average multiple for software stocks is around 6.0. That multiple got as high as 7.5 in 2014, then returned to that level in mid-2018 just before software stocks tanked. They came back and reached a peak valuation multiple of 9.1 just before COVID-19 hit. The market crash took multiples down to around 6.8, and they’ve since soared to all-time highs at 9.5.

This chart from Morgan Stanley and Thomson Reuters shows the trend.

software stocks

High-growth software names, those growing revenue north of 20%, are even more expensive. Their EV/Forward Revenue multiple is averaging 14.5 right now.

As you know I’ve been bullish on cloud software/internet/digital transformation stocks since well before I took over Cabot Small-Cap Confidential in 2015. And I remain so today.

The big-picture trends that looked good for most of these stocks look even better now. COVID-19 has pushed organizations more toward digitization than any expensive consulting engagement ever could. If a business wants to survive in the future, they know they better have a digital strategy.

Further, the business model for many of these stocks, which is typically based on recurring subscriptions, is also phenomenal during these times. Customers that are reliant on software for the day to day and strategic operations of their companies will keep paying, and even upgrade to expand functionality. In many cases new implementations are facilitated by the combined pricing (subscription) and delivery (cloud) model.

I’m speaking in generalities here. If you look at individual companies there are certainly some nuances. For example, Q2 Holdings (QTWO) can’t just turn on a digital banking solution for XYZ client over the course of a couple weeks. But Fiverr (FVRR) can get a new customer signed up and selling graphic design work on its platform in a few days.

Back to valuation, what’s happening (I think) is that the average investor now “gets it.” And even if they don’t they can’t ignore the strength in these stocks. That’s leading to more demand for shares, pushing valuations higher. And at the same time the revenue outlook for many of these stocks is improving, or at least is not nearly as bad as previously expected, when the world was going into lockdown.

Here’s the catch: The Fed and Treasury are flooding the world with capital. Yes, there are a lot of people, businesses and organizations hurt by this pandemic, and I don’t mean to toss that aside. But there are also plenty that are literally swimming in liquidity. Want to postpone mortgage payments? Sure thing! How about a low-interest loan for your business? You’ve got it! No job? Here’s unemployment, plus an extra $2,400 a month. Think the financial system is going to crash? No way – we’re here to backstop anything and everything.

You get the point. Sure, we can quibble about details and equality but the cash bazooka has been firing and we’d be foolish not to realize it has helped drive valuations higher.

Will lofty revenue expectations be fulfilled and justify said valuations for software stocks? Only time will tell.

I think investing in these stocks right now is a lot like playing with fireworks.

It’s really fun and exciting and there’s a decent chance things will mostly work out, despite a few errant explosions here and there. I’m doing it because I enjoy it, it’s rewarding and there’s always a new mortar that will light up the sky in a magnificent way. How could you possibly stay away?

But you’d better wear your safety glasses and gloves and be prepared if things start blowing up all around you.

You get the picture. Enjoy the current strength but be aware of the environment we’re in, and why. Accept that we could see a significant retreat in the prices of many of our stocks in the near term, but that the fundamental reasons behind their current strength should persist despite a retreat, and drive them higher over the coming years.

Changes This Week

Avalara (AVLR) moves to BUY
Cardlytics (CDLX) moves to BUY
Q2 Holdings (QTWO) moves to BUY


AppFolio (APPF) is up 13% over the past week and 340% since we entered the position. The company, which sells cloud-based solutions for rental real estate and law firms, pulled 2020 guidance when it reported Q1 results because it isn’t yet sure how COVID-19 will affect the business, and whether the net impact will be good or bad. There’s a case to be made that the pandemic is pushing more property managers to use its software; however, if the economy tanks and real estate goes with it then that would be bad (to state the obvious). Keep holding. HOLD

Arena Pharmaceuticals (ARNA) jumped 11% over the past five sessions as management began holding virtual investor meetings with Barenberg (May 18) and RBC Capital (May 20). There’s no new news – it’s still a buy for patient investors. The timeline to significant potential catalysts is getting shorter. BUY.

Avalara (AVLR) is our automated sales tax software stock and represents a play on a major trend that’s not going away because of the pandemic. Shares jumped out to a new all-time high a couple weeks ago then consolidated for a week. The uptrend resumed this week. It’s an aggressive call but I’m moving the stock back to buy. I’ll reverse course if we see shares fall back below the previous high, which is around 97. BUY

Cardlytics (CDLX) was moved back to hold last week after several weeks on the buy list. The reason was the post-earnings report rally failed. It sure reversed course this week and is up 37% over the past five sessions. The catalyst? More evidence that the economy is starting to open up, which means more consumer spending and incentives for marketers to put offers in front of them. For a while I’ve been pondering whether or not CDLX represents something of a leveraged version of Mastercard (MA) and Visa (V). Based on the respective stocks’ performance lately I’d say it does.

The chart below shows CDLX in green and V in pink dots. Directionally, movements have been quite similar over the last six months. Below the main chart, I’ve plotted correlation using a 10-day timeframe. A correlation coefficient (CC) over 0 is positive, while a reading of 1 would be perfect correlation. CDLX and V have a CC of 0.91, which shows extremely high correlation. Changing to a 20-day period brings that down a little, to 0.78, which is still really high. As compared to MA, CDLX has a 10-day CC of 0.96 and a 20-day CC of 0.79.


The takeaway here is that if you’re compelled to buy either V or MA right now but would like a lot more upside potential and are willing to accept the increase in downside risk, CDLX should be considered. At the risk of appearing wishy-washy on the stock after moving to hold last week, I’m moving back to buy today. I suggest trying to buy on a dip/day when bad news is circulating. As before, I’ll let the stock tell us what to do. If we see this rally begin to fade I’ll likely move back to hold. BUY

Domo (DOMO) has come back with a vengeance and is now near its pre-pandemic induced market crash level. That’s not to say the business is known to be cranking. We’ll need an update from management to assess the level of activity, and that won’t come for another two weeks. While it may be tempting to look at DOMO as a “missed opportunity” I’d caution against that. This has been a troubled stock for a while and our strategy hasn’t been to look to buy into the weakness but rather to exercise patience and see if we can get a better price when we sell, or if time heals some of the wounds the business suffered in 2019. The stock is up a huge amount over the past two months, but in fairness there are plenty of other stocks with more attractive fundamentals that have soared just as much. HOLD HALF
Earnings Date: Thursday, June 4

Everbridge (EVBG) just released COVID-19 Shield, a contact tracing solution for businesses and healthcare and government organizations. The solution can track risk of infection based on location, proximity to hot zones and/or recent potential exposure through travel. Data can be collected while individuals are in certain locations and they can opt in to share location data from their mobile device. Everbridge is currently hosting a “Coronavirus: The Road to Recovery” virtual leadership summit, which includes discussions on the role products like this can play in helping people get back to work, safely. The stock has been on fire lately but dipped 7% this week. Keep holding. HOLD

Everquote (EVER) hasn’t moved much over the last five sessions, and there’s no new news to report other than the IPO of SelectQuote (SLQT), another provider of online insurance comparisons for life, auto, home and Medicare insurance plans. SLQT’s debut, slated for today, doesn’t necessarily change the competitive mix but it certainly gives investors another option to play the trend. I suspect we’ll be talking more about that company in the near future. HOLD

Fiverr (FVRR) has gone vertical lately and even though we bought at a horrible time, just before the pandemic sent the market plunging, we’re now up over 100% on our position. The company offers a marketplace to buy and sell digital services and has been pulling in new buyers and sellers with everyone working from home. I suspect the net benefit will endure but can’t justify moving the stock to buy after such a huge move and with the stock trading at 13.5 times forward revenue (on an enterprise value basis). While that’s not a premium to the 14.5 average multiple of other high-growth software stocks it still represents a huge increase in expectations as compared to six months ago. Shares are up 21% over the past five sessions alone. Enjoy the ride, just don’t expect it to continue at this pace for much longer. HOLD

Goosehead Insurance (GSHD) rallied up near previous highs after reporting several weeks ago and has held up well at that level. No news. HOLD THREE QUARTERS

Health Catalyst (HCAT) was moved to sell last week. No news. SOLD

Inspire (INSP) was rated buy up until its earnings report, after which I moved to hold because of the murky outlook for procedures to bounce back. The big picture remains compelling and shares have shrugged off any concerns over the past week. Keep holding. HOLD

Karyopharm Therapeutics (KPTI) is still trading around our entry point from a couple weeks ago. The oncology company is developing novel drugs for the treatment of cancer and other diseases. Karyopharm’s SINE compounds are the first oral XPO1 inhibitors to enter trials and have a novel mechanism of action. The lead drug is selinexor, which, in combination with dexamethasone, is approved for patients with heavily pretreated multiple myeloma. The drug’s brand name for this approved indication is XPOVIO. The company just began booking revenue from XPOVIO and that launch significantly de-risks the stock, and raises the potential for future approval of the same compound for other indications. It’s a buy with many potential catalysts to come this year. Management is set to present BOSTON clinical data at ASCO in late May. FDA decision on XPOVIO as a second line treatment for multiple myeloma expected later in 2020. EMA decision on selinexor for multiple myeloma expected in 2020. FDA Priority Review decision on selinexor for DLBCL is expected on June 23. Phase 3 SEAL study results for liposarcoma are expected in 2020. XPORT-GBM-029 (GBM) is expected to begin later this year. Initial results from COVID-19 clinical trials are also expected in 2020. BUY

Ping Identity (PING) was recently sold to book a quick 37% profit in one month. We don’t normally move out of a stock with a profit that quickly – especially when the big-picture trend looks good despite short-term disruptions – but given the current environment I decided taking some money off the table while it was sitting there made sense. The stock is trading within 7% of our exit point. Keeping an eye on Ping for the future, possibly. SOLD

Q2 Holdings (QTWO) worked its way back to within 15% of its all-time high, even with a secondary offering. Under the circumstances that’s impressive. Also notable is that the previous high of 93.90 from February 20 was just pennies away from the August 18 high. That creates a zone of formidable resistance, but if/when QTWO punches through the ensuing run could be something to behold. I like how the stock has behaved after the offering (priced at 76.5, stock currently near 80) and that it hasn’t run wild like so many other software stocks. Enterprise value-based valuation, at 11.6 times forward earnings, is near the high end of the stock’s range but not at all-time highs. Moving back to buy but also will watch closely and move back to hold if things go south. BUY

Repligen (RGEN) has blown through the previous high and run wild to the upside, bringing our total gain to 159%. The challenge here is that valuation has moved to astronomical levels. The prior EV/forward revenue multiple peaked near 18 but has now soared to 22. That implies a lot of revenue growth that’s not yet factored into analyst estimates. I don’t doubt there could be an uptick in growth, but I’m not going to advise buying into it at this stage. Great stock to keep holding. HOLD

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