As we march toward the end of Q4 and the beginning of 2018, most investors are, rightly, turning their attention to what’s likely to happen in the year ahead. Returns this year have been nothing short of outstanding. While we’ve had bouts of volatility, especially in individual stocks, the chart below shows the astounding breadth of strength across almost all sectors.
The same is true of global stock markets. Most regions worked quite well. Take a look at the Vanguard Total World Stock ETF (VT), which is up 22% year-to-date, and never broke below its 50-day line!
It’s only rational to think that this ride can’t continue without at least some serious turbulence along the way. That said, with economic growth and earnings growth looking good, it seems premature to abandon the stock market now. Let’s agree to just tread a bit more carefully as we move through the beginning of 2018.
On the subject of small caps, I think we’re in for another period of sideways action, similar to that which followed the election in late 2016. It only makes sense that the small-cap indices should regroup after a furious rally on the prospects of tax reform. Provided a bill is signed into law that doesn’t disappoint, the S&P 600 index should be able to hold up just fine, but could easily dip back to 875, where it should be able to find support.
We haven’t had a lot of stock-specific news in recent weeks, so I’ve used today’s Weekly Update to summarize the investment thesis, story and major initiatives for each of our companies. This should help refresh your memory on what each of our stocks does, what their growth rates are, and why you should continue to buy (or hold) them as we head into the New Year.
Updates
AppFolio (APPF) specializes in property management software (over 90%) of revenue, and has a small business focused on the legal market. Revenue grew by 41% in 2016, and should be up by around 34% in 2017, a year in which AppFolio’s earnings should jump into the black (around $0.41) for the first time. The trend in forward earnings revisions is positive given that AppFolio’s Q3 showed its property management is gaining market share and more efficient customer acquisition costs (i.e., bigger customers with more units under management) is driving margin expansion and EPS growth. Analysts are now looking for revenue growth of 27% in 2018, and EPS of $0.54 (up from $0.43 two months ago). The stock has pulled back over the last couple of months, opening the door for investors to pick up shares of a quality company at what appears to be an attractive price. Keeping at Buy. BUY.
Apptio (APTI) is our newest stock and basically created the Technology Business Management (TBM) software category. The easiest way to describe TBM is as an IT department’s software equivalent to finance’s ERP platform, human resources’ HCM platform and sales’ CRM platform. The company should grow revenue by 15% to 16% in 2017 and 2018, and will lose money in both (around -$0.27 in 2017 and -$0.06 in 2018). The story is not as rapid as many out there in the software-as-a-service (SaaS) world, but it’s incredibly compelling. The cost of Apptio’s average annual software contract is around $400,000. That’s big bucks, and the fact that huge companies (revenues north of $20 billion) are paying that much should be solid evidence that Apptio is onto something. To expand its market, the company is introducing easy-to use solutions targeting specific users in smaller organizations. The idea here is that these companies can be up and running with a $100,000 software solution that includes annual maintenance. Early evidence shows these solutions are selling well. And another huge potential opportunity is the U.S. federal government, which spends over $90 million a year on IT. It’s not a well-known story, but don’t let that fool you—there’s a lot of potential here. Keeping at Buy. BUY.
Asure Software (ASUR) specializes in Human Capital Management (HCM) and Workforce Management software solutions. It can supply companies with the hardware and software to manage large, global workforces. And it’s growing through modest organic growth as well as a rollup acquisition strategy whereby it’s purchasing smaller service bureaus that use its software. It’s also made some more significant acquisitions to expand its software platform, and these (mainly iSystems, based in Burlington, VT) greatly expanded the number of potential target service bureaus. The stock has roared back since the last quarterly report showed growth was intact and that the departure of the prior CFO (who has been replaced) wasn’t a bearish sign (at least, no evidence of that has surfaced so far). Asure is a relatively small player in the huge HCM market and isn’t even mentioned in the media when others, like Paycom (PAYC), Ultimate Software (ULTI) and Cornerstone OnDemand (CSOD), are discussed. With time and a little luck, it will enter the discussion. Given that its current market cap is just $175 million, if it does, we’ll be up quite handsomely! This is a relatively early-stage business and the management team is proving itself to be capable, though the challenges will get bigger and bigger if Asure is to break out of the micro-cap category and challenge the bigger players. Revenue should be up around 55% this year, then 28% next year as less growth comes through acquisitions. Earnings growth should be around 117% (to $0.52) this year, then grow another 40% (to $0.73) in 2018. The stock is still trying to break above resistance at the 15 level. BUY.
AxoGen (AXGN) was my July 2017 recommendation and the stock has been one of our most impressive performers this year (it’s up around 65% since I recommended it). The company specializes in surgical solutions for peripheral nerve injuries, and its implants are considered regenerative medical products because their complex structure supports nerve cell regeneration in the patient’s body. AxoGen is relatively early in its life cycle and is introducing new products that expand its addressable market (including breast reconstruction and total joint replacement). As surgeons are relatively slow to adopt new technologies, and AxoGen management said most customers are early-adopters, the growth potential appears huge. Revenue should be up around 44% this year and another 40% in 2018. Earnings are trending toward breakeven, but are likely to be around -$0.06 to -$0.08 this year and next. The company completed a secondary stock offering in mid-November that caused the stock to dip, but it came roaring back after its second annual analyst and investor day revealed its updated product development roadmap. It’s a bit of a high flyer, but I’m keeping at Buy until the trend breaks. BUY.
BioTelemetry (BEAT) is best known for its remote cardiac monitoring business, but it also has divisions that provide services for drug and medical device trials, manufacturing medical devices, and, most recently, remote blood glucose monitoring (BCM) services. It recently bought out its largest competitor in the cardiac monitoring space, Switzerland-based LifeWatch. That acquisition has muddied the waters a bit as there is some product overlap and, as with all major acquisitions, management has to balance the disruptive realities with the need to get the merger work done, weed out redundencies and build out a healthy corporate culture. We’re on the outside looking in, and most of the windows have black-out shades. So we’ll have to have faith in management and go along with things until the team is ready to reveal what’s going on. That murky operating environment is one of the reasons that shares of the company began falling in September. The other is the risk of competitive threats, mainly from upstart iRhythm (IRTC), which is a much smaller, but much more rapidly growing (organic growth) company with a monitoring device in the patch form factor. BioTelemetry has a patch coming to market too, but it was behind the curve in this department (from what I understand). Notably, BioTelemetry has recently revealed collaborations with Onduo (owned by Sanofi and Alphabet), to supply remote blood glucose systems and resulting data for Onduo’s diabetes management program, and Apple, to provide cardiac monitoring services for the Apple Heart Study, which just launched. It’s too early to know, but on the surface, these appear to be material events that can contribute significantly to revenue over the long term. Those revelations have helped restore confidence in the stock, but it’s still a long way from its 52-week high (35% to be exact). I think there is considerable upside, and am keeping at Buy. Shares are just now moving above their 50-day line and another 3.5% to the upside will put them at their 200-day line. Breaks above these technical levels should attract buyers. BUY.
Datawatch (DWCH) was my October pick and it’s our smallest stock by market cap. It’s also our worst performer, which is incredibly annoying since fundamentally, I think the company is doing OK. It develops and sells self-service data preparation and visual data discovery software. “Self-service” means users are creating and analyzing the data without help from IT departments. The software pulls almost any type of data, including structured, unstructured and semi-structured data, from a wide variety of sources and formats, including ERP systems, reports, PDF files, excel files, websites, point-of-sale terminals and real-time streaming data terminals. The company has been around since 1986 and went public in 1999, and I believe it’s trying to get organized so it can sell itself (I’m speculating a bit, but not wildly). Datawatch has a lot of loyal customers, especially in the financial services market, and its software integrates well with other analytics platforms. It’s working on two big initiatives: expanding its addressable market by introducing new solutions and transitioning from selling perpetual licenses to subscription licenses (gradually). The first is great, and hopefully will help Datawatch expand into the enterprise market. The second is a messier process, but Datawatch is now roughly two years into the process and should start to deliver cleaner numbers. Consensus estimates are always a little iffy for these little companies, but currently they suggest Datawatch will grow revenue by 12% this year then 24% in 2018, and deliver EPS of $0.07 this year and $0.16 next. There’s a lot of upside potential here, the management team just has to deliver on its game plan. Shares fell below the 200-day line a couple of weeks ago and found some support in the 8.5 -to-9 range. I’m keeping at Hold until we see a more constructive trend. I’m likely to move back to Buy if the stock gets back above the 9.75-to-10 zone and holds there after multiple tests. HOLD.
Everbridge (EVBG) was recommended in December 2016. The company was founded in 2002, shortly after the 9/11 attacks, to provide fast, automated communications services during life-threatening situations and mission-critical business events. The software platform powers apps that help organizations and government entities keep people safe and business running. Fortunately for Everbridge, and unfortunately for society, business is good. Revenue should be up around 35% this year and 26% next, although given the trajectory of larger deals, an expanding product lineup and a recent capital raise (convertible debt) to fund overseas expansion (I suspect through acquisition, and threw out potential targets Enera and F24 AG last week), that 2018 growth estimate could prove to be low. Everbridge has a way to go before it will be profitable; EPS will likely be around -$0.24 this year and -$0.21 in 2018. The growth story is compelling given the size and durability of its end markets, and given that Everbridge still has a market cap of just $750 million, there’s likely a lot of upside here. We’re up around 75%, and I have the stock listed at Buy because I think the growth story has legs and shares are in high demand. BUY.
LogMeIn (LOGM) is not really a small cap anymore given its market cap is over $6 billion. But I’ve been a fan of this company since I started following it in 2014, and when shares cratered in the beginning of 2016, the deal was too good to pass on. We didn’t pick the bottom (we got in at 58, but it fell to 42 before the pain was over), but we got in at a good enough price to give us a double. The company specializes in collaboration and remote access software. Think of things like logging into a computer or server remotely, talking to customer service for an online retailer through a chat box, or participating in a company meeting through an on online interface, like GoToMeeting, which LogMeIn now owns. Revenue will be up around 200% this year, but that’s an outlier given that it’s mostly because it purchased the GoTo business. Moving forward, organic growth should be in the mid-teens unless the company is able to do much better on cross-selling and new product introductions than expected. And on that note, I think it will do better. That’s the pattern here. It appears to be a very well-run company and I wouldn’t be remotely surprised if it is several times bigger in a decade. We’re holding on because of that potential. HOLD HALF.
Materialise (MTLS) is our 3D printing specialist and was recommended in November. The Belgium-based company specializes in 3D printing software, 3D printed medical devices and on-demand 3D printing services for the industrial, medical and consumer industries. It does not manufacture 3D printers, other than one large-format proprietary model used purely for in-house printing. Given its location, it has the most amount of European exposure in our portfolio (60% of revenue). It’s like the Switzerland of the 3D printing industry; it tries to be friends with everybody (its software is open source) and excels at collaborations and partnerships. Many of these collaborations aren’t seen by us here in the U.S., but I think they well be, in time. If you want custom eye glasses or custom ski boots, you’ll have to go to Europe for now. But, if you need a skull implant, you can get that domestically (let’s hope you don’t!). A lot of 3D printers come with Materialise software, and given that players like 3D Systems and Stratasys aren’t doing so hot but Hewlett-Packard is rumored to be coming on strong, there’s likely some give and take going on in Materialise’s software sales. The idea is that its deals with Seimens and HP will become meaningful, but it’s in the early days, and especially with HP’s 3D printer, there just aren’t that many units out there (yet). I’ve watched the company for some time and went with it because I think the long-term potential of the industry is huge and I like the diversified revenue base. The company isn’t widely followed, but if we can trust the consensus figures, revenue growth should accelerate from 23% this year to 36% in 2018, while EPS should go from -$0.06 to $0.21. Shares have just completed a rather ugly-looking retreat to their 200-day line but haven’t fallen out of bed. This looks to me like the stock can pull out of this dip and I’m keeping at Buy. BUY.
Primo Water (PRMW) is our bottled water company and only real consumer-oriented stock. It’s not big in the northeast (at least not here in Rhode Island), or maybe I don’t see it because I don’t go to Wal-Mart all that often (I last saw Primo’s display at a Hannafords in Williston, VT). If you didn’t already know, Primo sells those big jugs of drinking water, as well as the water dispensers. They’re essentially the same as at an office, but oriented to home use. It also has a refill business, which means consumers take their empty jug to a big machine, stick it under a spout, put in cash or a card, and get a water jug filled with purified water. The company is about a year into a major acquisition after buying up Glacier, which was mostly focused on refill. It’s also been dealing with the slowdown in retail, which means customers like Office Depot are shrinking locations quickly. Fortunately, Primo has a great business with Wal-mart, and each of those locations does multiples of the business that one Office Depot location did, so the business is still growing. That said, the Glacier acquisition required taking on a lot of debt, and issuing stock, which has been dripping out into the market (it should be over within a couple of months) likely has been holding the share price back a little. On the positive side, management is very scientific about its market analysis and has been testing a price increase, as well as looking at expanding into the grocery chain market. Both could be significant. Shares have been a little wild but have done much better after the last quarterly report. I’m keeping at Buy since I think there’s still upside here and that, ultimately, Primo will sell itself. BUY.
Q2 Holdings (QTWO) provides software to banks and credit unions and is up 60% since I recommended it in April of 2016. Its platform was purpose-built to deliver a secure and consistent user experience across online, mobile, tablet, text and voice channels so that account holders will remain loyal to their financial institutions. Revenue visibility is great, and management says it can typically see where 90% of its revenue will come from over the upcoming 12 months. That said, as it moves upmarket and lands bigger clients, implementation times are growing. The two trends to watch here are customers and users. Customer growth is slowing, but user growth should be accelerating. This is because there are more users (you and I are users of our respective banks’ software) at bigger banks. The punchline is that Q2 Holdings is a relatively steady growth story and gets a slice of financial institution IT spend. It also gets a piece of the pie when financial institutions want to capture more customers—it sells software to help them do so (like an email offer to you from your local credit union for a great interest rate on a new car). Revenue should be up almost 30% this year and 24% in 2018, while EPS should flip from -$0.02 this year to around $0.14 next year. That jump to profitability is a major event. Shares have been weak lately and just broke below their 200-day line, in part because of a recent note from J.P. Morgan in which the firm says U.S. software stocks are unlikely to do as well in 2018 as they did in 2017 (up 30% year-to-date). It moved Q2 to “neutral,” but the price target of 50 was unchanged (34% above where shares are now). I think this is a buying opportunity. BUY.
U.S. Concrete (USCR) was recommended in January of this year and is a domestic supplier of ready-mixed concrete. The company is based in Texas, and does most of its work in Texas, New York/New Jersey, and California. It has also recently begun to expand into Philadelphia. It’s attracted to markets where logistics are challenging (i.e., it’s hard to get heavy concrete trucks from batch plants to job sites) and economic growth is robust. That mix means it has competitive advantages, pricing power and plenty of work, all of which are good for investors! The company is growing both organically and through acquisitions. Its industry is very fragmented, and U.S. Concrete is working to vertically integrate more, which means it’s buying up aggregate facilities (as well as ready-mix operations) near its largest markets so it can supply its own aggregate. Shares can be volatile at times, but the long-term trend is up, and it should remain so provided that GDP growth is reasonably robust and management continues to execute its growth plan. It’s fair to expect around 15% revenue growth a year, with EPS growth in the 20%-to-40% range. The CEO, Bill Sandbrook, is a frequent guest on CNBC (Jim Cramer appears to like him and the company), and he has recently said that his company has a tax rate of around 40%. If that goes into the low 20% range, he’ll put the money into trucks, equipment, market expansion and other initiatives that will increase EPS. Keeping at Buy. BUY.
