We’re two weeks into the New Year and small caps have just broken out to a fresh all-time high.
No doubt small caps are being pushed along by the likelihood that tax reform will benefit the small-cap asset class more than large caps. That’s because small caps’ median realized annual tax rate of 32% in 2016 was much higher than the 28% rate for large caps. Small caps also underperformed large caps in 2017, so a little make-up performance is due.
But small caps aren’t the only stocks moving higher. Just about everything else is too! Most of the data points toward a bullish outlook for global equities, including slow-ish but steady GDP growth in the U.S., and GDP growth in both Japan and Europe. The Purchasing Managers Index (PMI), an indicator of economic health in the manufacturing sector, is also showing expansion across the globe. The evidence on hand has led the New York Fed to place a less than 11% probability of recession in the next year.
Of course, this all doesn’t mean stocks are going to the moon. In fact, most of the year-end estimates I’ve seen for the S&P 500 suggest analysts see the index up roughly 10%. That’s not bad, but it’s already moved 3.5% higher in just two weeks!
It can be hard to maintain balance when everything seems to be working. But we know from experience that investors get knocked on the back of the head when they’re least expecting it. So it’s important to keep your feet on the ground, even when the stock market is flying.
Our portfolio has soared over the past week right along with the market. Our average gain of 3.2% was led by Datawatch (DWCH), which was up 25% on acquisition rumors, Materialise (MTLS), which was up 14% on a strong 2018 outlook for the 3D printing industry from IDC, and Everbridge (EVBG), up 7% on continued traction with statewide and citywide deals.
Our newest addition, Instructure (INST), was also up 5% on no new news.
On average, our stocks are beating their benchmark by around 20%. Everbridge, AxoGen (AXGN) and LogMeIn (LOGM) are our biggest outperformers (beating the Russell by 84%, 58% and 54%, respectively), while Materialise, Datawatch and BioTelemetry are our three laggards (trailing the Russell 2000 by 12%, 5% and 4%, respectively). With a little luck, the strength in these three positions will continue, and get them back in the black.
I have only one change today. I recommend selling, Primo Water (PRMW), which we’ve had for a while, but I’ve lost confidence that it can outperform in the year ahead. Details below.
Updates
AppFolio (APPF) has been consolidating in the 40 to 43 range since the beginning of December in what is likely a well-deserved pause after almost a two-year rally. I think the stock will work through this in due time. Keeping at Buy. BUY.
Apptio (APTI) is still trending in the right direction and remains comfortably above its 50-day line. No new news to report, but I noticed Morgan Stanley disclosed a 5.2% passive stake in December. We’re up around 10%. Keeping at Buy. BUY.
Asure Software (ASUR) announced three more acquisitions two weeks ago that fit into the company’s roll up strategy. Shares are unchanged this week, and are roughly two months into a consolidation phase, with the stock trading between 14 and 15.5. There is some resistance at 15.5 from last spring, and if the stock works through that, it’ll take some work to break through its 52-week high of 17.27. Keeping at Buy. BUY.
AxoGen (AXGN) has been on a tear, but pulled back slightly this week (-3%). Ironically, the reason appears to be that the company pre-released Q4 2017 earnings that should come in slightly better than expected! Revenue should be up 45% to $16.5 million ($15.7 million was expected) with full-year revenue coming in at around $60 million (up around 46%). Management also said that 2018 revenue should be up at least 40%, with gross margins above 80%. No EPS guidance was given, but consensus estimates currently call for a loss of around $-0.17 next year. Management is also presenting at the combined 2018 Meetings of the American Association for Hand Surgery (AAHS), American Society for Peripheral Nerve (ASPN) and the American Society for Reconstructive Microsurgery (ASRM). The meetings are taking place in Phoenix, Arizona from January 10-16. Expect some product and/or trial-related updates to follow these events. Despite the little wobble this week, the trend remains intact. BUY.
BioTelemetry (BEAT) is roughly unchanged from last week and the stock looks to be consolidating around its 200-day line. Things have been relatively quiet since the company announced its involvement in trials with both Onduo (diabetes) and Apple (heart). To see if anything was happening, I went to both of those companies’ websites. Nothing going on at Onduo. But when I went to the Apple Heart Study webpage, and scrolled down a bit, I saw this:
Two things jump out at me about this. First, it’s nice to see a direct mention of BioTelemetry on Apple’s Heart Study webpage. Second, note how it refers to the ECG Patch! This form factor is a big deal for BioTelemetry because they didn’t have it, but iRhythm did. Now, BioTelemetry finally does. And it’s being used as part of this study (interestingly, I can’t find the product on the company’s website). If you click on the “learn more” link you can download a guide for how to use the patch (image of step 3 below to give you an idea of the size).
I think this is a big positive as this patch is much more aligned with the type of form factor that people are likely to want for continuous monitoring (the guide says for up to seven days). It will be interesting to hear management speak about this on the next conference call, which will likely be in late February. Given the huge upside potential in the stock, I’m keeping at Buy. BUY.
Datawatch (DWCH) jumped back above 11 after Reuters reported last Friday that the company has hired a financial advisor after receiving acquisition interest. As I said last week, I’ve believed the company has been working to get its house in order to sell itself. And part of this process has included an initiative to release subscription-based cloud software solutions. The company also announced this week that it will release earnings on January 25 at 4 PM, with a conference call to follow at 5 PM. You can bet that acquisition interest will be discussed, but equally important will be that the company reports a decent quarter! If there’s a legitimate buyer poking around, it would be far better if the company is executing on its growth plan than if the wheels are coming off. I’ll preview expectations next week. For now, just continue to hold. HOLD.
Everbridge (EVBG) sent me an update just as I started typing this that Vermont (where we often go skiing) has another winter storm warning due to ice and snow, starting today. I love this company’s app, which is much easier to use than the system Vermont was on before. Notifications pop up on the app just like a text message does, and you can read the alert in a PDF. It’s also very easy to send a response (which I haven’t had to do yet). My experience with critical communications platforms is, admittedly, quite limited (which I think is a positive!). But so far, it’s easy to see why more states and communities are going with Everbridge. This week we learned that New York City has selected the company to power its citywide emergency notification system (amber alerts, weather warnings, life safety threats, evacuation notifications, etc.). And that’s likely part of why the stock continues to move higher. We’re now up just over 100% after shares broke through their previous all-time high on Tuesday. Keeping at Buy. BUY.
Instructure (INST) is last Friday’s new addition, and sells cloud-based learning management systems (LMS) to academic and corporate customers. It’s a small company, but has been grabbing market share quickly in the higher education market. Its new corporate solution, Bridge, is potentially a major growth catalyst and Instructure is rolling out new modules at a pace of roughly one every 12 to 18 months (the second just came out). The stock pulled back from a 52-week high in late November, and has been consolidating just below its 50-week line. It jumped a few percentage points above that technical level yesterday, but still appears to be in a very attractive buy range. BUY.
LogMeIn (LOGM) has been trading in a choppy pattern for several months, but when you step back, you see that the general trend remains up. We’re up around 106%. Keep holding. HOLD HALF.
Materialise (MTLS) came back to life this week after IDC reported that global spending on 3D printing should grow by around 20% in 2018, with discrete manufacturing, healthcare, education and consumer markets leading. As a diversified industry player (software, manufacturing and medical), Materialise has broad exposure. Management will present at the Needham Growth Conference next Wednesday. BUY.
Primo Water (PRMW) has moved modestly higher over the last two weeks, and is up around 47% since I added the stock to our portfolio back in March 2016. Today, I’m moving the stock to Sell.
I do this with mixed emotions. On the one hand, I love the story of Billy Prim and how he started this business after selling Blue Rhino, then grew it to a point where distribution covered the country. I believe that clean drinking water ranks high on consumers’ list of priorities. Upside over the next 18 months likely comes from deleveraging (hopefully non-dilutive), pushing through price increases (potentially, but not a given), and hopefully, expanding in grocery channels, which should be easier given the Glacier acquisition.
On the other hand, Primo’s stock has only performed in line with the Russel 2000 since we’ve owned it, which has almost been two years. Across the country, retail locations have shrunk dramatically. Thankfully, Primo has a good relationship with Wal-Mart, but the chances of that company significantly expanding its footprint are slim in my opinion (we just learned it will close over 260 Sam’s Club stores yesterday).
The big question for me is: Where does Primo go from here? It seems increasingly hard for Primo to grow its footprint when retail locations are shrinking. And in an age where only 3% of groceries are purchased online, online grocery purchases represent the low, low, low hanging fruit for companies that want to grow e-commerce sales! And it’s why both Amazon and Wal-Mart are so focused on this initiative. Yes, a lot of food and grocery items are difficult to buy online. But homogeneous items aren’t on that list. The only issue with water is that it’s heavy, making shipping to individual homes costly. But if/as consumers increase online orders for repeat purchases (laundry soap, toilet paper, flour, sugar, etc.) the hassle factor of driving to the store to buy jugs of water goes up significantly. And, let’s face it, lugging big jugs of water to the car isn’t fun. I’ve done it, and one of the best days of my life was when I installed a reverse osmosis water filter under the kitchen sink! While that whole experience turned me on to Primo, it just seems to me that more consumers will drift away and either; (1) install home filters, or (2) go with a water delivery service so jugs of drinking water are dropped off at their house. The latter is a potential opportunity for Primo investors since it could sell itself to a company that already does this. Consolidating into a larger company would mean one provider with both at-home and bricks-and-mortar locations, and Primo’s long-standing relationship with fulfillment through DS Services, which is owned by Cott Corporation, makes that company the most-likely acquirer in my mind. This said, I’m not sure we want to wait around for a potential takeout that might never come.
Primo just finished leaking shares into the market to help pay for the Glacier acquisition. But, it also filed a shelf registration in December for up to $125 million, which I assume will be triggered before too long to help pay down debt. That event will be dilutive. While part of me would like to hang on and see where Primo takes us, I think the smart thing to do is lock in the gain now while the stock appears stable and things are relatively quiet. Therefore, with mixed emotions, I’m moving to Sell. SELL.
Q2 Holdings (QTWO) dipped back below its 200-day line this week, but the dip isn’t deep enough to get me concerned. Keeping at Buy. BUY.
U.S. Concrete (USCR) made another acquisition this past week, picking up the assets of On Time Ready Mix, a ready-mixed concrete producer serving commercial and residential segments, primarily in Queens, New York. The stock is looking strong, and I’m keeping at Buy. BUY.
