In the fourth quarter of 2018 it felt like we all finally succumbed to some festering illness that landed us in the intensive care unit. Thus far, the beginning of 2019 has the feeling of a trip home from the hospital and the beginning of the healing process.
My best advice on how to handle things at this stage is to do what I’ve heard from every Cabot analyst—don’t get too excited because we don’t know if we’re out of the woods just yet.
That’s sensible advice when the long-term trends have broken and the main engines of growth—accommodative fiscal policy and a synchronized global growth—are running on fumes.
That said, there seems to be a lot of opportunity out there right now. And there comes that time in a recovery when you begin to feel energetic and ravenously hungry again!
Cautious advice at this time is meant to keep us all from glazing over the reality that we’ve just been through a harrowing experience and that scars remain.
Sector after sector has turned over and pounded investors with rapid and painful declines. That, in turn, has driven many individual stocks down to levels that seemed beyond the realm of possibility back in August.
That’s just what corrections are. You see them at the index level, but really feel them at the individual stock level.
The upside is that these corrections are typically a great time to buy. That doesn’t mean stocks can’t go lower—of course they can. But buying a greater share of a good company at a lower price is a proven method to building long-term wealth (on the flip side, buying a lot of a crappy companies at just about any price rarely works out well).
Looking forward, I think there’s an opportunity to make money at the index level. You can probably buy a small-cap ETF, like the IJR, and do OK in the year ahead, while not taking on a lot of risk. The two-year chart of the S&P 600 below shows what I mean.
If you think small caps will deliver a positive gain over the two-year period beginning January 1, 2018 through January 1, 2020, you should be buying now (i.e. because the index is currently down from the beginning of 2018).
Also, if you like stocks when they are relatively cheap, you should be buying now.
Small caps are expected to grow earnings by 14.6% in 2019 and by 15.4% in 2020. But they are trading at 14.5 times forward earnings. That’s the cheapest they’ve been since 2012. And other than dips to this valuation in 2011 and 2008-2009, you have to go back to 2002-2003 to find the index trading at a similar valuation.
Of course, the real money (and more risk) lies in the individual stocks.
I love our current portfolio, and think we have a good selection of secular growth stories that will lead to outperformance in the year ahead.
Still, as you’re buying shares in these companies remember to average in. The market is likely to go through some ups and downs, even though the first couple of weeks of 2019 have been relatively good. You can balance your risk by spreading out your purchases over time rather than going “all in” on any given day.
Changes this week
None
Updates
AppFolio (APPF) announced this week that it has acquired Dynasty Marketplace, which develops artificial intelligence (AI) software solutions for the real estate market. The company’s solutions replace manual tasks and automate leasing communications to help customers grow their portfolios. One example of how it works is that a prospect sends an inquiry and the software sends an automated but contextually appropriate response via text and/or email. Dynasty’s software integrates with a variety of property management platforms, including RealPage (RP). It will be interesting to hear how that arrangement will work out in the future given that AppFolio and RP are competitors (or potential merger candidates?). The purchase price was $60 million. HOLD 1/2.
Arena Pharmaceuticals (ARNA) has gone on a nice little run lately and is (just barely) trading at its highest level since mid-October. This week the development-stage biotech stock announced more good data for etrasimod, for treatment of moderate to severely active ulcerative colitis (UC). The oral drug candidate showed long-term safety and efficacy in the open-label extension of the Phase 2 OASIS trial. Etrasimod addresses a potential market opportunity of $4 billion to $8 billion, and it’s not the only trick up Arena’s sleeve (it recently out-licensed its ralinepag asset to United Therapeutics (UTHR) in exchange for up-front cash and future royalties). The company will be moving etrasimod on to a Phase 3 in UC, as well as Crohn’s, plus a Phase 2 program in atopic dermatitis. Management spoke at the JP Morgan conference this week. I haven’t had time to review the entire transcript. But suffice to say the company is executing well and the future looks bright. Keep averaging in, but be aware a little pullback here is quite possible given the broad market’s recent strength and that we’re right up against short-term resistance. BUY.
Bottomline Technologies (EPAY) keeps moving sideways and needs to break back above 50 before any real progress can be made to the upside. It’s a digital business-to-business payments stock, with a little digital banking exposure too. There’s no significant news. BUY.
CareDx (CDNA) is last week’s new addition and, as you know if you’ve read the report, specializes in diagnostic testing and surveillance solutions for heart and kidney transplants. The real short version is that it’s technologies drastically reduce the need for invasive biopsies (tissue samples) and can tell clinicians much earlier if there is risk of organ rejection. It’s another super-targeted medical technology company. The company received early financial backing from Illumina (ILMN) and, in many respects, remains a partner and source of technology spinouts for that company. The stock’s been climbing since my report went out on Monday so I’m keeping at Buy, but would advise that you place some limit buy orders in the 23 to 25 range as well to see if you can’t pick up a few shares below where they are now. BUY.
Codexis (CDXS) is a protein engineering company that specializes in the discovery, development and commercialization of novel proteins, which are used in a wide range of industries to make manufacturing processes faster, cleaner and more efficient. It currently has a portfolio of 43 proteins, 32 of which are partnered with customers and 11 of which are being developed on Codexis’ dime. A year ago, it had just 33 proteins.
One of the exciting aspects of the company is that it’s just recently begun to apply its protein engineering platform, CodeEvolver, to develop early-stage, novel biotherapeutics. It sees a potential market of around $6 billion for enzyme therapeutics and has one clinical and five preclinical programs in the works.
The clinical program is for CDX-6114, for the potential treatment of phenylketonuria (PKU) disease in humans. PKU is an inherited metabolic disorder in which the enzyme that normally converts the essential amino acid phenylalanine into tyrosine is deficient. That deficiency causes toxic levels of phenylalanine to accumulate in the brain, causing serious neurological problems, including intellectual disability, seizures and behavioral problems. Treatment options basically amount to dietary restrictions to reduce the amount of phenylalanine and use of nutritional supplements. PKU affects around 50,000 people in the developed world.
CDX-6114 is an oral treatment that removes phenylalanine from the body. It’s a promising asset, enough so that in late- 017 Nestlé Health Sciences stepped up with $14 million to obtain an exclusive license on the compound. It paid another $4 million milestone payment (upon first human dosing in a Phase 1a dose-escalation trial) in 2018 and Codexis is in line to receive another $3 million if Nestlé exercises its option to advance the compound.
All in, Codexis is eligible to receive up to $86 million in development and approval milestones, up to $250 million of sales-based milestones if sales surpass $1 billion in a single year, and tiered royalties (based on net product sales) ranging from middle single digits to low double digits.
I covered all this in my report on Codexis, but I’m going back down the rabbit hole today because Codexis just received the thumbs up from the FDA that it can continue with its clinical trial protocol of CDX-6114.
This approval triggers a 40-day window, ending February 17, within which Nestlé needs to decide if it will exercise its option or not (it may get an extension if certain anti-trust filings are required).
Bottom line: The clock is ticking and we should know relatively soon if Nestlé is on board. It would be a great show of confidence in CDX-6114, CodeEvolver and Codexis if it is.
Codexis was just added in December and we filled the second half of the position last week. Keeping at Buy. BUY.
Chefs’ Warehouse (CHEF) distributes roughly 50,000 units of specialty foods, ingredients and staples to around 30,000 independent restaurants, specialty stores, country clubs and other foody-type establishments in the U.S. Few people want to be in this business since it’s basically impossible, but this family-owned company has been doing it for a while and seems to have it down. It’s consistently profitable and has a steady growth profile, in part due to acquisitions. In 2018 revenue should be up around 11%, with 8% growth in 2019. EPS growth is expected at around 77% this year (to $0.78) and 27% in 2019 (to $0.99) driven, in part, by technology and warehouse investments that make the business more efficient. I moved the stock back to Buy in December after it pulled back near its 200-day line. It’s still roughly 14% off its high and I like it here. BUY.
Everbridge (EVBG) is only 10% off its high and is trading above both its 50- and 200-day moving average lines. The trading action has been pretty choppy since the end of September but it’s encouraging to see how shares have held up in a relatively tight range between 45 and 58, for the most part. We’re looking for revenue to be up around 44% this year and 27% in 2019, with an EPS loss of -$0.55 in 2018 improving to a loss of around -$0.34 next year. The difference in the expected growth rate this year and next is partially attributed to a large acquisition made in 2018. It’s been one of our best performing positions and while we’ve taken some profits, it’s rated Buy now because I think it’s one of the most compelling secular growth stories out there in software. Management just announced that Harris County, Texas, the third-largest county in the country, will use Everbridge’s platform to power its public alert system. BUY.
Goosehead Insurance (GSHD) is another compelling growth story and one which I doubt many growth investors (or any investors, for that matter) are aware of. The company sells personal lines insurance and is disrupting the market by deploying a cloud-based sales and support platform coupled with a hybrid corporate and franchise distribution model. Most policies are either homeowner or auto policies, both of which are relatively sticky products. It just went public at the beginning of last year so that’s part of the reason nobody knows about it. The other is that insurance companies aren’t really on the radar of growth investors. But we’re looking at around 40% revenue growth this year and 30%+ in 2019, with potential for that forward forecast to jump quite a bit. Plus, Goosehead is profitable (expected EPS this year of $0.25). The stock has done a nice job climbing off its November lows. Keeping at Buy. BUY.
Q2 Holdings (QTWO) sells cloud-based virtual banking software to regional and community financial institutions. It’s enjoying strong end-market dynamics as financial institutions are enjoying improving net interest margins. Revenue is expected to accelerate from 24% in 2018 to over 27% in 2019 as the company goes live with larger installations. This should also help margins and drive EPS up from $0.11 this year to $0.28 in 2019. I recently upped it to Buy and am keeping it there, though I should note we’ll need a nice surge in demand for the stock to break back above 55. BUY.
Rapid7 (RPD) is a security software stock and that end-market exposure has been a big plus lately as security is one of those areas of technology spending that’s not exactly a place CIOs are likely to cut spending. Is there anybody who’s not concerned when there’s a data breach at a company they’ve given personal and financial information to? Rapid7 is on the back end of a transition to the cloud and subscription-based pricing model. That transition has caused a deceleration in the company’s growth rate because of the way revenue is recognized under the new model (over time, rather than all up front). But we’re still looking at around 20% revenue growth in full-year 2018 and 2019, and nearly break-even on the bottom line in 2019. Keeping at Buy but keep new purchases small since we’ve seen the stock jump nearly 20% over the last five sessions. Management will report Q4 results on February 7. BUY.
Repligen (RGEN) is a pure-play supplier of bioprocessing technologies that make it more efficient to manufacture biologic drugs. It is a leader in areas such as filtration, pre-packed chromatography columns and Protein A ligand manufacturing. Management presented at the JP Morgan Healthcare conference and said momentum in these areas of the business continues and that it’s on track to meet its long-term revenue goal of $400 million to $500 million by 2023, implying 10% to 15% annual revenue growth (organic). Acquisitions could be additive. Repligen’s acquisition of Spectrum is tracking as expected and is on target to achieve $15 million to $20 million in synergies (60% from cross-selling) by 2020 (roughly $3 million achieved through the first nine months of 2018). Management is also planning on expanding its product portfolio (it has a history of innovation in specialty markets), beefing up its IP portfolio and integrating global operations to drive efficiencies. It also has around $190 million in cash so has capital to keep the M&A engine purring. In short, at 55 the stock looks like a great value. Keeping at Buy. We filled the second half of our position on December 31. BUY.
