A quick note. I put out the January Issue of Cabot Early Opportunities today and in that I discussed some of what we’re seeing in the growth stock universe. Because that conversation is directly relevant to our small-cap portfolio I wanted to share some of the same commentary here. I apologize if this seems repetitive to those that subscribe to both advisory services.
The real short version of what’s going on out there is … we’re officially in a bear market in growth. And it’s been particularly tough going in the super-fast-growing small-cap stock arena.
Across the market cap spectrum shares of good companies have consistently failed to hold at expected support zones. That’s a major diversion from patterns we’ve typically seen since the market bottomed in March 2020.
Moreover, trading patterns have completely disconnected from company-specific factors. It’s all about Omicron/Covid, interest rates, inflation and the potential market impacts of numerous other risks.
From a policy perspective it’s about the end of life support at the hands of doctors at the Fed, Treasury and U.S. government. And those docs saying it’s now up to corporations and consumers to keep the economy’s heart beating.
I think that’s probably a healthy thing in the long run but it’s causing a lot of discomfort right now.
The bad news is that storm clouds have started to come together and some models predict a pretty ugly forecast. Should inflation persist, Omicron (and other variants) continue to cause supply chain and economic disruptions, businesses and consumers fail to pick up the baton from the docs, and interest rates surge we could be in for a nasty 2022. Higher rates and lower productivity isn’t exactly a recipe for economic success.
On the other hand, EVERYTHING looks grey when storm clouds are overhead. At these times it’s easy to play the Eeyore card and think, as the world’s most pessimistic grey donkey said, “The sky has finally fallen. Always knew it would.”
But that’s a dismal way to go through life. And when it comes to the market there is always a silver lining somewhere.
Software stocks have been some of the very worst performers lately. Depending on how you slice the space the net result is that the broad software universe is down roughly 25% from the November peak.
That’s bad, but it’s not out of the norm for software corrections. They were down 20% in February 2021. After that, software stocks ran 30% higher.
Some of the more resilient companies during corrections are the larger, more profitable ones. We don’t own any of those.
Many of the very hardest hit companies are exactly the type we do own. Smaller, higher growth, higher valuation, often not yet profitable small- and mid-cap stocks.
The upside to this is that these are also the stocks that rally the furthest and the fastest when things turn around. We will own them when that time comes.
What should we expect in the next couple of months?
Looking back in time, the one factor that has overwhelmingly led to upside performance coming out of corrections – especially with smaller companies – is revenue growth and revenue beats.
This plays directly into our hands. But in order for these stocks to begin working again investors will need to refocus on the factors that contribute to sustained revenue growth, namely demand, market expansion, sales execution, etc.
I suspect this will begin to happen as we get deeper into Q4 earnings season (February). We’ll need management teams to provide good 2022 revenue guidance for many of these stocks to work.
On the other hand, we could continue to see multiple compressions among high-growth, small-cap names if the aforementioned storm clouds intensify and/or when the Fed rate hike cycle finally begins.
As I look over the data it seems we should be nearing a time when many of these names will rally, at least for a short spell. But again, it’s felt that way at multiple points during this decline. So we’re going to have to keep being careful.
Arena Pharmaceuticals (ARNA) continues to trade in the low 90s as we await regulatory approval of the proposed Pfizer (PFE) acquisition. No news on ARNA. Regarding PFE, it’s worth mentioning that analysts are increasingly bullish on that stock given the pending rollout of the oral COVID-19 therapy (Paxlovid). Pfizer has significant cash flow/revenue owing to COVID treatments and there are additional indications (Lyme, flu, RSV, arthritis, ulcerative colitis and more) for which Pfizer has either pipeline treatments or assets that it is acquiring (like ARNA). Obviously, Pfizer isn’t a fit for this advisory service, but I feel it’s important to flag the potential opportunity given the ARNA acquisition. SOLD HALF, HOLD HALF
Avalara (AVLR) continues to look cheap, trading with an EV/forward revenue multiple of 11.5. Expected revenue growth in 2022 is 23%, with upside potential. If AVLR hits the Q4 numbers and offers upside guidance to 2022 we “should” see shares gain ground. Profitability is a weakness (investments likely to drive greater EPS loss in 2022 than 2023) but given post-correction focus on revenue for high-growth companies that’s not a huge concern of mine right now. BUY
CS DISCO (LAW) is now past lockup expiration (Monday, January 17) and has, for now, been able to hold near the IPO price (32). Keeping at buy. This is a potential disruptor in the legal industry (software focused) and has potential revenue upside to analyst estimates in 2022 (27% growth currently expected). BUY
Everbridge (EVBG) will see CEO David Meredith put in his last official day in a couple of weeks (January 30). We are awaiting further clarity on the state of the business. HOLD
Inspire Medical Systems (INSP) pre-announced Q4 results two weeks ago and I provided details last week. No news since. The stock is trading right on its 200-day moving average line. BUY
JOANN (JOAN) management at the ICR Conference and, as discussed last week, JPMorgan followed up the presentation with a note outlining five reasons to buy the stock. Those reasons are: (1) reopening/normalcy should be a benefit, (2) strong competitive position in a niche industry, (3) store refreshes provide additional upside, (4) “Blue Ocean” initiatives on the horizon (think JV with Singer as example), and (5) most attractive valuation in Hardlines. BUY
Kornit Digital (KRNT) is searching for support after we reduced our position size by a quarter. It’s been a very ugly month for KRNT and the stock’s movement continue to appear disconnected from the expected performance of the company. Kornit is seen growing revenue by 24% in Q4 2021 and 27% (to $420 million) in 2022. Next year adjusted EPS is seen rising 57% to $1.35. SOLD A QUARTER, HOLD REST
Rani Therapeutics (RANI) has held up fairly well recently and is up nicely (from 15 to over 20) since the beginning of the month. Of course, this is a very volatile stock so that could change very quickly. But it appears that the investor base remains focused on the catalysts we’re looking forward to in the coming year. Those studies are RT-101 (acromegaly), RT-102 (osteoporosis) and RT-109 (growth hormone deficiency). BUY
Revolve (RVLV) is another name where it appears the stock is just flailing around, disconnected from what’s going on in the business. While it is a high multiple stock, Omicron-related social disruptions may put a dent in Q1 and shipping is a bit of a pain point (but less so than for peers), Revolve has also been ramping up marketing spend and acquiring customers at a record pace. Sales in October were keeping up pace with the 58% growth posted in Q3, and the Forward brand is cranking. There are no guarantees, but expectations for 24% revenue growth in 2022 and 10% adjusted EPS growth (to $1.24) appear to leave some room for outperformance. If that plays out RVLV should do well this year. BUY
Repligen (RGEN) presented at the JPMorgan healthcare conference recently, and I detailed the highlights last week. Recall that management maintained guidance for $200 million in COVID-related revenue in 2022 and that they cited increased demand for both existing and in-development vaccines. Beyond COVID revenue growth in the core business was up 37% in the most recent quarter. No doubt this is a painful correction but it’s hard to envision RGEN not trading meaningfully higher in 2022. HOLD
SiTime (SITM) has begun to slip this week as the broader semi space pulls back (yesterday SOXX fell below support zone that had held since November). Keeping a close eye on this and thinking earnings can’t come soon enough (just under two weeks now). SiTime is a fabless semiconductor company that provides MEMS (micro-electro-mechanical systems) and silicon-based timing systems to a broad array of end markets, including datacenter, automotive, aerospace, industrial and mobile/consumer electronics. BUY
Earnings: Wednesday, February 2
Shutterstock (SSTK) delivered a beat and raise quarter in October and the combination of massive cash flow ($3.70 per share in 2020) a small dividend (yield is 0.84%), share buybacks and exposure to high-growth markets (such as large tech investments in the metaverse, for which SSTK can provide content) should keep investors engaged in the name. We will see. Earnings are due out in three weeks. BUY
Earnings: Wednesday, February 10
Sprout Social (SPT) is one of the crop of high growth software names that has taken it on the chin during this correction. We took a partial profit (1/4 position) recently to lock in a 90% gain, just in case. There’s no news since, but we do have an earnings date of February 22. SOLD A QUARTER, HOLD REST
Earnings: Wednesday, February 10
Thunderbird Entertainment (THBRF, TBRD.CA) remains in a consolidation phase with no major news to report. BUY
Xometry (XMTR) is another of our high-growth, new to the market potential disruptors. I like the company’s exposure to the manufacturing industry. Revenue is seen up 76% next year. The stock sold off recently but is bouncing back somewhat today. Lockup expiration passed recently as well. BUY
Please email me at email@example.com with any questions or comments about any of our stocks, or anything else on your mind.
|Stock Name||Date Bought||Price Bought||Price on 1/20/22||Profit||Rating|
|Arena Pharmaceuticals (ARNA)||2/2/18||39||91||134%||Sold Half, Hold Half|
|CS Disco (LAW)||9/2/21||57||31||-46%||Buy|
|Inspire Medical (INSP)||10/4/19||59||212||262%||Buy|
|Kornit Digital (KRNT)||3/4/21||102||99||-3%||Sold a Quarter, Hold Rest|
|Rani Therapeutics (RANI)||10/7/21||17||21||24%||Buy|
|Repligen (RGEN)||11/2/18 and 12/31/18||59||188||218%||Hold|
|Revolve Group, Inc. (RVLV)||4/1/21||46||42||-8%||Buy|
|SiTime Corporation (SITM)||12/2/21||296||204||-31%||Buy|
|Sprout Social (SPT)||9/3/20||36||61||67%||Sold a Quarter, Hold Rest|