Cabot Stock of the Week Issue: August 7, 2023

No bull market comes without a few hiccups, and so last week’s 2.5% pullback in the S&P 500 is totally normal, especially given that it came in the heart of a weak second-quarter earnings season, in which the average company has reported a 5.2% decline, according to FactSet.

While the dip in the major indexes was modest, however, earnings blowups among growth-ier titles – particularly those that entered earnings at or near 52-week highs – have been far more pronounced. It happened to our Tesla (TSLA) a couple weeks ago, to our Microsoft (MSFT) and Spotify (SPOT) the following week, and to DoubleVerify (DV), Shopify (SHOP) and Uber (UBER) this week. Mind you, with the exception of Spotify, all of those companies reported anywhere from solid to spectacular earnings, but none of that has mattered this earnings season: Companies that have beaten EPS estimates in Q2 have seen their shares fall by an average of 0.5%, the worst performance since the second quarter of 2011, according to FactSet.

So, this isn’t normal. Recognizing that, I have elected not to sell a single one of those earnings “victims,” though I am downgrading DV to Hold. Again, aside from Spotify, which I downgraded to Hold last week and which is only hanging on to our portfolio by its fingernails, nothing is broken with any of those companies; if anything, it’s just the opposite. They are merely stocks that were guilty of running “too far too fast” ahead of earnings, and investors took the opportunity to cash in, even if those earnings results gave them no real reason to.

Pulling back, it’s still a bull market, and this backwards earnings season is mercifully almost over, with 84% of S&P companies having already reported. The sooner earnings season ends, the sooner the buying we saw through most of the summer is likely to resume, at least to some degree. Thus, I view the recent collapses in certain growth stocks as buying opportunities.

Speaking of buying opportunities, today we add a familiar name that has become yet another red-hot artificial intelligence play – and one that pays a dividend. It’s a longtime holding of Cabot Dividend Investor Chief Analyst Tom Hutchinson. Here are Tom’s latest thoughts on it.

Broadcom Inc. (AVGO)

Artificial intelligence has been around for a while. But the technology recently got more real in terms of company bottom lines months ago when semiconductor company Nvidia (NVDA) reported earnings that blew away expectations, citing massive demand for AI technology that was much larger and sooner than the market anticipated.

The new wave of technology could have an impact like that of the internet proliferation or the wireless phone mania. It’s a game-changer. AI provides such advantages in terms of efficiency and cost savings that many companies can’t afford to fall behind. It’s a matter of survival in many cases. That’s why there is a huge scramble to adapt the technology ASAP.

According to a recent CxO Pulse Survey, 67% of U.S. organizations plan to increase their spending on technology and are prioritizing investments in data and AI. A whopping 95% of organizations are increasing their investments as a percentage of revenue. And 97% of executives say AI will be transformative to their company and industry.

Few stocks have benefited from the recent AI craze like AVGO has. The stock is up 60% YTD and 112% from the October low. Despite the recent spike, AVGO still sells at a reasonable valuation for the level of earnings growth and should be an excellent investment.

Broadcom is a global infrastructure technology leader and an industry Goliath with $34 billion in annual net revenues. It’s an icon of the technology revolution with roots that trace back over 50 years to the old AT&T/Bell Labs. The company has many category-leading products in semiconductors and infrastructure software solutions.

Broadcom provides components that enable networks to operate together and communicate with each other from the service provider all the way to the end user and device. That may sound complicated. But there are two simple reasons to own AVGO. One, it will continue to benefit from businesses moving online and into cloud-based applications. Two, it is getting a huge benefit from the fever to adopt artificial intelligence technology.

It’s a huge company that has grown largely through acquisitions, using its entrenched status and deep pockets to acquire burgeoning technologies. Broadband, its namesake, is the high-capacity transmission technology that uses a wide range of frequencies that enable a massive number of messages to be communicated simultaneously. Broadcom products enable it by providing world-leading dominance in networking and wireless connectivity.

The company is an early comer to the technology party that provides crucial infrastructure that enables other technologies that come along the way. The company is so entrenched in the infrastructure of today’s technology that 90% of internet traffic uses Broadcom’s systems.

Broadcom has consistently delivered better-than-expected earnings. It did so again in the most recent quarter and upgraded its earnings guidance for 2023. The company isn’t dependent on product sales to retail consumers but rather the continuing use and expansion of technology itself. It benefits from AI in a brilliant way.

The company makes generative AI chips. These chips don’t provide AI functions per se; rather, the technology enables AI to connect to all other systems, which they must to be of any use. The sheer volume increases from the new technology as well as soaring demand for the next generations of its chips should enable Broadcom to achieve a high level of profit growth for years to come.

Broadcom is a large, older technology company that pays dividends. It’s natural to assume the heady growth days are behind it. But this is a stock that has provided nearly 40% average annual returns for the past 10 years. The AI craze adds another powerful growth catalyst and puts those level returns in play going forward.

Broadcom does report earnings on the last day of this month. And that’s a risk in the near term, especially after the recent run-up. But this company has consistently been posting better-than-expected results and I expect more of the same this quarter.

Current Recommendations

Changes Since Last Week:
Brookfield Infrastructure Corporation (BIPC) Moves from Buy to Sell
DoubleVerify (DV) Moves from Buy to Hold

I already mentioned some of our earnings blowups at the top, which has prompted me to downgrade DoubleVerify to Hold. The only Sell today is Brookfield Infrastructure Corporation (BIPC), which is another earnings blowup but, unlike the others, the stock wasn’t at or near 52-week highs prior to the selloff, so the damage is a bit more acute. With a full portfolio, something had to go, and BIPC was an easy choice.

As for the rest, believe it or not, some stocks were actually UP on earnings last week (take a bow, Terex!), while others are chugging along, looking poised for another run-up as soon as all the earnings selling dust settles and the bull market buying resumes, which I fully expect it to.

Here’s what’s happening with all our stocks, a few more of which report earnings this week, so be on your guard!

Updates

Aviva plc (AVVIY), originally recommended by Bruce Kaser in Cabot Value Investor, appears to have bottomed last week after falling sharply below 10 for the first time in a month. There was no news. Shares of this London-based life insurance and investment management firm now have more than 40% upside to Bruce’s 14 price target, and as he noted in his latest update, “The shares offer a generous 8.3% yield. On a combined basis, the dividend and buybacks offer more than a 10% ‘shareholder yield’ to investors.” BUY

Blackstone Inc. (BX), originally recommended by Mike Cintolo in Cabot Top Ten Trader, was down a point in its first week in the Stock of the Week portfolio. And that makes sense: Blackstone is a mega-cap alternative asset manager that is what Mike calls a “Bull Market Stock,” meaning it thrives in bull markets because, as Mike put it, its “giant portfolio increases in value, bringing in more fees, greater realizations and, as sentiment heats up, greater inflows, too.” It’s still a bull market, but last week was a down week, so it’s no surprise BX shares were down too (albeit mildly). The stock is still up 39% year to date, and yet trades roughly 30% below its late-2021 highs. The market will bounce back, and so will BX. BUY

Brookfield Infrastructure Corporation (BIPC), originally recommended by Tom Hutchinson in Cabot Income Advisor, reported earnings last Thursday and the market didn’t like them. Shares tumbled more than 11% since we last wrote, and are still falling, despite handily beating earnings estimates. But the stock is not the company, and the fact is the stock has now fallen well below both its 50- and 200-day moving averages. So, it’s time to step aside before those losses mushroom even further. MOVE FROM BUY TO SELL

BYD (BYDDY), originally recommended by Carl Delfeld in his Cabot Explorer advisory, is down about 4% since hitting new 2023 highs above 71 a week ago. Considering the market was down, the pullback in BYDDY shares is not even slightly surprising. There was no news. We’re still up about 20% on this Chinese electric vehicle giant in three and a half months, so if you have not yet bought shares of BYDDY – our highest-conviction, long-term position in the portfolio – this dip is an ideal opportunity to do so. BUY

Comcast Corporation (CMCSA), originally recommended by Bruce Kaser in the Growth & Income Portfolio of his Cabot Value Investor advisory, held its post-earnings gains quite well last week, as the stock has largely remained at 52-week highs above 45. A strong quarter was the impetus behind the run-up, and Bruce dug into those results in greater detail last week: “Comcast reported a strong quarter, with adjusted earnings of $1.13/share increasing 12% from a year ago and beating the consensus estimate of $0.98 by 15%. Revenues rose 2% and were about 1% above estimates. Adjusted EBITDA rose 4% and was about 6% above estimates.

“Margins expanded nearly across the board. The company generated strong free cash flow of $3.4 billion despite the elevated $3.0 billion in capital spending which included funding the construction of its new Epic Universe theme park. Comcast repurchased $2.0 billion in shares, helping reduce the share count by about 7% from a year ago.

“In Connectivity & Platforms, profits rose by 4.4% due to lower costs, as revenues were flat. Comcast was able to raise residential prices by 4.5% which helped offset modest losses in total customer count and in weaker video and advertising revenues. Domestic wireless and international broadband revenues remain small but continue to grow rapidly (20+%). The residential broadband customer count was nearly flat – impressive although perhaps seasonally boosted.

“In Content & Experiences, profits rose by 7.5%, helped by record results in Theme Parks and a return to profits in the Studios segment, which more than offset weakness in Media profits and higher overhead costs. Media profits fell due to lower advertising revenues and higher losses in the Peacock streaming unit (loss was $651 million compared to a loss of $467 million a year ago).

“Super Mario Bros. became the second-highest-grossing animated film in worldwide revenues, and Peacock doubled its subscriber base (to 24 million). Comcast added 316,000 wireless lines as this service continues to ramp up.

“We are wary of the company’s elevated capital spending, now at over 12% of revenues and up 20% from a year ago. Comcast is building a new theme park – an acceptable one-time surge as long as the park becomes adequately profitable. But, the company is also investing in ‘line extensions and scalable infrastructure’ which sound more like recurring spending. Cable and telecom companies must spend constantly to maintain and upgrade their basic facilities – much of this money provides no profit boost or competitive edge. Rather, it merely maintains the status quo and is in effect negative 100% ROI spending. This bug is a constant weight on our valuation target. Comcast is well-managed and has wide margins so it can afford the spending, but nevertheless, the cash flows out of the company’s coffers with little benefit in return.

“The balance sheet carries reasonable but massive net debt of $87 billion, even if it is only 2.4x EBITDA and at management’s target level.

“Comcast shares … have 1% upside to our 46 price target. Given the small upside remaining to our price target, we moved the shares to a Hold last week. We are re-evaluating this target and our rating in light of the strong earnings report.”

As for us, since we’re not strictly value investors, we will keep Comcast shares at Buy, which I feel even more strongly about after the stock held firm during last week’s market dip. But with a 42% gain on the stock, if you got in early after our recommendation, it wouldn’t be the worst time to shed a few shares and let the rest ride if you haven’t already done so. BUY

DoubleVerify (DV), originally recommended by Mike Cintolo in Cabot Growth Investor, was one of the growth stock earnings implosions discussed above. Shares plummeted from 52-week highs above 42 to the mid-33s in the last week, a 20% haircut. Ouch! Here’s what Mike had to say about it: “DoubleVerify (DV) was acting about as good as can be heading into earnings, with a breakout many weeks ago and a smooth uptrend from there. But, despite a solid quarterly report, the stock imploded this week for no obvious reason. We sold half our stake on Tuesday and could sell the other half soon if the stock can’t find its footing.” Let’s downgrade it to Hold as well and see if it bounces back. Thankfully we had a pretty solid cushion (15%) prior to last week’s earnings sell-off, which as Mike said was not due to some glaring weakness in earnings or revenue growth, both of which topped estimates. So, let’s assume it’s the latest “victim” of this earnings season’s trend of hot growth stocks falling apart on earnings despite good numbers; if it soon finds a bottom, it will likely bounce back. But until it finds that bottom, I wouldn’t recommend starting new positions. MOVE FROM BUY TO HOLD

Eli Lilly and Company (LLY), originally recommended by Tom Hutchinson in the Dividend Growth Tier of his Cabot Dividend Investor advisory, remains smack in the middle of its two-month range between 434 and 469. That could change tomorrow (August 8), when the company reports second-quarter earnings. Analysts are expecting big things: 16.9% revenue growth, 58% EPS growth. Those are high bars to cross, and the company did fall short of bottom-line estimates last quarter, so be on your toes with this one. But given that we have a 36% gain on the stock in four and a half months, I doubt anything that happens tomorrow would prompt me to sell (hopefully those aren’t famous last words!). BUY

GitLab (GTLB), originally recommended by Tyler Laundon in Cabot Early Opportunities, is off about 6% in the last week on no news, likely getting dinged for no good reason like many growth stocks last week. Let’s see if it bounces back this week. Shares are still above their 200-day moving average and hovering right around the 50-day line, which will hopefully act as support. GitLab provides a source code management (SCM) platform with a host of collaboration, sharing and tracking tools for software developers. The company could be an acquisition target, is an AI play, and trades at less than half its November 2021 highs (125), so I still like it. As long as the stock holds the 50-day line, this could be a nice entry point. BUY

Kimberly-Clark de México (KCDMY), originally recommended by Carl Delfeld in his Cabot Explorer advisory, is down modestly (about 3.5%) since hitting new highs near 12 in late July. There’s been no news since parent company Kimberly-Clark (KMB) reported earnings that beat top- and bottom-line estimates and raised organic sales and operating margin guidance for 2023. Earnings per share improved 23% year over year while organic sales jumped 6%. The company did not raise full-year guidance, which spurred a bit of modest selling, but the damage has been limited. This is still a Buy, as it remains a play on Mexico’s 25% manufacturing discount to U.S. and Chinese companies. BUY

Las Vegas Sands (LVS), originally recommended by Mike Cintolo in Cabot Top Ten Trader, retreated a bit this past week but remains in its recent range between 56 and 60. I still like this Macau-centric casino operator as a play on China’s delayed post-Covid recovery, but will keep it at Hold until it breaks above 60. HOLD

Microsoft (MSFT), originally recommended by Tyler Laundon in Cabot Early Opportunities, has tumbled since reporting fiscal fourth-quarter earnings two weeks ago, but appears to have found support in the 326 range. The earnings weren’t bad: Revenue and earnings topped analyst estimates, but fiscal-year 2024 guidance came in below investors’ rather lofty expectations, hence the post-earnings selloff. A sober look at those results shows that Microsoft’s revenue increased 8% year over year, buoyed by a 26% bump in its Azure cloud computing segment, while profits lifted 20% from the same quarter a year ago to top $20 billion for the first time. Due to its leadership position in artificial intelligence, however, Microsoft has created outsize investor expectations, and its more modest guidance for next year has left investors initially disappointed. Still, the growth is impressive, and MSFT remains a long-term Buy. BUY

Neo Performance Materials Inc. (NOPMF), originally recommended by Carl Delfeld in Cabot Explorer, was down another 6% this week and is not off the most encouraging start since we added the stock to the portfolio last month. As long as shares stay above 6 – where the stock found support after dips in May and June – we’ll hang in there, especially with the company set to report earnings this Friday, August 11. Neo manufactures the building blocks of many technologies and advanced industrial materials. These include magnetic powders and magnets, specialty chemicals, metals, and alloys – all using rare earths and critical metals. Additionally, the stock is a hedge on rising U.S./China/Taiwan tension. BUY

Novo Nordisk (NVO), originally recommended by Carl Delfeld in Cabot Explorer, is virtually unchanged in the last week as we await second-quarter earnings results this Thursday, August 10 before the market opens. Analysts anticipate 40.3% revenue growth and 63% EPS growth for this red-hot Danish maker of the blockbuster weight-loss drug Ozempic. Momentum in the stock has slowed to a crawl, but we have a 21% gain on it, and shares not trading near their highs heading into earnings could be an advantage this earnings season. So we’ll keep it at Buy, but definitely only nibble if you plan on doing any buying prior to Thursday’s report. BUY

ServiceNow (NOW), originally recommended by Mike Cintolo in his Cabot Top Ten Trader advisory, has tumbled in delayed fashion after barely budging following earnings last week. Shares were down more than 5% this week on no news, so the pullback is likely market-driven. As for the quarter, it was solid: Adjusted EPS was up 46% year over year (and ahead of estimates), while revenues improved by 22.7%. But the top-line beat was narrow enough (0.99%) that NOW shares haven’t been rewarded for the strong quarter (not that they’re alone this quarter). With shares well above their 200-day moving average and sitting on their 50-day line, we’ll keep our Buy rating for now. A new partnership with Nvidia and Accenture to accelerate adoption of artificial intelligence software in the corporate market means plenty of potential upside remains. BUY

Shopify Inc. (SHOP), originally recommended by Tyler Laundon in Cabot Early Opportunities, is yet another growth stock earnings blowup. Shares have fallen more than 15% since reporting earnings last Wednesday, despite decent results (sound familiar?). Revenues improved 30.8% year over year, beating estimates, while earnings per share of 14 cents widely outpaced the six cents per share analysts were expecting. But investor concerns about long-term growth are weighing down the stock as the e-commerce giant transitions from serving mostly small retailers to bigger fish – citing the company’s decision to cut 20% of its staff in May as a red flag. It seems the earnings call didn’t assuage those fears. Still, a 15% sell-off seems like an over-punishment. I’m betting the stock will bounce back in the coming days/weeks as the current mini-pullback fades and the bull market resumes. With the stock still well north of its 200-day moving average, I’m keeping it at Buy. BUY

Si-Bone (SIBN), originally recommended by Tyler Laundon in Cabot Early Opportunities, will report earnings after the bell today. It was up 2% in Monday trading (as of this writing), which seems encouraging. Less encouraging is the fact that the stock has been slowly trickling lower for about the last six weeks since it topped out near 29 in late June. Perhaps an earnings beat (22% revenue growth is expected, on narrowing profit losses) will trigger a turnaround. We may know in a couple of hours. Si-Bone is a small-cap MedTech company that specializes in implants that solve issues of the SI joint and pelvis. BUY

Spotify (SPOT), originally recommended by Mike Cintolo in his Cabot Top Ten Trader advisory, was back down this week after showing signs of life late in the previous week following an earnings miss sell-off. The stock is holding above its post-earnings low (140), so we’ll hang on for now. Any dip below that 140 number would likely have us selling. Stay tuned. HOLD

Terex (TEX), originally recommended by Mike Cintolo in Cabot Top Ten Trader, got a welcome boost from earnings last week, pushing shares up about 7%. The results were quite good: adjusted EPS of $2.35 blew analyst estimates ($1.61) out of the water and were a 120% improvement from the same quarter a year ago. Revenues increased 30% year over year. Strong demand, higher pricing and improved manufacturing efficiencies were behind the impressive quarter. The company also raised full-year 2023 guidance, likely giving shares an extra jolt. We now have an 8% gain on the stock in a month, well ahead of the S&P’s 2% gain during that time. Not bad. BUY

Tesla (TSLA), originally recommended by Mike Cintolo in Cabot Top Ten Trader, was down another 8% this past week. The only real news is that longtime Chief Financial Officer Zachary Kirkhorn is stepping down after 13 years with the company. Chief Accounting Officer Vaibhav Taneja will replace him. While losing a reliable top executive probably prompted at least some selling, the retreat in TSLA shares has more to do with a) the narrow margins (9.6%) the company reported during its late-July earnings release; b) the recent market pullback; and c) normal consolidation following a monster run-up the first half of the year, when the stock more than doubled. In fact, TSLA has still exactly doubled despite falling 16% from its mid-July top. With revenue (+46%) and net income (+10.5%) still growing by double digits, odds are the stock won’t stay down long, so I’ll keep it at Buy. BUY

Uber (UBER), originally recommended by Mike Cintolo in Cabot Growth Investor, is down 9% since reporting earnings last Tuesday. But there’s no cause for concern, as Mike wrote in his latest update: “Uber (UBER) has taken some lumps this week with everything else, but the chart remains in good shape and the Q2 report was terrific, pointing to big things down the road. For the quarter, bookings for trips (up 28% in currency-neutral dollars) and delivery (up 14%) were stronger than expected, even including shrinkage in the small freight business, which led to a 17% increase in currency-neutral revenues and another big leap in EBITDA ($916 million, up from $761 million the prior quarter and $364 million a year ago) and free cash flow ($1.14 billion, about 56 cents per share). Some other stats caught our eye, too, including the fact that 13% of delivery bookings now involve something other than restaurants (groceries, etc.), while the ad business on Uber, Uber Eats and in-car tablets is now a $650 million annual business (up 30% from the prior quarter and that’s without many big outfits signing up yet). Of course, none of this stopped the stock from falling after the report—it’s been that kind of earnings season—but shares are still around their 25-day line even after more downside today. All told, we’re optimistic longer term, so we’ll stay on Buy, though as with most things, aim for dips if you’re looking to grab shares.” I concur. We still have a better than 30% gain on the stock, so if you missed out on those gains or want to add to your position, this earnings overreaction looks like a good time to buy. BUY

If you have any questions, don’t hesitate to email me at chris@cabotwealth.com. You can also follow me on Twitter, @Cabot_Chris.

Here, too, is the latest episode of Cabot Street Check, the weekly podcast I host with my colleague Brad Simmerman.

The next Cabot Stock of the Week issue will be published on August 14, 2023.