Cabot Stock of the Week Issue: January 22, 2024

New all-time highs! We’ve been seeing a lot of them in the Stock of the Week portfolio of late, so it’s no surprise that the market is now following suit. So much for those early-January doldrums!

Of course, potential potholes remain, most notably the just-underway earnings season. Earnings helped fuel the rally in November and December, though most of that run-up was fueled by the suddenly dovish Fed. Now, the Fed seems intent on tempering expectations for when rate cuts will commence, and as a result, a majority of economists no longer anticipate the first cut to come in March, according to the CME Group Fed Watch Tool. And yet … the market has marched to new highs anyway. So, perhaps it’s best not to sweat the macro, and instead embrace – and profit from! – the new bull market.

That’s precisely what we’ve been doing in Stock of the Week, with more than three-quarters of our stocks showing double-digit gains. But it can’t hurt to cover your bases, and not simply have your foot on the growth pedal in case the rally does come to a screeching halt, even if it’s a temporary one. So today, we add a dividend-paying, blue-chip value stock – a familiar name to long-time readers, and one that’s long been a favorite of Cabot Value Investor Chief Analyst Bruce Kaser.

Here are Bruce’s latest thoughts on it.

Cisco Systems, Inc. (CSCO)

Cisco Systems Inc. (CSCO) is a technology giant that generates over $55 billion in revenues. Its routers, switches and other gear connect and manage corporate, government and telecom data and communications networks. Augmenting this gear is Cisco’s broad range of applications, integration and security software and related services that allow the company to provide one-stop-shop capabilities yet also customize packages that match each customer’s needs.

Founded in 1984, Cisco emerged as a dominant provider of internet hardware and became one of the Silicon Valley tech darlings during the late 1990s dot-com bubble. However, due to its then-extreme overvaluation and stagnating revenue growth, Cisco’s shares fell sharply and remain 35% below the March 2000 peak of about $80.

The primary weight on Cisco’s long-term prospects and valuation is the concern over how it will generate growth given a moderate but steady secular headwind – its core business struggles against the rising adoption of cloud computing, which reduces the need for Cisco’s gear and its one-stop-shop capabilities.

However, Cisco benefits from its strong reputation and entrenched position within its customers’ infrastructure. As long as it can stay close enough to competitors’ offerings, the company should retain these valuable intangible assets and buy itself plenty of time to transition to healthier growth.

Cisco’s long-term prospects have been improving, which started with the promotion of company veteran Chuck Robbins to the CEO seat in 2015. Under the new leadership, Cisco is accelerating its efforts to remain relevant and increase its value to customers. It continues to build out its offerings in the critical and faster-growth cloud services, hybrid work, security and 5G categories. To provide more recurring revenues and reduce its dependence on one-time equipment sales, Cisco is shifting its business mix to a software and subscription model. Progress is encouraging, with total revenue growth projected at a 3-5% pace. Software sales now comprise a third of total revenues, and 44% of all revenues are sold on a subscription basis.

Supporting his efforts on the financial side, Cisco replaced its CFO in December 2020 with Scott Herren. Herren previously helped Autodesk achieve a similar and successful rebuilding.

Last November’s 10% one-day sell-off, driven by the fiscal 1Q24 earnings commentary, continues to offer investors an opportunity in Cisco’s shares. While the actual earnings were impressive – rising 29% from the prior year and beating estimates by 8% – guidance for the second quarter and full year fell below estimates. Customers will be digesting their large volume of purchases made over the past year or so, which will dampen results for the next few quarters. While Cisco’s underlying fundamentals, including its long-term revenue trajectory, core expenses and free cash flow remain sturdy, the near-term hiccup drove investors to flee the stock. One indicator of the company’s value: the shares have recovered more than half of the November post-earnings decline.

Investors may also be showing some modest concern about Cisco’s huge and expensive $28 billion acquisition of Splunk. Announced this past September, the deal will drain most of the cash from Cisco’s fortress balance sheet for a transaction valued at 28x cash operating profits. However, this acquisition adds valuable cybersecurity tools to Cisco’s product and service array, which will help bolster its relevance and competitiveness. Over time, Splunk will likely add sizeable profits to Cisco’s bottom line that offset the elevated price. And, Cisco should continue to generate immense free cash flow to help replenish its coffers. The deal is projected to close by September 2024.

Financially, Cisco is solid. It is highly profitable, with a wide 65% gross margin and an impressive 35% operating margin. Free cash flow runs about $13 billion a year and is nearly 24% of revenues – a rare feat for any company. Cisco historically returns most of this cash flow to shareholders through dividends and buybacks and appears committed to this discipline. Notably, over the past five years, Cisco has reduced its share count by over 18%. While Splunk’s all-cash deal structure pays out most of Cisco’s current cash, it is likely cheaper in the long term than a stock deal.

The company has its challenges. In addition to the earlier-noted secular headwinds and customer inventory digestion issue, as well as the upcoming Splunk integration, Cisco needs to navigate what appears to be a slowing tech spending environment. We are also a tad wary of the company’s generous stock-based compensation program but recognize the company’s need to retain capable talent.

Overall, Cisco is a solid and resilient company with improving growth prospects that investors continue to underestimate. The shares trade at an unchallenging 9.8x cash operating profits and 13x earnings per share based on pre-Splunk fiscal 2024 estimates. The 3.0% dividend yield, which is readily sustainable, adds to the shares’ appeal. With continued revenue growth and solid cash flow production, we see Cisco shares having a prosperous future.

Current Recommendations

For the first time all year, we’re selling a stock – and it’s one of our favorites. BYD (BYDDY) is one of the most impressive, fastest-growing companies on Earth, and I love its long-term outlook. But because it’s a Chinese company at a time when investors are selling out of Chinese stocks like they’re the last items at a yard sale, it’s simply not performing well enough now to warrant inclusion in an otherwise stellar portfolio.

So, our portfolio stays at “only” 27 stocks. Here’s what’s happening with all of them.

Changes Since Last Week:
BYD (BYDDY) Moves from Hold to Sell

Updates

10x Genomics (TXG), originally recommended by Carl Delfeld in his Cabot Explorer advisory, dipped another point, from 45 to 44, since our last issue, but actually fell as low as 41 at one point. It’s up 6% in early trading today, on no news, so it seems the selling (also on no news) was overdone. Let’s see how it reacts in the coming days. We downgraded it to Hold last week, so I wouldn’t initiate any new buys until it’s clear that 41 was a short-term bottom. HOLD

Alexandria Real Estate Equities, Inc. (ARE), originally recommended by Tom Hutchinson in the Safe Income Tier of his Cabot Dividend Investor advisory, isn’t off to the most auspicious start since we added it to the portfolio two weeks ago, falling from 128 to 124. Still, some minor weakness was to be expected after a huge run-up in November and December. In his latest update, Tom wrote, “The Fed’s indication of three rate cuts next year added another up leg for some of the best interest rate-sensitive stocks. ARE has soared over 40% since the low of late October. But we didn’t miss the boat. The stock is still more than 40% below the all-time high. The company also has a highly reliable and growing business that should thrive in any economy. It’s cheap with strong momentum ahead of a period of likely strong performance as interest rates abate.” BUY

American Eagle Outfitters, Inc. (AEO), originally recommended by Mike Cintolo in Cabot Top Ten Trader, has had a down couple weeks but is still north of early-January support in the high 19s. The resilience of the U.S. consumer – evidenced by the 3% bump in holiday spending – gives this retail stock something of a floor, and trading at a mere 12 times forward earnings with better than 40% EPS growth expected this year, I like the upside. BUY

Aviva plc (AVVIY), originally recommended by Bruce Kaser in Cabot Value Investor, keeps holding steady right around 11, though it is flirting with the top of that range as I write this. There’s been no news. Shares of this U.K.-based life insurance, savings and investment management company still have 26% upside to Bruce’s 14 price target and offer a 7.2% dividend yield to boot. And, as Bruce noted in his latest update, “We anticipate a dividend increase for 2024. On a combined basis, the dividend and buybacks offer more than a 10% ‘shareholder yield’ to investors.” Good reasons to buy. BUY

Blackstone Inc. (BX), originally recommended by Mike Cintolo in Cabot Top Ten Trader, has bounced back nicely with the market, rising to 121 from 118 since we last wrote – living up to its Bull Market Stock (Mike’s term) reputation. We’ll see how it behaves after reporting earnings this Thursday, January 25. Analysts expect 9.8% sales growth but an 8.4% decline in EPS. We’ll see how Thursday’s results compare. BUY

Broadcom Inc. (AVGO), originally recommended by Tom Hutchinson in Cabot Dividend Investor, is at it again – up more than 100 points (nearly 10%!) in the last week to shatter its previous record high! Remarkably, there was no obvious candidate. Its strength is more general, as Tom wrote in his latest update: “This former solid dividend paying technology infrastructure stalwart turned into a sex symbol after artificial intelligence spending exploded last spring. AVGO exploded 75% higher since then. The stock tends to surge higher, then bounce around sideways for a while until the next surge higher. The latest surge was because the company reported earnings that impressed the market. Earnings remained solid and Broadcom also cited the potential to double AI revenue from $4 billion in 2023 to over $8 billion in 2024. Until the pattern changes, I expect AVGO to have another surge higher in the next several months.” Well, that surge has arrived (Tom wrote this last Wednesday). And we now have a 38% gain on the stock in just over five months. We’ll officially keep it on Buy for now, but I’d keep new positions to a minimum given the stock’s lofty perch at the moment. BUY

BYD (BYDDY), originally recommended by Carl Delfeld in his Cabot Explorer advisory, remains a massive underperformer, dipping below 50 for the first time in a year. I’ve been saying for months that this Chinese EV maker is one of my favorite long-term stocks, but Chinese stocks are so out of favor at the moment that its strong fundamentals – overtaking Tesla in total sales for the first time last quarter – aren’t enough to save it from being caught up in all the selling. You can’t just be a cheerleader, rooting for the stocks you like most even as they keep falling. So, today, we’re going to sell BYDDY. There’s a very good chance we’ll add it back at some point later this year, but not until it – and Chinese stocks in general - can right the ship. But now is not the time to own this time after two straight months of declines. MOVE FROM HOLD TO SELL

Comcast Corporation (CMCSA), originally recommended by Bruce Kaser in the Growth & Income Portfolio of his Cabot Value Investor advisory, keeps holding at 43. There’s been no news. Earnings are due out this Thursday, January 25, so that could be just the thing to get the stock out of its current rut. Some other bit of good news, as Bruce wrote last week, is that “Comcast’s live-streaming (on Peacock) of the Kansas City Chiefs – Miami Dolphins game set a record for a streaming event, with 23 million viewers. The internet volume was also a single-day record. Despite a few delays during the game, we’d view the effort as a success in Peacock’s efforts to establish a widely recognized streaming brand. The effect on Comcast’s earnings is for now unknown and depends on the revenues generated from new subscriptions and from advertising, as well as the costs involved. We expect to hear more color during the next quarterly report. Separately, as the political season rolls toward the fall elections, we would expect to see a surge in advertising revenues for Comcast’s networks.” BUY

CrowdStrike (CRWD), originally recommended by Mike Cintolo in Cabot Growth Investor, was up another 4.4% in the last week to reach yet another share price apex, just under 300. In his latest update, Mike wrote, “The stock did show some minor ‘exuberance’ signs last week, including three straight gaps higher, something that often leads to some weakness. Of course, the main trend here is fine for both the stock and business, but as with many names, we’re half-expecting further near-term wobbles. If you own some, just sit tight—if you don’t, you can consider buying a small position on dips of five or 10 points.” Up 88% in the four and a half months since we added it to the portfolio, CRWD has been our best performer by a mile of late. As I advised in last week’s issue, if you got in shortly after our early-September recommendation, now is the time to sell about a quarter or a third of your original position to book profits on our considerable gain. If you are not yet in, as Mike said, keep new buys small. BUY

Dave & Buster’s (PLAY), originally recommended by Mike Cintolo in Cabot Top Ten Trader, bounced off support in the mid-48s and is up slightly since we last wrote. There’s been no news. This is a bounce-back retail candidate that’s still up nearly 40% in the last three months, so a modest pullback like the one it’s been mired in all January is not surprising. Trading well off its 2017-2018 highs and expected to grow sales and earnings by double digits this year, PLAY has plenty of upside. BUY

DraftKings (DKNG), originally recommended by Mike Cintolo in Cabot Growth Investor, is back with a vengeance, hitting its highest point since early December! Mike theorized why in his latest update: “DraftKings (DKNG) is symptomatic of what we’re seeing in January—in the first week of the year, shares dove below the 50-day line and gave back all of their post-earnings gains from November, and last week it couldn’t get off its knees even as growth stocks did. But this week, DKNG has rallied hard, bolstered by an analyst report this morning that said ESPN’s new offering isn’t gaining revenue share, increasing the odds that DraftKings and FanDuel will basically remain the leaders over time. The rebound is obviously encouraging, but we’ll stay on Hold and see whether the stock can hold the move—or if more volatility is in store.” We’ll do the same. But another week like last week and we’ll surely bump it back to Buy. BUY

Dynatrace (DT), originally recommended by Tyler Laundon in Cabot Early Opportunities, is off to the races again, up more than 13% this month to reach new 52-week highs! The catalyst for this strong move appears to have been a January 5 upgrade (to Buy from Hold) from Jefferies analyst Brett Thill, who set a price target of 70 for this AI-powered data analytics upstart. That’s still 19% above the current share price. So, we’ll keep the stock at Buy even with a 31% gain in three months. BUY

Elastic N.V. (ESTC), originally recommended by Tyler Laundon in Cabot Early Opportunities, has more than recovered from a late-December dip, up 6.5% in the last week to hit a new 52-week high. In his recent update, Mike wrote, “Elastic (ESTC) looks great, roaring back from a couple of bad days to start the year to nose out to new price highs this morning (though the RP line remains a bit shy of its prior peak). If this was two months ago, we’d buy more today without hesitation—and, frankly, if you really wanted to add, we wouldn’t argue with it. But given the choppy situation of late (including the return of some selling on strength), we’ll stand pat tonight and see how ESTC handles itself after the upmove of the past few days; a couple of days of calm trading could have us filling out our position. Tonight, though, we’ll stick with a Buy a Half rating.” With a 60% gain in two and a half months, this stock has now reached CrowdStrike levels of outperformance. So, as I advised with CRWD (see above), it would be wise to trim a few shares – perhaps a quarter of your original position – to book some profits IF you bought shortly after our November 7 recommendation. For everyone else, nibble on dips. BUY

Eli Lilly and Company (LLY), originally recommended by Tom Hutchinson in the Dividend Growth Tier of his Cabot Dividend Investor advisory, has retreated a bit since touching new highs above 642 10 days ago. Totally normal action. The story remains very intact for this co-leader in the nascent weight-loss drug space. In his latest update, Tom wrote, “This superstar big pharma stock has been a lot like AVGO. It periodically surges higher and then consolidates by going sideways for a while until the next surge higher. LLY closed with a 2023 return of 60% and an average annual return of 52% over the last three years. LLY is already up double digits in 2024.

“Weight loss drug Mounjaro was approved by the FDA in November. Some analysts estimate it could potentially be a $20 billion per year drug. That would match the best-selling drug ever. It still has its Alzheimer’s drug up for FDA approval in the months ahead. Earnings are expected to grow at about a 25% per year clip over the next several years, but that number could be higher with the new drugs.” BUY

Green Thumb Industries Inc. (GTBIF), originally recommended by Michael Brush in Cabot Cannabis Investor, is right where it was a week ago, in the low 13s. There have been no catalysts for the stock or the cannabis sector, though the looming possibility of rescheduling (by the DEA, from a Class I drug to a Class III) seems to be keeping the sector in Wall Street’s relative good graces longer than it has been in quite some time. Perhaps the sentiment tide is finally turning for the long-maligned cannabis sector. BUY

Intel Corporation (INTC), originally recommended by Tom Hutchinson in the Dividend Growth Tier of his Cabot Dividend Investor advisory, has been in the 46-48 range all month after zooming as high as 50 in late December. Maybe earnings – out this Thursday, January 25 – will reignite shares. Analysts are looking for 7.9% revenue growth but for earnings per share to more than quadruple. BUY

Krystal Biotech (KRYS), originally recommended by Tyler Laundon in Cabot Early Opportunities, keeps ping-ponging between 125 and 129. Tyler provided some color on the stock in his latest update: “Krystal Biotech (KRYS) struggled in November after Q3 sales missed, likely because patients didn’t convert to Vyjuvek as quickly as expected once the drug was approved. But KRYS got back into a groove in December and is currently pushing up against overhead resistance near 130 – 133. The big questions lingering from the Q3 call surround conversion of new patients and pricing. My hunch is that we won’t know much more until around March 12 when KRYS is expected to report and without new information shares won’t be able to break significantly higher. I like KRYS but am a little concerned about what could happen to the stock if Q4 results don’t address all the issues from Q3. Therefore, with some questioning of the decision, I’m going to sell KRYS today … and keep an eye on it through the next earnings report. If all looks good we may revisit the name.” So, Tyler’s out, at least temporarily. Does that mean we should bail on KRYS too? I say no: Shares are WELL above their moving averages, we have a nice double-digit gain on the stock, and it’s flirting with new highs. Let’s hang on and see if we can squeeze a bit more juice out of this ripening small-cap biotech. BUY

Microsoft (MSFT), originally recommended by Tyler Laundon in Cabot Early Opportunities, has kept rising after last week’s break to new highs. It’s now the most valuable publicly traded company in the world. Earnings are due out January 30. Let’s see if they’re good enough to keep the momentum going. BUY

Novo Nordisk (NVO), originally recommended by Carl Delfeld in Cabot Explorer, has settled into a range between 105 and 108 after another big run-up in December. Its place as a co-leader in the weight-loss drug market (along with LLY, above) is secure, and Goldman Sachs estimates it could become a $100 billion market by 2030. Thus, shares of the Danish pharma giant likely are far from peaking. BUY

Nutanix (NTNX), originally recommended by Mike Cintolo in Cabot Top Ten Trader, has broken out in a big way, advancing to 55 from 45 in the last three weeks. In his latest update, Mike explained why: “Nutanix (NTNX) looks amazing, with some M&A rumors last week (which we discussed in the issue) and a couple of bullish analyst notes this week fueling a big advance. Big picture, this strength and the underlying story bode well—we think the stock could be a new emerging blue chip of sorts if all goes well. That said, shares have had a great run, have had a lot of good news and are now sticking straight up in the air. Thus, we’ll take partial profits here, selling one-third of our stake and giving our remaining shares some rope.” With a 54% gain on the stock in three and a half months, I suggest you do the same. BUY

Pinterest (PINS), originally recommended by Mike Cintolo in Cabot Top Ten Trader, remains stuck in the 36-37 range. In his latest update, Mike wrote, “Pinterest (PINS) hasn’t done much since I added the stock a month ago. The next big thing is to see if the company’s partnership with Amazon (AMZN), announced last April, will begin to bear fruit early in 2024. That’s the expectation. From there the next opportunities are more partnerships and international expansion. Revenue growth is already expected to double in 2024 (to roughly 18%) while EPS should grow north of 20%. We’ll learn more in early February, when Pinterest is expected to deliver Q4 2024 results.” BUY

PulteGroup, Inc. (PHM), originally recommended by Mike Cintolo in Cabot Growth Investor, has finally broken above 105 resistance, rising to 108 as of this writing. It could be the start of another rally, though it’s doubtful to replicate its six-week rally from 69 to 104 from late October through mid-December. Earnings, due out January 30, may determine how far this fresh breakout takes the stock. BUY

ServiceNow (NOW), originally recommended by Mike Cintolo in his Cabot Top Ten Trader advisory, keeps hitting new all-time highs, up another 4.5% in the last week! The blue-chip software company reports earnings this Wednesday (January 24), so it’s possible the numbers are good. We’ll know in a couple days. BUY

Tesla (TSLA), originally recommended by Mike Cintolo in Cabot Top Ten Trader, has sunk like a rock this month, falling from a high of 261 in late December to 209. Keep an eye on 197 as the next level of support; that’s where the stock dipped to at the end of October before rallying. Earnings are due out this Wednesday after the market close, so it’s possible even a mild beat could stop the bleeding. Expectations are quite underwhelming: 5.1% revenue growth, and a 36% EPS decline. That’s a low bar to cross for a company with a stellar history of growth. But I wouldn’t go buying more shares on that premise. Let’s hold on and see what the Q4 results look like. HOLD

Tripadvisor (TRIP), originally recommended by Mike Cintolo in Cabot Top Ten Trader, had an excellent debut week in our portfolio, advancing more than 8%. There was no news – we simply may have timed this one right after it fell from the mid-21s in late December. Now it’s well on its way to recovering all those mini-losses. Longer term, this is a play on yet another big year for travel and tourism – in a stock that still trades well below its highs. BUY

Uber (UBER), originally recommended by Mike Cintolo in Cabot Growth Investor, tacked on another point or two since our last issue. Here’s what Mike has to say about the stock: “Uber (UBER) is acting just as it ‘should,’ with a strong, persistent move into December, some tightness near year-end, a lower-volume dip to the 10-week line and a quick snapback to marginal new highs. If the market remains in good shape, we’re optimistic Uber is a ‘new’ liquid leader that can keep going higher—near-term, though, a lot will depend on whether January has another pothole in store for growth stocks. We’ll stick with the same advice: Hold on if you’re in, and if not, aim for dips of three or four points.” BUY

Varonis (VRNS), originally recommended by Tyler Laundon in Cabot Early Opportunities, is down a tad since hitting new 52-week highs. In his latest update, Tyler wrote, “Varonis (VRNS) has been acting very well among a fantastic backdrop for cybersecurity stocks (lots of bullish analyst commentary). The irony is that what’s good for these stocks is generally bad news for IT departments (rising threats). Varonis’ earnings date isn’t far off, it’s been confirmed for February 5. We’re looking for Q4 revenue growth of 6.5% ($151.8 million) to cap off a year of roughly 5% growth and for EPS of $0.23 to bring the 2023 total to $0.32. Looking into 2024, revenue growth is seen accelerating to nearly 10% (cloud transition still working well) and EPS growth should be at least 20% ($0.39 expected). VRNS is a well-liked stock among the analyst community and while the stock is looking a little stretched, I think any dips should be bought.” BUY

If you have any questions, don’t hesitate to email me at chris@cabotwealth.com.

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 January 29, 2024.