Cabot Top Ten Trader Issue: August 19, 2024

Very Impressive

The market isn’t totally out of the woods at this point—the intermediate-term trend of most indexes and growth measures is essentially neutral here, there’s plenty of overhead to chew through and, even when looking at objective measures (like the number of new highs, etc.), it’s far from 1999 out there. That said, there’s no doubt the rebound has been impressive, with some indexes (S&P 500, NYSE Composite, Nasdaq) recouping 60% to 80% of their corrections in short order, and as we’ve written about the past two weeks, individual stocks are acting much peppier of late, with tons of bullish earnings gaps and a decent amount of upside follow-through. What happens from here will be key: Some backing off would be normal, but if any retreat is tame and individual stocks continue to flex their muscles, it would be a good sign—though obviously a huge drop would be iffy. For now, we continue to slowly rebuild exposure but are remaining flexible, mostly sticking with smaller positions on the buy side and honoring stops if the sellers show up again. We’ll nudge our Market Monitor up to a level 6, but are taking things on a day-to-day basis.

This week’s list is another that’s loaded up with powerful charts, all of which have recently surged on earnings reports and shown upside action after. Our Top Pick is Shift4 Payments (FOUR), which has been extremely tedious for the past 16 months but is flashing some overwhelming buying power as the sector improves.

Stock 1

AppLovin (APP)

Why the Strength
AppLovin is an emerging blue chip that few have heard of, as it’s looking like one of the next big plays in online and mobile advertising. The company’s claim to fame is its AI-powered Axon 2.0 advertising engine, which ingests tons of data to identify and target users for marketers; it was launched in the first quarter of 2023, and it’s been a huge hit, constantly improving as it takes in more data and results, with more advertisers spending more money with the company. (In fact, in the latest conference call, the top brass said the system is effectively supply-limited, with advertisers willing to spend more on the platform as the system improves and can handle steadily larger volumes.) Right now, the ads are mostly targeted to mobile game users, and while growth has been fantastic (see table below) and free cash flow is massive ($2.50 per share in the first half of the year), there were worries that the industry would be saturated, stunting growth in 2025 and beyond, while AppLovin’s ability to move into other areas was an unknown. But both of those thoughts were essentially shot down by management after the Q2 report: The top brass said it believes 20%-plus annual growth is possible for many years just within the mobile game area as Axon’s intelligence improves and more money is spent using it; meanwhile, early tests in other areas like e-commerce and elsewhere have been promising in terms of returns for advertisers. Thus, while the booming top-line growth will probably slow in the quarters ahead, it should remain healthy while EBITDA and free cash flow grow even faster—and if/when Axon enters new industries, business could pick up in a big way. It’s a great story that big investors are piling into (1,078 funds own shares, up from 879 and 570 the prior two quarters).

Technical Analysis
After a huge off-the-bottom run, APP stalled out in the mid-40s last fall and actually based out while the market got going, but the Q4 report in February broke the stock out and produced a very solid move into the 90 area in May. After a double top in July, shares skidded sharply and looked done for, especially when the after-hours reaction to the Q2 report brought good-sized losses. But instead, APP has turned up, and done so powerfully, rallying back on two weeks of above-average weekly volume toward its old highs. Like most things, there’s overhead to deal with, but we’re OK with a small buy and a loose stop—and possibly buying more on a clear breakout above 91.

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Stock 2

Cirrus Logic (CRUS)

Why the Strength
After the weakest year of the last decade in 2023, global smartphone shipments grew 7% in Q2 to mark the third straight quarter of year-on-year growth. The strong recovery in this market, especially for iPhones, is a big reason for the enthusiasm behind fabless chip producer Cirrus (covered in the July 22 issue). The Austin-based company is well known for its analog, mixed-signal and audio DSP integrated circuit and supplies audio and voice processing chips used in Apple iPhones (the firm’s biggest customer, accounting for around 80% of revenue). In fiscal Q1 (ended June), stronger-than-expected iPhone 15 demand contributed to the company’s stellar financial results, led by revenue of $374 million that increased 18% from a year ago (a huge acceleration from recent quarters), along with earnings of $1.12 that beat estimates by 50 cents, while free cash flow for the past four quarters totaled a whopping $9.50 per share with a 28% margin! The balance sheet also remains strong, as Cirrus ended the June quarter with $745 million in cash (about 10% of the market cap) and no debt, allowing the company to repurchase 361,000 shares in the quarter (share count down 1.8% in the past year), with $274 million remaining on the repurchase authorization. Management further guided for fiscal Q2 sales of around $520 million at the midpoint, up 40% sequentially (8% year over year) if realized in what is the second strongest quarter of the year seasonally. The bullish guidance is supported by next month’s release of the new iPhone 16, which will feature more of Cirrus’s content inside it, including an updated audio decoder, a custom boosted amplifier and a higher attach rate of camera controllers. Additionally, Cirrus said it’s seeing strong design activity in laptops, and it just introduced its latest products in a series of data converters targeting professional audio, consumer and industrial applications. Going forward, the firm plans to focus on increasing its high-performance mixed-signal (HPMS) product line while expanding its market in laptops and AI-driven devices. Several Wall Street firms have raised target prices for Cirrus in the wake of the Q1 results (another reason for the stock’s strength), with analysts seeing 12% bottom-line growth for Q2, which is likely conservative.

Technical Analysis
We were stopped out of our remaining position in CRUS earlier this month by the huge chip sector selloff, essentially getting us out at breakeven on that chunk (we had taken partial profits earlier). The decline, while a doozy, came to a halt when shares found support around 110 and was followed by an equally sharp upside reversal, bolstered by the blowout Q2 report. Impressively, shares are now back to the previous high at 142, well ahead of the overall market—while some near-term volatility is definitely possible, we’re OK buying on minor weakness.

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Stock 3

Doximity (DOCS)

Why the Strength
Doximity is the leading digital network for healthcare professionals in the country, with 90% of all medical school graduates, over 80% of U.S. doctors and 50% of all nurse practitioners, physician assistants and pharmacists as verified members. (The company’s contention is that, aside from the iPhone, “There’s never been a piece of technology adopted by clinicians as quickly as Doximity.”) Among its features, the cloud-based platform allows its medical clients to conduct virtual patient visits, send and receive electronic faxes on the go, securely collaborate on patient treatment while on-call, as well as stay up to date with the latest medical news and research. Doximity’s focus of late has been on expanding its offerings while increasing user engagement and using artificial intelligence to customize experiences and enhance its product suite. The company said the increasing integration of AI into its platform is a “cornerstone” of its growth strategy, and its recent efforts on this front are paying off: The firm’s AI-powered Doximity GPT tool is seeing wide adoption among doctors, with over 1.5 million letter requests or prompts, enabling clients to streamline administrative burdens. Thanks to these innovations, the firm continues to grow its user base, as a record 590,000 unique healthcare providers used its AI, telehealth, messaging and workflow tools during fiscal Q1 (ended June). Also during the quarter, Doximity’s top 20 clients (primarily pharmaceutical manufacturers) expanded their purchases faster than other segments of its clientele, growing 21% on a trailing twelve-month basis, which the top brass attributed to the fast pace of its product development and its “land and expand” strategy. On the financial front, revenue of $127 million increased 17% from a year ago, while earnings of 28 cents a share topped estimates by six cents and adjusted EBITDA surged 42%. Going forward, Doximity said it’s focused on delivering “industry-leading products” to sustain the long-term growth story. Wall Street expects 10%-ish growth for the top and bottom lines in fiscal 2025, which should prove conservative.

Technical Analysis
After more than doubling from its IPO price in mid-2021, the next couple of years were rough ones for DOCS, with shares tumbling all the way to 20 last September before buyers stepped in. The stock climbed to 30 between November and January and then spent the next six and a half months building a launching pad for the next phase of its turnaround. Earnings were the catalyst for the recent high-volume lift-off, with DOCS rallying to yearly highs and holding the gains in recent days. If you’re game, aim to enter on minor weakness.

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Stock 4

Fortinet (FTNT)

Why the Strength
An alarming spike in both the volume and the sophistication of digital crimes is providing a sizable tailwind for global cybersecurity spending, which is projected to grow at a 13% annual clip between now and 2030. Fortinet occupies a top spot in the cybersecurity software space by using artificial intelligence and machine learning to stay ahead of evolving threats, while also providing solutions for the fundamental problems of an increasingly bandwidth-intensive network environment. Its cybersecurity leadership position (it serves nearly three-fourths of Fortune 500 and Global 2000 companies) accounts for its impressive revenue and cash flow growth rate in recent years. Sales and billings were better than expected in the latest quarter, thanks in part to its Security Operations (SecOps) and Secure Access Service Edge (SASE) solutions, which grew at a healthy rate with “meaningful penetration” of the firm’s installed base (more than 90% of billings from these two segments came from existing customers). Total revenue of $1.4 billion increased 11% from a year ago in Q2, and while product sales declined 4%, service revenue soared 20%. Earnings of 57 cents beat estimates by 16 cents, and while free cash flow (FCF) of $319 million was 27% lower due to a $190 million deferral of cash tax payments, without the one-time tax effect, Fortinet’s FCF would have increased by almost 30% and came in well ahead of net income. Other key metrics were equally healthy, including total deferred revenue of $5.9 billion that jumped 15% from the year-ago Q2. The upbeat results prompted a number of Wall Street institutions to raise price targets for the stock (a reason for the strength), including a major bank that highlighted the firm’s improving margins, while Fortinet itself said key indicators point to a better environment ahead as the firewall market turns up. Analysts see low-teens percentage sales growth for 2024 and some acceleration is seen near term.

Technical Analysis
After a sterling post-pandemic run, FTNT hit a highwater mark last summer at 80 before the bottom dropped out last August on an ill-received earnings report, eventually pulling the stock as low as 44 in November. Shares recovered back to the mid-70s in the spring but once again found sellers, moving lower and then tightening up over the next few months. But the long digestion phase from last fall now looks to be over, with a huge earnings reaction and follow-on buying in recent days. It could easily exhale, but we’re OK starting a position near here or (preferably) on dips.

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Stock 5

Monday.com (MNDY)

Why the Strength
Monday.com offers shared workflow and automation software designed to be easy to use by non-tech types, like salespeople, marketers and human resources professionals. The company has quickly expanded its Work OS platform from basically one app when the business went public three years ago to a whole platform that streamlines team communication with instant synced messaging and lots of customizable project management and data sharing options, helping with work and project management, CRM and development, too. The system is designed with features people find simple, like the ability to drag and drop columns and events around a virtual whiteboard and tons of automation features. The software also acts as a connective layer for apps like Gmail, Zoom and Salesforce, enabling automation of alerts and tasks to be pulled from those into the whiteboard. Just recently, the company rolled out its mondayDB 2.0 suite that can handle up to 500,000 items on a dashboard, allowing the firm to service corporate clients with more complex projects. The firm’s been implementing price hikes, which are helping the bottom line as clients roll into new contracts—the hikes haven’t affected client retention much, and with and about 60% of clients still to be moved to the higher pricing tiers, Monday.com has increased its outlook for the year to about $960 million sales, up about 32%. That might be a touch conservative given that Q2 results, announced last week, saw sales rise 34% to $236 million, earnings more than double to 94 cents per share and free cash flow was over $1 per share. Like seemingly every other tech company, Monday.com says AI is a priority, with its early implementation in customer service enabling about half of customer service queries to be automatically resolved. If AI does help, it’ll help boost Monday’s already high margins, which came in easily above 20% pre-tax in Q2. It’s a solid story and investor perception may finally be kicking into gear.

Technical Analysis
MNDY looked like it was ready to go after gapping up on earnings in May, but the narrow market advance meant the stock couldn’t get going through round-number resistance near 250, which left it open to the quick selloff when the market went over the falls earlier this month. But as was seen in April, the 200-day line held, MNDY bounced—and then soared above that 250 resistance last Monday and built on those gains a bit afterwards. There’s some near-term risk, but we’re OK with a small position here or on a shakeout with a stop near the 50-day line.

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Stock 6

Rocket Cos. (RKT)

Why the Strength
Despite some signs of gradual recovery in home listings and sales, home affordability remains at historically low levels due to persistently high mortgage rates and rising home prices. Yet this dynamic hasn’t dented the financial and market share growth of Rocket—and with rates starting to ease, big investors are thinking a new growth wave could be around the corner. The Detroit-based fintech consists of mortgage, real estate and financial service businesses, with the stated goal of helping its clients “achieve the dream of homeownership and financial freedom.” The company’s flagship business, Rocket Mortgage, has provided over $1.6 trillion in home loans since 1985, and its expansion into complementary industries like real estate services and personal lending seeks to “reinvent and enhance” the client experience by leveraging the AI-driven Rocket Logic platform by expediting loan processing, handling client interactions and streamlining various tasks traditionally performed by human agents. Accounting for the latest show of share price strength was a 23% year-over-year gain in adjusted revenue (which strips out unrealized gains or losses from mortgage servicing rights) to $1.2 billion, and an EPS of six cents that beat estimates by a penny as profitability expanded for the fifth straight quarter. The sanguine results were driven by a 10% increase in loan origination volume from Rocket Mortgage despite the challenging environment, to $25 billion, with a major industry ratings firm naming Rocket number one for client satisfaction in mortgage servicing. The company also expanded its AI-powered live chat, resulting in a three-fold boost in conversion rates for clients using the chat compared to those who didn’t (80% of its clients prefer live chat to personal assistance). It also accelerated the rollout of Rocket Logic Assistant, an AI-powered personal assistant, to Rocket’s entire banking team. Additionally, the firm just launched an upgraded workflow system that streamlined the loan onboarding process to drive efficiency at scale. All told, Rocket said its AI investments have facilitated client retention rates that are 3x higher than the industry average, while generating recurring cash flow without additional costs. Thus, the firm looks lean and mean just as a new mortgage borrowing upturn looks likely—expect big earnings growth ahead.

Technical Analysis
After crashing in 2021 and early 2022, RKT spent the period from mid-2022 to October 2023 building a huge, volatile bottoming area, with shares finally seeing some buying late last year as the stock moved up to 15. But as Fed rate cut expectations were scaled back, shares spent another few months building a tightening base. Now, as people see the Fed finally turning into a friend, RKT is off and running, rising seven weeks in a row, mostly on big volume. If you want in, aim for minor weakness, though we’re not expecting a big retreat.

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Stock 7

Sea Ltd (SE)

Why the Strength
Singapore-based Sea Ltd. is one of Southeast Asia’s and South America’s leading e-commerce, online entertainment and financial service providers. Its e-commerce (Shopee) and digital gaming (Garena) segments have been compared to Amazon and Activision, while its digital payments arm, SeaMoney, offers e-wallet services, payment processing and other financial products. Garena, the lowest-revenue but highest-profit segment, is a big reason for the stock’s recent strength: Although it has underperformed since 2022, its top game Free Fire (a huge hit during the pandemic) has since seen its numbers stabilize and turn up again in the last two quarters. Despite an 18% year-on-year revenue drop in Q2, daily active users have rebounded in the last two quarters, reaching about 650 million as of Q2, a 19% year-on-year increase, while paying users grew 22%. And despite a minor EBITDA dip, the all-important Shopee segment just posted its third straight quarter of higher earnings since last year’s company-wide turnaround. Meanwhile, SeaMoney (which supports the Shopee marketplace) saw a 21% revenue jump in Q2 after registering four million first-time borrowers (up 40%), with further support coming from stronger consumer and small/medium business credit business, as loans of $3.5 billion also increased 40%. Collectively, the results contributed to total revenue of $3.8 billion which climbed 23%, and while earnings of 31 cents a share missed estimates, they improved 11% sequentially. The sanguine results prompted management to increase its full-year forecast for gross merchandise volume to mid-20% growth (up from the earlier high-teens target). Looking ahead, Sea is focused on initiatives to make it easier for sellers to join its ad platform (sellers who pay for ads increased over 20% in Q2), while increasing Off-Shopee credit use. After a couple of years in the wilderness, Sea has turned the corner, with 20%-plus revenue and booming earnings growth expected for many quarters to come.

Technical Analysis
After reaching an all-time high around 350, SE hit the wall in late 2021 and sunk to a multi-year low at 35 last August, which was followed by a five-month bottoming process that saw the low tested multiple times without breaking. The turning point arrived shortly after the calendar flipped, with SE moving up nicely between January and March and, after a brief exhale, rallying to 76 by June. The correction from there was sharp, with the stock knifing down to its 40-week line, but it found support with the market and then gapped and ran after earnings, hitting fresh 15-month highs. We’re fine with a small buy here or, ideally, on dips of two or three points.

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Stock 8

Shake Shack (SHAK)

Why the Strength
From an investor’s point of view, the attraction with Shake Shack is that it’s a combination growth and turnaround play that, after many years of uneven bottom-line performance, is starting to see consistent growth while a new CEO offers hope of more of that down the road. The company, of course, got its start mostly in New York City and is essentially a yummy roadside burger joint that also has top-notch hot dogs, chicken sandwiches, fries, shakes and the like. Business has always been solid on the top line, thanks mostly to a huge cookie-cutter story, opening both company-owned (mostly in the U.S.) and licensed (international) locations—Shake Shack had 547 restaurants at the end of June, up 16% from a year ago (41 more company-owned, 35 more licensed), with similar growth expected for many years to come. In the past, same-store sales generally lagged but are beginning to improve some (up 4% in Q2, the fastest growth in a while, though that was solely due to higher prices), and the bigger part of the story is that the firm is finally cracking down on costs: In Q2, the company’s restaurant-level profit margins leapt to 22%, up one percentage point from a year ago, as cost of goods sold fell to 27.8% in the quarter, down 1.2 percentage points and labor costs and building costs slipped a bit, too, all of which led to a great bump in EBITDA (up 27% from a year ago). Expect similar growth through 2025, with upside if inflationary trends in things like food and packaging continue to cool (or even pull back a bit). Another plus is the firm’s new CEO, which it stole from Papa John’s, where, as CEO, he led the firm to solid results.

Technical Analysis
SHAK has shown the ability to have some big, multi-month moves, though they usually occur after sustained drops that wipe out the weak hands. That’s the situation we see today: After rallying to 110 in March, shares stalled out and then suffered through a persistent decline that took the stock into the high 70s by the end of July. But shares rebounded strongly after that thanks to the Q2 report and, after a quick market-induced shakeout, have pushed all the way back to their prior highs. Today’s drop looks normal given that SHAK just tested its prior highs, but we’ll set our buy range up from here, aiming to buy on a confirmation of the recent strength.

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Stock 9

Shift4 Payments (FOUR) ★ Top Pick ★

Why the Strength
For the past 18 months, Shift4 has quacked like a new fundamental leader in the payment space, with innovative and end-to-end solutions that combine software and payments for a variety of end markets, including restaurants (which were the main focus up until a few years ago and still make up a good chunk of volume, with Shift4 gaining share; its latest SkyTab point-of-sale system is growing like mad thanks to its cloud features and lower cost of ownership), sports and entertainment (including many big stadiums and franchises like the Colts, Bulls, Patriots, Grizzlies, Pacers and Bears; its offering is able to link concessions, parking, retail, ticketing and more), hotels and resorts (this group now makes up a whopping one-third of volume; it inked deals in Q2 with the Whistler Blackcomb, one of the best ski resorts in the world, many locations across Yosemite National Park and a couple of Nobu hotels), casinos (inked a deal for the Massachusetts state lottery) and nonprofits (Boston Marathon just signed up), and it’s going overseas, too. Growth has been consistently good for a while in just about every area, and that continued in Q2: End-to-end payment volume boomed 49%, while revenue less network fees lifted 41%, EBITDA was up 48% and free cash flow came in well ahead of net income. More than that, the top brass moved estimates up a bit, with the full year likely to see 45%-ish revenue growth (“well north” of 25% growth excluding M&A), with EBITDA lifting in the high 40% range and free cash flow coming in around $400 million, or well over $4 per share. And given that many of the big deals signed in the past couple of quarters will take time to come online, there’s every reason to expect rapid growth to continue—indeed, analysts see the bottom line lifting nearly 30% in 2025, which will probably prove conservative. Throw in a reasonable valuation and talk earlier this year of possibly getting taken over, and there’s a lot to like in Shift4.

Technical Analysis
FOUR showed great relative strength in early 2023, but since then it’s been a tease, with consistently great results only leading to lots of wild swings between 45 and 80 (ballpark). However, there’s no question that, just looking at the chart, this rally attempt looks different, with a double bottom (in the 56-58 area) and now two massive-volume buying weeks (seven straight days of a huge buying volume), each of them closing near the peak for the week. The mid-80s does offer resistance, but we think a small buy here or on minor weakness is worth the risk, with FOUR’s potential upside big if it gets going from its long consolidation.

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Stock 10

TG Therapeutics (TGTX)

Why the Strength
TG Therapeutics is in its second year of sales of its first commercially available drug, Briumvi, which treats patients with relapsing forms of multiple sclerosis. Sales exceeded management expectations in the most recent quarter by 12%, leading to the business generating $73.5 million total revenue, nearly all of which was from the one drug. Management bumped up its full-year Briumvi sales sights for the top end to $300 million, up from $260 million at the start of 2024. The business has an “enhanced” version of Briumvi in Phase III Trials, which focuses on expanding the drug to a related but distinct market: The version of Briumvi that’s approved focuses on the loss of the CD19 antigen, while trials are focusing on the loss of the CD20 antigen, which could be a market roughly four times as large. Recent data there shows that targeted patients should be able to safely shift to Briumvi from existing treatments. The business has two other in-house treatments focusing on B-cell eradication in Phase I trials and TG also struck a deal to license a B-cell therapy from Precision Bioscience this year. With that, TG has rights to all non-cancer applications, which management thinks should have great potential with autoimmune diseases. Even so, that’s all pre-clinical work right now, and that means the success of Briumvi is what the business rides on for the next few quarters. The year-over-year comp gets a little harder for TG in the current quarter, since it started selling in the E.U. just over a year ago, but the company is seeing progress in getting the drug picked up by the U.S. Veterans Administration Centers for Excellence. All in all, analysts see sales actually accelerating (up 51% for 2025) and the bottom line is already in the black and should pick up in a big way in the quarters to come.

Technical Analysis
TGTX is very volatile and has had some exaggerated moves (up and down) during the past year, but it’s been shaping up for a few months, mainly thanks to bullish earnings reactions in February and May and then, after a run to 23 and shakeout with the market in August, another gap up on earnings this month, too. Even better, TGTX powered to new highs today on big volume, which, while possibly leading to some near-term wiggles, is certainly a good sign. Expect plenty of volatility, but we’re OK starting a position here or on dips of a point or so, but use a liberal loss limit.

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Previously Recommended Stocks

The next Cabot Top Ten Trader issue will be published on August 26, 2024.

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