Cabot Top Ten Trader Issue: December 18, 2023

Fed Finally off the Market’s Back

Note: We will have a Movers & Shakers update later this week, but just a heads up, there will be no Top Ten issue next week (December 26), as it’s the second of our two weeks off all year. For those that celebrate, we hope you have a very, very Merry Christmas!

Onto the market, things can always change—a renewed uptick in inflation or changing economic conditions—but after two years of rate hikes and hawkishness, it looks like the Fed is finally “officially” off the market’s back, with the rate hike cycle over and it’s possible some with cuts are on the horizon next year. Interest rates have been the tail that’s wagged the market for two years, so that’s obviously good, and it’s no surprise that stocks (especially the broad market) catapulted on that news. With all of that said, it’s important to keep your feet on the ground; we’re not expecting a major dip, but it’s certainly possible stocks (and bonds for that matter) could wobble a bit or we could see some rotation (which popped up late last week) now that the good news is out. Even so, the rubber-meets-the-road evidence is strongly positive, and this comes after two years of, at best, tough trading, and for some areas, a punishing bear phase. We’re moving up our Market Monitor to a level 8.

This week’s list is a balanced one, with some growth, some cheap names coming back from the depths, some cyclicals and more. Our Top Pick is Blackstone (BX), the granddaddy of Bull Market stocks that should do very well if this advance continues and the overall environment has truly changed. Try to buy on dips.

Stock 1

Advanced Micro Devices (AMD)

Why the Strength
Spending on artificial intelligence (AI) infrastructure for the data center market is projected to increase from around $30 billion this year to an astonishing $400 billion-plus by 2027. The big news with AMD is that it sees its data center-class MI300 super-chip as an integral player in this market, with the company’s new AI accelerator (hardware designed and used to process visual data) being capable of performing up to 1.6 times better than the systems of its main competitors. AMD’s MI300 accelerator series was released earlier this month to great fanfare and looks like the main reason for the stock’s recent strength—the company indicated that it’s already seeing “very strong demand” for its Instinct MI300 graphics processing units (GPUs), which are being billed as the “highest-performance accelerators in the world for generative AI.” AMD also said it’s building “significant momentum” for its data center AI solutions with the biggest cloud companies, server providers and AI start-ups, with the idea that the new products would “dramatically accelerate” the pace of innovation across the entire AI ecosystem. Another big story here is that AMD’s MI300X chip is expected to compete directly with chip giant Nvidia, which currently controls 80% of the data center AI accelerator market, specifically with its H100 GPU—the most widely used AI chip, and which sells for ~$30,000. (Advanced Micro says the MI300X is faster and offers up to a 60% better performance than the H100.) The new launch prompted several Wall Street institutions to up their price targets, with one major bank asserting that the trends in the AI infrastructure market will likely take decades to play out, leaving AMD with plenty of runway. Analysts expect 16%-ish sales growth next year while earnings rebound meaningfully, with the AI excitement having many thinking there should be lots of upside from there.

Technical Analysis
AMD rallied to a high above 130 in June, but turned lower that same month ahead of the tech sector-wide downturn in July. Shares slowly ground their way down to 93 by late October, when earnings (and the market) came to the rescue and kicked off an explosive rally to above 120 over the next few weeks. A short-lived pullback earlier this month was reversed at the 25-day line, with huge-volume buying seen in recent days following the recent AI announcements. AMD is a herky-jerky stock historically, with wild moves the norm, so we’ll set our buy range down a bit from here.

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Stock 2

Birkenstock (BIRK)

Why the Strength
A German maker of comfortable, durable sandals, Birkenstock has gone from a brand for free-spirited, earthy-crunchy folks, as well as people needing orthotics to a fashionable curator of some 700 versions of sandals and other footwear, using a “luxury scarcity model” to build a sense of demand and maintain pricing power. The company also collaborates with other luxury brands and designers for even scarcer limited editions. The approach brings big margins because Birkenstock tends to focus on one type of sandal silhouette (hence reducing costs) to produce a sizable line of sandals, from affordable ($60 or so) pairs, with half a dozen or more increasingly scarce varieties priced all the way up to $700. (Recent top-end collaborations have been with cult brands Manolo Blahnik, Dior and Adererror.) The 250-year-old business shifted from producing enough to meet demand to a scarcity model a decade ago, cutting reliance on specific retailers during that time while beefing up direct-to-consumer sales and successfully entering the closed-toe shoe market. It has a strong record of customer loyalty in part because it remains intent on maintaining quality: Birkenstock’s vertical manufacturing process sees all of its goods crafted in company-owned factories in Europe with suppliers held to strict quality and ethical standards. Sales hit about $1.46 billion last year, a 20% compound average growth rate over the past 10 years. Today about 38% of sales are direct to consumers, with 54% of revenue in the Americas, 36% in Europe and the rest in Asia. In the first nine months of its fiscal 2023, revenue was up 21% while net income jumped 47%. The firm’s Q3 ended in September and … there hasn’t been a report yet, and no date for one provided to this point, though the company did announce a big debt paydown with the proceeds of the IPO. Overall, Birkenstock is a unique retail new issue.

Technical Analysis
BIRK held its IPO in October, pricing at 46. Shares promptly shed 10 points in the bearish market but spent the subsequent six weeks steadily edging higher until recapturing its IPO price to start this month. A newly public stock can be volatile as it finds a base of investors willing to support shares—indeed, trading volume here is borderline at the moment—but with the market’s winds at its back, we think BIRK can do well. You could nibble here if you really want in, but we’ll set our buy range down a bit.

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Stock 3

Blackstone (BX) ★ Top Pick ★

Why the Strength
We’re all for a good software, networking, retail or medical growth leader, but Bull Market stocks—firms whose business is directly linked to the movement in asset prices—are also a sector worth monitoring if you think the market has truly turned the corner. We wrote about KKR last week, and Blackstone is another—really the granddaddy of the group, with a huge asset base and its fingers in many different money jars: Total assets at the end of September were just over $1 trillion, with private equity, real estate and credit each making up around 30%, while hedge fund solutions made up the rest. Importantly, nearly three-quarters of those assets were fee-related, which bring in regular income and smooth out results (and result in a solid payout; last quarter’s dividend was 80 cents per share, which was down from higher payouts a few quarters earlier). In terms of trends, though, there’s no doubt the weak stock and bond markets (tighter money) have slowed things down; assets were up just 6% from a year ago, with just $25 billion of total inflows in Q3. Of course, seeing any growth is a good thing given what was going on, and more important, all that is in the past—the market is clearly looking ahead and seeing that (a) the firm’s current holdings have greatly increased in value of late, (b) they should continue to do so given the Fed, and (c) as money becomes easier (or at least doesn’t get tighter) and sentiment improves, inflows should pick up … all of which will also lead to higher dividends (the payout is variable) and share buybacks, too. It’s not changing the world but Blackstone has a history of doing well in strong uptrends and we don’t see why this time should be any different.

Technical Analysis
BX bottomed last December and did show a few signs of bullishness earlier this year, but the stock’s fall correction was tough—and, net-net, shares were around 89 at the end of October, back to where they were in January of this year and not all that far above its nadir near 80 last year. But the action since the low has been powerful (much more persistent and powerful than rallies earlier this year), with BX galloping to new 20-month price (and 13-month RP) highs last week. We do think some fidgeting is likely after the post-Fed boom last week, but we’re not expecting a major retreat. We’re OK starting a position here or (preferably) on dips.

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Stock 4

Capital One Financial (COF)

Why the Strength
Banks—particularly regional lenders—have struggled mightily with higher interest rates in the last two years, and more than most industries, as rate-related headwinds increased deposit costs and lowered the value of their bond portfolios, plus for those dealing with so-so quality borrowers, credit quality also came into question. But with the Fed calling off the dogs and bond yields experiencing a sizable drop, financial stocks are experiencing a resurgence as the value of their fixed-rate securities (largely purchased when rates were lower) is now increasing. Virginia-based Capital One is a bank holding company specializing in credit cards, auto loans, banking and savings accounts, with nearly $500 billion in assets. Results here have stabilized after big declines in recent years, with a solid improvement in Capital One’s net interest margin (the amount earned on loan interest compared to the amount paid in interest on deposits), thanks in part to wider credit card yields (the highest of the major loan categories) and higher credit card balances. The company’s consumer and total deposit growth has also been outperforming its industry peers (4% year-to-date for Capital One versus 2% for the overall industry), which has allowed it to expand its interest-earning loan book and get profits headed up. This was on display in Q3 when the company posted revenue of over $9 billion that increased 6% from a year ago, and earnings of $4.45 that improved by the same amount, led by “strong” top-line growth in its domestic card business and driven by increasing loans. But the stock’s change in character is mostly about what’s to come—if money is set to become easier (or at least not get tighter), the odds favor improving delinquency rates (which Capital One was already seeing anyway) and a faster rebound in the bottom line, not to mention a likely pickup in new asset acquisition should the economy get a boost. Wall Street sees a 7% bump in the bottom line next year, but the market clearly thinks that will prove way too low.

Technical Analysis
COF isn’t a normally Top Ten-type stock, but it’s showing super strength here after a couple of poor years as investor perception rapidly changes for the better. Indeed, shares fell from near 180 in 2021 and didn’t bottom until May of this year near 84, and as of late October, shares were still stuck under 90. But COF rallied with the market last month and has seen a moonshot on accelerating buying volume since Thanksgiving, reaching 19-month highs. Normal pullbacks should lead to further upside.

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Stock 5

Datadog (DDOG)

Why the Strength
One of our favorite long-term tech trends is observability, which revolves around the fact that enterprises these days often have dozens of different applications from a variety of vendors to manage every part of their business—but making sure they’re all working (and working together) is hard to do. That’s where Datadog comes in, with one of the leading platforms that combines app performance and tech infrastructure monitoring, log management, cloud security, digital experience monitoring (measuring the quality of a user’s interaction with an app, browser, etc.) and much more (19 offerings in all), allowing clients to make sure everything is performing according to plan. There is plenty of competition, but Datadog is one of the real leaders, and experts see the overall sector booming another 40% in just the next three years, so there should be plenty of opportunity for everybody. The company has more than 26,000 customers (up 22% from a year ago) and retention rates are in the mid- to high-90% area, so once the company gets a client in the door, they stay—and often sign up for more capabilities over time (82% of clients use at least two modules; 21% have signed up for at least six). To be fair, growth has slowed as the tech selling environment turned tough the past two years, but revenues still rose 25% in Q3 and the figure should stabilize around there for the next year—and even that could prove too low given some of the forward-looking measures (billings up 30% in Q3, remaining performance obligations up 54%) seen. It’s not the hypergrowth outfit it was during the pandemic, but this “old” leader looks like it can lead again with solid sales, earnings and free cash flow growth (free cash flow margins of 25% during the past 12 months!) going forward.

Technical Analysis
DDOG has followed a similar pattern to many growth stocks, with a huge decline in 2022, a bottoming-out phase for many months, and a nice rally in the spring—followed by yet another tedious decline in the summer and fall as the market retreated. Q3 earnings, though, brought a massive-volume rally (biggest weekly volume since 2020) and shares moved all the way back to their old high, and after a brief rest, DDOG pushed just above key resistance near 120. We’re OK buying some around here, though we prefer looking for dips as the stock may need some more time to gather strength.

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Stock 6

Expedia (EXPE)

Why the Strength
Industry analysts are predicting a record international air travel boom for 2024, with worldwide tourist arrivals expected to exceed pre-pandemic levels (while increasing 12% from 2023). As one of the world’s top travel aggregators, Expedia is well-positioned to receive a big chunk of this anticipated spending trend. The company bills itself as the premier one-stop travel site for customers who want to build a dream vacation, allowing them to bundle their hotel stay with a car rental or flight. Expedia has also embraced the artificial intelligence (AI) revolution and is using it to further enhance the customer experience: the firm recently announced a new in-app travel planning experience powered by ChatGPT which allows customers to get recommendations on places to go, where to stay, how to get around and what to see and do based on the chat. (AI is also expected to help Expedia increase its advertising reach while reducing ad expenses.) Growth has been solid here for a while, with big free cash flow as well, and Q3 was another example of that with the firm producing record and estimate-beating revenue and profitability, reflecting the “resilience of travel demand and continued improvements stemming from the execution of the company’s strategy.” Sales of almost $4 billion increased 9% from a year ago (a record for any quarter), while earnings of $5.41 beat estimates by 41 cents. The firm’s closely watched gross bookings metric of $26 billion was 7% higher, while booked room nights rose 9% and lodging bookings were up 8%, hitting a record for any third quarter. Expedia further reported adjusted EBITDA growth of 13%, and several Wall Street firms subsequently raised their guidance and target prices. Moreover, that type of growth should continue, if not accelerate, which leaves the stock looking very cheap—and management agrees, as it’s been buying back a ton of stock (share count down more than 8%) and re-upping another huge share buyback authorization recently.

Technical Analysis
EXPE got off to a vigorous start in 2023, jumping over 40% in the first few weeks of the year. But it met formidable resistance at 120 in February and spent the next nine months oscillating in a 30-point trading range and failing to break above resistance on two other attempts. In fact, overall, shares basically bottomed out between 90 and 120 for more than a year! However, the Q3 report brought not just higher prices, but overwhelming buying power, including three straight big-volume weeks off the low and further upside since with next to no pullbacks along the way. We’ll try to nab shares on a dip of a few points toward the rising 25-day line.

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Stock 7

Installed Building Products (IBP)

Why the Strength
Installed Building Products (IBP) is the nation’s premier contractor for residential and commercial insulation installation (it has a 30% market share in the former category), with more than 240 locations across the U.S. It also offers a range of indoor and outdoor home improvement products, including rain gutters, garage doors, fireplaces, closet shelving and bath hardware. The company believes it’s either the number one or number two insulation installer in half the markets it operates in, and thanks to its aggressive growth strategy (IBP has acquired a whopping 180 companies in the last 25 years!), it has managed to replace the traditional middlemen in the homebuilding industry by directly connecting homebuilders with insulation manufacturers, while independently handling the purchasing, delivery and installation of the product. Of course, the weak residential housing market has dented results—in Q3, installation revenue declined 2% from a year ago, though per-share earnings of $2.79 were up 11% and beat estimates by 19%, with quarterly net profit margin and adjusted EBITDA margin hitting all-time records. The company said softer single-family home sales in the quarter were partially offset by multi-family and commercial sales growth (multi-family revenue is supported by a “stable” backlog). Of course, more important than any of that, and the reason the stock has gone vertical of late, is that the recent plunge in interest rates should boost single-family home sales and more, supercharging demand for its offerings. Wall Street sees modest, steady top- and bottom-line growth ahead, though that almost surely assumed a continuing tough environment—estimates should head higher from here. A modest dividend (0.7% yield) and share buyback program help the cause.

Technical Analysis
IBP fell 50% or so during the bear market but bottomed out for a few months and rallied back when 2023 came around, actually making it back to all-time highs in the summer. The market correction after that, though, did lead to a tough retreat, down 33% through October. But while the correction was straight down, the recovery was just as one-sided—IBP has rallied seven weeks in a row to new highs, with last week’s rally coming on huge volume as the Fed backed off. Like many names, we suggest aiming for dips to enter.

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Stock 8

Monday.com (MNDY)

Why the Strength
Tel Aviv-based Monday.com offers a cloud-based platform that allows users to create and customize their own tools, applications and project management software, serving a customer base in over 200 industries. The company’s Work OS platform helps teams run every aspect of their work (including the planning, running and tracking of projects), and its highly customizable software can be used for everything from customer and sales management to project management. Despite slower customer spending across the cloud software space, Monday has lately seen eye-opening growth in big-spending customers and significant profitability upside. In Q3, revenue of $189 million exceeded expectations, soaring 38% from a year ago, while EPS of 64 cents beat estimates by a ridiculous 43 cents, which sent the stock flying. The same-customer revenue growth rate for customers with more than $50,000 in annual recurring revenue (ARR) was 15%, and the number of customers with at least that amount of ARR was 2,077—up almost 60% from a year ago. Other metrics were equally impressive, with billings growth of 35%, record quarterly cash flow and operating margin, plus free cash flow margin of 34% (up from just 10% in last year’s Q3). In the wake of the strong Q3 print, several analysts upped their price targets, with one big bank bullish on the firm’s various new products and on the developing narrative surrounding artificial intelligence, as Monday has recently released advanced AI formula and builder solutions. Management guided for Q4 mid-point sales of $197 million, up 31% of realized, while Wall Street sees the bottom line up 35% in 2024, both of which should prove conservative. It’s also worth noting the company says the growth plans should remain in fine shape despite the war, giving big investors confidence to get back in.

Technical Analysis
MNDY imploded from above 400 to below 80 during the bear market but jaggedly made it back to 190 or so this spring (including some big-volume buying after Q1 results). The stock, though, stalled out in the summer and got hit hard in the fall, losing 35% with the market and, of course, in October after the Israeli war began. The rebound has been impressive, and after three weeks of tight closes, shares have since rallied to new highs. MNDY’s volatility is extreme, so if you want in, look for dips of a few points to enter.

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Stock 9

NexTracker (NXT)

Why the Strength
Nextracker is a leading provider of solar trackers, which move photovoltaic panels during the day so they are always receiving maximum sunlight. The company designs, manufactures and installs its trackers, with about 60% of sales coming from the U.S. Utility-scale solar farms generate up to 25% more electricity using a tracker compared to fixed panels, which appeals to long-lived projects even though they add about 7% to the upfront cost of a solar farm. Investors are taking a shine to Nextracker now partially because it’s in the midst of formally splitting off from Flex International, which still owns about 52% of Nextracker after bringing the business public in February. The full separation will be done by the end of Nextracker’s 2024, which ends March 31, and will remove potential overhead supply of stock. The business becomes fully independent at a good time: Solar tracker firms took a hit from surging steel prices during the pandemic and other supply chain impacts, but steel prices have eased and suppliers are back in line. Domestic green energy producers are also starting to take advantage of 30% investment tax credits for domestic green energy production stemming from last year’s green energy bill. The tailwinds helped Nextracker mark three straight quarters of growth as its second quarter, which ended Sept. 30, saw 23% revenue growth to $573 million and earnings per share of 65 cents, more than triple a year ago and well ahead of expectations for 35 cents. The business has a $3 billion backlog of orders, including recently inking a deal with Clearway Energy, a large American renewable energy producer. Nextracker’s been hiking its guidance for 2024 results all year, and Wall Street sees solid (nearly 20%) top-line growth through next year while earnings tag along.

Technical Analysis
Solar stocks were one of the worst-performing groups up until the market bottom, but interestingly, NXT held firm—as of a couple of weeks ago, the stock was less than 10% off its high, while peers were down 30% to 60%. And now that the buyers have returned, it’s looking like this name is grabbing a leadership position: NXT formed a sloppy but valid launching pad during the past four-plus months with a couple of positive volume clues, and last week’s move to new highs is a good sign. We advise aiming to nab some shares on a dip.

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Stock 10

Wingstop (WING)

Why the Strength
There aren’t many retail stocks that are in the leadership ranks these days, but we do see a couple of restaurant names, which are being bolstered by solid long-term stories, great execution and, likely, a thought that fading inflation (in some cases turning into deflation) will help the bottom line. Wingstop is a name we’ve followed off and on for years, and it’s a classic long-term cookie-cutter operation that’s made some positive changes in recent quarters that should boost the bottom line. As its name suggests, Wingstop’s offerings are straightforward, mostly wings with a variety of rubs/flavors, along with fries, shakes and the usual comfort fare, and it sells them via 2,099 restaurants around the world (up 10.5% from a year ago; 88% are still in the U.S. though the international count is growing faster than the overall pace)—and down the road, management thinks it can have north of 3,000 locations both in North America and another 3,000 overseas, so there’s tons of expansion potential. In terms of changes, the firm embraced digital ordering during the pandemic, and that’s helped things in a big way; in Q3, two-thirds of all orders came digitally, which tends to boost margins. More important, Wingstop has moved ahead with non-wing offerings like chicken sandwiches, which not only broaden the menu but decrease its reliance on wing prices, which are very volatile and in the past have impacted the bottom line in a big way. Big picture, growth here is very solid (including domestic same-store sales of 15% in Q3) and EBITDA is growing faster than revenue (up 37% in Q3), and there’s no reason to think the firm won’t get much larger over time. The valuation isn’t cheap, but Wingstop is on pace to become a top global restaurant brand.

Technical Analysis
WING imploded from nearly 190 to 70 or so during the bear market, but then staged a massive rebound from there, making it all the way back into all-time high ground this summer before falling back to etch a painful but reasonable launching pad (33% deep) over the next 24 weeks. WING’s breakout came on earnings November 1 (just as the market was getting going) and the stock has effectively gone straight up from there, with last week’s mini-wobble not leading to any real selling yet. We’ll set our entry range down a smidge toward the rising 25-day line.

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Previously Recommended Stocks

The next Cabot Top Ten Trader issue will be published on January 2, 2024.