Cabot Top Ten Trader Issue: February 5, 2024

Getting Divergent

As we’ve written many times of late, we trade almost solely based on what we call the primary evidence—the intermediate-term trend of the major indexes, and the action of leading stocks of all types—and those two key areas remain bullish, so we’re still thinking mostly positive (especially when looking at the bigger picture). But there’s no question things are getting more and more divergent: The broad market and even most big-cap stocks are flat to down so far this year, and more recently, as interest rates have backed up (the intermediate-term trend of rates is now on the fence) and financial stocks get hit, we’re seeing selling pressures start to spread. That doesn’t necessarily portend doom, but coming on the heels of a multi-month advance, this kind of action does raise the risk of a change in character, via either a general market pullback or some sort of sharp rotation. Given everything, we’re going to pull our Market Monitor down a notch to level 7—still bullish, but holding a little cash, booking some partial profits on the way up and being more discerning on the buy side makes sense.

This week’s list has its share of hot stocks, and we’re impressed that we’re still seeing some strong earnings winners that are moving on very, very strong volume. For our Top Pick, we’ll go outside the tech space—SAIA (SAIA) just lifted out of a multi-month base on earnings and could be leading a new group move in the trucking sector thanks in part to less competition. Try to buy on dips.

Stock 1

AppFolio (APPF)

Why the Strength
One theme we’re intrigued by in the market are cloud software operations that are focused on a specific niche—where a firm specializes in a certain business function or serves just one industry—and AppFolio is a great example of that. The firm’s cloud software offering is specifically used for real estate management, making the lives of property managers of all types of real estate (single- or multi-family, affordable housing, student housing, commercial, etc.) far more productive, helping owners, vendors and renters to connect and communicate; allowing users to bill, track and account for payments and bills; while more quickly responding to issues at properties via online workflows and the like—all with a top-notch customer service department behind it to help out. (There’s also marketing, staffing and training modules, so we’re talking about a one-stop-shop here.) This is no small fry operation, either: At the end of 2023, the firm’s clients were managing 8.2 million units, and business has been strong for a while, with sales, earnings and free cash flow plowing ahead at rapid and consistent rates in recent quarters (see table below). And investors are excited about the firm’s AI push, which seems fairly advanced: First off, 93% of clients now use at least one of the firm’s AI-enabled features, and the company is piloting Realm-X, which is the industry’s first AI-powered conversational interface, allowing customers to ask how something works, ask for reports, have it complete tasks like drafting a communication and automate some processes and workflows, too. Because of this and more, AppFolio is having success going up market, signing up some huge property management firms, and surveys of all clients show many expect to add to their management portfolios this year as economic uncertainty eases. Analysts see revenues up 23% this year while earnings and free cash flow (up 85%) leap, but even that could prove conservative.

Technical Analysis
APPF bottomed in May 2022 and effectively spent eight months building a bottom before getting going with the market, rallying up to the 195 area last July. Round number resistance near 200 proved too much to overcome in the months that followed, with APPF actually sinking even as the market got going late last year. However, the Q4 report changed everything, with a monstrous-volume move (biggest weekly volume ever) to new highs (up 28%!) and with very little giveback since. We’re OK buying some here or (preferably) on a little weakness.

Weekly Chart

Daily Chart

Stock 2

Axon Enterprises (AXON)

Why the Strength
Axon Enterprises has a great long-term growth story, and after a lot of ups and downs during the past couple of years, the stock is set up for a run if the market and Q4 results (likely out late this month) cooperate. The firm is best known for its Taser electrical weapons that are increasingly popular with cops and other law enforcement agencies (the latest release has more probes and a much greater range), which help cut down on deadly encounters. But the bigger idea is the firm’s move a few years ago into things like body and dashboard cameras (including a recently-launched body camera for retail workers), dispatch and reporting software and—most important—its Evidence.com cloud hub, where all recorded data is stored, shared and managed, which effectively leads to more open-and-shut cases in the courtroom. (Management said recently that it’s Microsoft Azure’s largest cloud storage customer, and uploads more video every year than YouTube!) To that end, Axon just announced the acquisition of a firm that will broaden its real-time capabilities, with incident alerts, live-streaming and location mapping even as situations are unfolding. Growth here has been solid for a long time, bolstered by the firm’s move to a recurring revenue business model (even many Tasers are sold via bundles, with training and cartridge updates; all told, something like 90% of revenues here are subscription-based)—in Q3, the firm’s annualized recurring revenue came in at $619 million, up 54% from a year ago, while the total value of all contracts inked was a big $5.8 billion, up 56%, both of which should continue to drive sales, earnings and EBITDA higher for many quarters to come, especially as Axon’s cloud offerings are still in the early stages of being adopted. The valuation isn’t cheap, but Axon looks like the hands-down leader in providing technology for law enforcement, not just in the U.S. but other English-speaking countries as well.

Technical Analysis
AXON went down the chute in 2022 but actually made it all the way back to all-time highs last spring before another long, but reasonable, consolidation, as shares dipped as much as 24% and mostly meandered for six months. The stock got going with the market in November, however, rallying eight weeks in a row to new high ground, and the latest six-week rest looks tidy, with the 50-day line offering support and some subtle signs of accumulation on the weekly chart. We’re OK starting small here, using a tight stop and adding on any powerful breakout.

Weekly Chart

Daily Chart

Stock 3

Celestica (CLS)

Why the Strength
Electronics contract manufacturer Celestica ended 2023 on a high note and sees the good times continuing this year, thanks largely to multiple tailwinds from sectors as diverse as aerospace and defense (A&D) to artificial intelligence-related computing. Last week, the company released Q4 earnings that turned heads as free cash flow (FCF) of $84 million doubled from a year ago, while revenue of $2.1 billion increased 5% and per-share earnings of 76 cents beat estimates by 12%. The company emphasized that “strong momentum” remains in place entering 2024, particularly for its A&D business (electronic components, integrated systems and unmanned aerial vehicles) thanks in part to a “sustained recovery” in domestic air travel last year that surpassed pre-pandemic levels in many countries—and resulting in sales growth of more than 30% compared to 2022. Celestica’s defense business is also anticipated to see solid growth in the coming year thanks to new program wins and increased public spending on military technology. Overall, the company expects low-double digit percentage growth across the A&D business in 2024 and anticipates continued full-year growth in the hardware platform solutions (networking, storage and computing) business. Additionally, Celestica sees demand in its communications end market turning up in Q1, driven by a resumption of strength in networking demand from hyper-scalers, which is expected to persist throughout the year. What’s more, the top brass said it believes the fundamentals supporting its overall business are “very constructive.” Celestica guided for full-year FCF of at least $200 million, with Wall Street seeing sales and earnings growth of 10% and 20%, respectively, for 2024. A modest valuation (15x trailing earnings) is another plus.

Technical Analysis
CLS built a huge launching pad from early 2022 until June of last year, when it decisively broke out on the upside as volume really picked up. Shares advanced over the next few months (albeit with some dips and shakeouts, like the one seen in October), but the buyers have remained in control—and now shares are surging again, with CLS powering ahead to new highs on a cluster of big-volume buying before and after earnings. It’s a bit out of trend on the upside, so we’ll set our buy range down a couple of points.

Weekly Chart

Daily Chart

Stock 4

Encore Wire (WIRE)

Why the Strength
Encore Wire doesn’t have a story that gets your heart thumping—the firm makes copper and aluminum wires and cables for a variety of end uses, including some faster-growing areas like alternative energy infrastructure and data centers as well as everyday construction and the like. To be fair, Encore does have some competitive advantages, including reliable long-term suppliers of base materials (which are still in somewhat short supply) and a single site manufacturing model, giving it more flexibility to change course and meet client needs (which has allowed it to grab market share over time). But the big idea here is one we’ve seen a lot since the pandemic: Selling prices and earnings went wild in the wake of the virus, and while demand is strong (sequential copper volumes were up 7% or so in Q3), prices are normalizing (prices down 4.3% sequentially), leading to the shrinking sales and earnings you see in the table below. However, (a) that normalization is taking a lot longer than initially thought, keeping earnings elevated (north of $17 per share likely this year), (b) management thinks margins will settle out well above pre-pandemic levels, while volumes are already much higher than 2019, and (c) the top brass has used the spigot of cash flow to rapidly buy back shares, with the share count down something near 25% since 2020 and down 11.6% in Q3 from a year ago, which is another reason earnings per share are likely to stay in nosebleed territory. Of course, if the economy really tanked, demand could slacken—but things are looking like they might strengthen, especially if residential building gets back on track this year. It’s not a true growth story, of course, but Encore Wire should be a cash machine for many quarters to come.

Technical Analysis
WIRE boomed to new all-time highs about a year ago, but it ran into a wall, sinking 33% over 10 weeks and then chopping sideways close to its 40-week line for many months. As with everything else, the stock’s character changed near Halloween, with shares stair-stepping higher since then, including a very tight five-week range and a recent push to new highs. WIRE is a bit thinly traded, but we’re OK taking a stake here.

Weekly Chart

Daily Chart

Stock 5

Interactive Brokers (IBKR)

Why the Strength
Geopolitical instability and economic uncertainty have combined in recent months to create some big waves across multiple financial asset categories—but higher volatility is proving to be a boon for brokerage firms, which are benefiting from rising trading interest among both retail and institutional clients, as well as from elevated interest rates, boosting interest income. Interactive Brokers operates the nation’s largest electronic trading platform based on daily average revenue trades, brokering stocks, bonds, options, futures and cryptocurrencies. Aside from its retail clientele (roughly 55% of the business), the firm differentiates itself from competitors by working closely with institutional firms (the other 45% of business), including mutual funds, hedge funds and investment advisors. Along with growing interest in the so-called “Magnificent Seven” stock names, options trading has seen surging popularity—both as a risk mitigation tool and as a “standalone zero day to expiry” vehicle (in Interactive’s words)—with both trends resulting in higher trading volumes and contributing to a solid Q4 report. Although earnings of $1.52 a share missed estimates by three cents, revenue of $1.1 billion rose 17% from a year ago, thanks to increased customer accounts and customer equity (up 23% and 39%, respectively) and average daily trading volume (up 2%). A key highlight in Q4 was the $730 million in net interest income that increased 11%, plus full-year income that boomed 65%—both thanks in part to higher interest rates on the short end, which appear likely to stick for a while longer give the Fed’s musings last week and still-strong economy. The company said individual traders saw the fastest account growth among its five client segments in 2023, with proprietary traders having the fastest client equity and commission growth. Management expects the strength to continue in 2024 and plans to roll out new platform features and new countries where clients can trade; indeed, January trading metrics (volume up 11%, client equity up 26%, margin loan balances up 12%) tell us the year is is off to a great start. Analysts see full-year earnings growth of 10%, which is likely too low.

Technical Analysis
IBKR exited the 2022 bear market several months before the major indexes, double bottoming between May and July and then moving all the way to all-time highs by the spring of 2023. However, the March peak led to a long period of sluggishness, with the stock making actually falling (net-net) until mid-December. But then the buyers took firm control: IBKR is up seven weeks in a row, the last five of which came on above-average volume, with last Friday’s Q4 reaction the highlight. There is some resistance in this area, but we’re thinking retreats will likely be contained—you can enter here or (preferably) on dips of a point or two.

Weekly Chart

Daily Chart

Stock 6

NexTracker (NXT)

Why the Strength
Nextracker’s fiscal 2024 third quarter results, reported last week, blasted past consensus, delivering earnings per share of 96 cents, nearly double expectations and more than triple a year ago, on sales nearly $100 million better than projected at $710 million. The reason is that solar power is booming and Nextracker is the leader in providing solar trackers to utility-scale developments. A solar tracker moves photovoltaic panels in concert and gradually throughout the day so each panel always receives maximum sunlight, thus boosting electricity yield. In fact, relative to just having all the panels fixed in place, utility-scale solar farms generate up to 25% more electricity using these trackers, which appeals to long-lived projects even though they add about 7% to the upfront cost of a solar farm. The U.S. is Nextracker’s most important market, contributing most of its annual sales, and domestic sales jumped a whopping 70% last quarter. The U.S. is benefiting from renewable energy incentives as well as the easing of pandemic-era supply chain issues, though there were also strong orders from India, the Saudi peninsula and Africa. While trackers are a simple idea, it takes some sophistication to properly model how to maximize solar panels in specific locations, and Nextracker has secured a series of patents on technology that does a better job of maximizing sunlight that’s diffused from cloudy days. Also helping the cause is that, following an initial spin-off from Flex Ltd a year ago, that company has now fully spun off its shares, removing some potential overhead. We like the accelerating sales and earnings growth here, and while analysts see slower growth in fiscal 2025 (starting in April of this year), estimates have just been hiked in a big way ($3.06 per share vs. $2.64 before the quarterly report).

Technical Analysis
Solar stocks have been some of the market’s big laggards, but NXT had been holding firm, with marginal new highs last July and again in December despite the group’s awful action. The most recent dip came with the final spin-off from Flex, but NXT held support near the 40-week line and then catapulted higher late last week on huge volume. If the sector was in gear, we’d likely advise buying some stock here—but because it’s not, we’ll try to get in on dips.

Weekly Chart

Daily Chart

Stock 7

SAIA (SAIA) ★ Top Pick ★

Why the Strength
After landing 28 terminals from last year’s bankruptcy of trucking giant Yellow, leading less-than-truckload (LTL) carrier Saia just released details of a $1 billion CapEx plan which, if successful, would account for up to a third of its annual revenue. Fifteen-to-20 of those recently acquired terminals will be open this year, with additional plans to move around 10 of its present locations to bigger facilities. And if all goes according to plan, by the end of this year Saia will have as many as 215 terminals in use (up 14% from a year ago), allowing the company direct access to new markets while adding density to existing markets and serving as replacement terminals for some of its existing leased and owned facilities. (All of this is in addition to the nearly 20 new facilities Saia has opened in the last two years.) Translation: Business should pick up nicely going forward, and last week’s stellar Q4 report pointed to the potential, featuring consensus-beating revenue of $751 million that increased 15%, plus EPS of $3.33 that topped estimates by 13 cents and was up 26% from a year ago. Other key metrics for the quarter were equally impressive, including LTL shipments and tonnage per workday increases of 18% and 8%, respectively, and revenue per shipment that rose 2%. Additional good news included the company’s fuel expense decreasing by 12% despite mileage increasing 8% (thanks to a sharp decline in national average diesel prices), plus a 60% increase in cash on hand (to $297 million) and a 45% reduction in total debt (impressively, the firm is now nearly debt free). Heading into the New Year, the top brass is confident it can keep the momentum moving forward after a promising start: January showed shipments and tonnage per workday increases of 12% and 3%, respectively, despite inclement weather in parts of the U.S. Analysts see earnings ramping around 20% in each of the next two years, and given recent trends, we’d bet that’s too low.

Technical Analysis
SAIA shaped a huge base from the market top in late 2021 to June of last year, then broke out on the upside and motored to new highs for the next couple of months on Yellow’s bankruptcy. However, the 430 area brought in sellers, with SAIA correcting 23% and setting up for the next six months. But last Friday’s earnings reaction looks decisive, with shares reversing a small-ish gap down open and soaring above the 500 area. We wouldn’t criticize you for nibbling here, but officially we’ll set our buy range down a bit.

Weekly Chart

Daily Chart

Stock 8

Snowflake (SNOW)

Why the Strength
Cloud giant Snowflake is well known for its cloud data warehousing solution that allows enterprise customers to consolidate data—typically generated on Alphabet, Amazon or Microsoft cloud services—onto a single, global platform. This partly accounts for the stock’s latest strength, as Snowflake reacted in sympathy with Amazon’s consensus-beating Q4 results last week (which contained quite a bit of favorable cloud-related insights). Snowflake’s recent strength is also the result of its own sanguine earnings report for Q3 (released around Thanksgiving), which featured a 32% year-on-year revenue bump, a 24% increase in customer count and a 52% pop in the number of lucrative big-spending clients ($1 million or more in the trailing 12 months) that are signed up. Another reason for Wall Street’s excitement is the company’s recent announcement that it was granted special authorization to conduct more business with the federal government, opening up a huge opportunity for further revenue expansion: Snowflake received FedRAMP High Authorization status in December on Amazon’s GovCloud platform, which basically states that Snowflake is a secure, low-risk proposition for public agencies who wish to do business with the firm. (It also allows Snowflake to offer its Government & Education Data Cloud for federal, state, local and education workloads.) Finally, Snowflake was recently named a top pick for 2024 in generative artificial intelligence (GenAI) by a major investment bank, which said the company should benefit from the analytics, data, security and cloud infrastructure aspects of GenAI. The top brass sees a multi-year, $200 billion opportunity in GenAI alone and believes Snowflake will be the “prime choice” for cloud customers on this front. Fiscal Q4 results are due February 28, and analysts see continued 30%-ish sales and even faster earnings growth for many quarters to come.

Technical Analysis
SNOW spent more than a year bobbing and weaving within a wide lateral trading range, effectively etching out a huge bottoming formation for the rally of the last couple of months. Shares got going with the market in November, rallying to their highest level since the summer of 2022 before round number resistance near 200 led to a five-week rest that got support at the 10-week line. And now SNOW is trying to get going again, with two straight big-volume buying weeks, including last Friday’s surge. It’s not completely free and clear, but we’re OK starting a position on todays dip or on a bit more weakness.

Weekly Chart

Daily Chart

Stock 9

WillScotMobile (WSC)

Why the Strength
Non-residential construction is on a roll, with the U.S. Labor Department’s numbers for January showing a notable sector-wide expansion across several key metrics—including the 10th straight month of jobs added. With new construction comes a corresponding demand for mobile space solutions such as contractors’ offices, canteens, workshops and other accommodations, and that’s where WillScot enters the picture. The company sells and leases mobile offices and portable storage units with basic furniture and appliances, as well as modular classrooms and other temporary space solutions. Its customers span a wide range of industries, from commercial and industrial to government and other end markets, with over 350,000 mobile office trailers across a network of 270 North American branches. Last week, WillScot shook up the industry after it announced an agreement to acquire McGrath RentCorp, a leading temporary space solutions rental provider, in a deal valued at nearly $4 billion, which is a big chunk (north of 40%) of the current market cap. WillScot expects the combined company will generate approximately $700 million of annual free cash flow by end of the first full year following closing, with “significant” further free cash flow margins over time. The deal is being viewed by analysts as an integral part of WillScot’s preparation for an ongoing expansion of government-funded infrastructure projects across the country (a result of the 2021 Infrastructure Investment and Jobs Act). Of course, business was already solid and very profitable: Last year, WillScot saw persistent rental demand across its commercial, education and portable storage customer bases, and in Q3, it generated free cash flow of $148 million—up a whopping 77% year-on-year and north of 70 cents per share, well above reported earnings. It’s a solid long-term growth story and the McGrath move should be a big boost. Earnings are likely out toward the end of the month.

Technical Analysis
WSC rallied to new all-time highs early last year, but with growth about to slow, the stock topped in March near 52 and slipped jaggedly down to 34 into the market’s October low. The initial rebound was decent (including four solid up weeks on above-average volume), followed by a modest five-week rest period. And then came the McGrath announcement, which caused the stock soar last week on its heaviest week of volume since 2021! The 50 level could provide some resistance, though we’re not expecting a big pullback.

Weekly Chart

Daily Chart

Stock 10

Zillow (Z)

Why the Strength
Zillow is establishing itself as the super app for house hunting. The company says two-thirds of U.S. buyers use their app and that 80% of their traffic comes direct from people using its mobile app or going directly to the web address in a browser. That has analysts believing Zillow can isolate itself from whatever disruptive effects AI may have on looking for homes and apartments online. The more Zillow can solidify itself as the default way to look for a house, the more it should be able to grab more of the $17,000 in various fees the average American homebuyer pays. Right now, the company makes its money splitting commissions with buyer agents located through Zillow – about $4,100 a closing. Remarkably, Zillow probably generated $1.92 billion in 2023 even though just 1% of users produced any revenue for the business, meaning there is a lot of growth to be had even if monetization rises just a smidge. Management is pushing ancillary services, too, connecting mortgage lenders with buyers, automating closing services and getting sellers and agents to use ShowingTime+, a fee-based tech service that spruces up listings by automating photos and providing better virtual tours and layouts for properties. In the near-term, the business is likely to benefit from the easing of mortgage rates, which should lead to a housing market bounce back after a difficult 2023. Q4 results are set to be announced February 13 and are expected to show some improvement over a year ago, with $451 million in revenue, up $16 million, with earnings per share of 15 cents, down six cents. But this is about what many hope will be a much better 2024, with analysts see 10%-plus revenue growth and earnings up 23%, both of which could provide conservative if the industry really gets moving.

Technical Analysis
Z had a fairly solid off-the-bottom rally after 2022’s massacre, but the decline that began in August took back most of that move, with shares sinking 41% in two and a half months. However, that makes the comeback from there all the more impressive: Z actually nosed out to new highs in December, and the past six weeks have seen a well-controlled, low-volume rest as the stock gathers strength for a sustained move. Given the back-up in rates the past few sessions, we’ll set our buy range for Z up from here, looking to enter on strength.

Weekly Chart

Daily Chart

Previously Recommended Stocks

The next Cabot Top Ten Trader issue will be published on February 12, 2024.

Copyright © 2024. All rights reserved. Copying or electronic transmission of this information without permission is a violation of copyright law. For the protection of our subscribers, copyright violations will result in immediate termination of all subscriptions without refund. Disclosures: Cabot Wealth Network exists to serve you, our readers. We derive 100% of our revenue, or close to it, from selling subscriptions to our publications. Neither Cabot Wealth Network nor our employees are compensated in any way by the companies whose stocks we recommend or providers of associated financial services. Employees of Cabot Wealth Network may own some of the stocks recommended by our advisory services. Disclaimer: Sources of information are believed to be reliable but they are not guaranteed to be complete or error-free. Recommendations, opinions or suggestions are given with the understanding that subscribers acting on information assume all risks involved. Buy/Sell Recommendations: are made in regular issues, updates, or alerts by email and on the private subscriber website. Subscribers agree to adhere to all terms and conditions which can be found on CabotWealth.com and are subject to change. Violations will result in termination of all subscriptions without refund in addition to any civil and criminal penalties available under the law.