Cabot Top Ten Trader Issue: July 1, 2024

Stay Flexible

If you’ve been with us for a while you might remember that we frequently write that January can be a tricky month: As the calendar flips, tax-related moves (profit taking) can occur and big investors will often reposition their portfolios, creating lots of crosscurrents. July is not the same thing, but we have a bit of the same feeling here as we start the second half of the year—we’re not predicting anything one way or the other, but we wouldn’t shocked to see some repositioning and volatile action in the days ahead given how many investors are rowing in different directions already. Our point: Don’t fight the evidence, which continues to tell us things remain choppy and narrow, with trends proving mostly fleeting—but also stay flexible in case the market flashes some change in character as the calendar flips, which could upend some leadership but also provide some fresher breakouts and buying opportunities. Right now, we’ll once again leave our Market Monitor at a level 7, taking things on a stock-by-stock basis.

This week’s list has a ton of setups, with many stocks rounding out launching pads that could get going if all goes well. Our Top Pick is CyberArk Software (CYBR), which has terrific growth numbers, is part of the strengthening cybersecurity area and has come under some strong accumulation. Try to start a position on dips, with the idea of adding more of a decisive breakout.

Stock 1

AppFolio (APPF)

Why the Strength
There’s no question cloud software is still in a mega-growth phase, so while most of that sector lagged in the first half of the year, we’re keeping an eye on a few that have recently perked up. If the group does enter a sustained rally, AppFolio has the makings of a fresh leader. The firm looks to have the leading offering for real estate management—whether it’s student housing, commercial properties, affordable housing (and the associated regulations), or single/multi-family housing, the firm’s easy-to-use platform makes a property management team far more efficient, centralizing data and tracking (work orders, renter requests, payments and billing, etc.) and creating a place where renters, owners and managers can connect and communicate. Plus, it’s branched out into marketing and staffing help, and it backs it all up with what it believes is the best customer service out there (for both managers and their clients/renters), all for a reasonable fee of at most a few bucks per month, per unit. It’s a simple idea, but AppFolio seems to have cracked the code, especially when it comes to rapid innovations, including the ability to onboard new clients more quickly (22% quicker, in fact, thanks to some AI innovations) and a new product launched earlier this year for larger, more complex real estate operations (helping it to upsell large current clients and get new ones, too). The formula has worked and there should be plenty more to come: The firm had nearly 20,000 customers at the end of Q1 managing 8.3 million units (up 11%), with revenues growing much faster than that (up 38%, though part of that is because the firm stopped waving some eCheck fees) and the bottom line firmly in the black. The top line is more likely to grow 20% to 25% through the end of 2025, a slight slowdown from recent quarters, but (a) that’s probably conservative and (b) earnings should boom and free cash flow (which was 21% of revenue in Q1) should do the same. It’s a good niche cloud software story.

Technical Analysis
APPF had a choppy consolidation last summer and fall that spilled into a deeper dip into January—but then the Q4 report appeared to change the stock’s character. However, shares couldn’t follow through much on that move, with some downs and ups (including on Q1 earnings) after that but no net progress for four months. Recently, though, APPF actually flashed some tight trading even as software stocks were mauled (a constructive sign) and it has recently tested round-number resistance near 250. We’ll set our buy range up from here, aiming to enter on a clear breakout.

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Stock 2

Carnival (CCL)

Why the Strength
The persistent nature of the “revenge travel” trend of the last couple of years has resulted in higher bookings and earnings for cruise industry leader Carnival in recent years, despite higher ticket prices—and, defying expectations, trends are as strong as ever today. That was one of the key takeaways from last week’s stellar Q2 results, which included record revenue, operating income and booking levels, all of which allowed the company to make “incredible strides” in just about every metric the firm reports. Revenue of $5.8 billion increased 18% year-on-year, while per-share earnings of 11 cents soared past estimates by 13 cents and adjusted free cash flow of $1.3 billion (north of $1 per share) doubled from a year ago (all reasons for the stock’s strength). More important is that there are no signs of any slowdown: Customer deposits reached an all-time high of over $8 billion, obliterating the previous record from last year by over $1 billion, and other figures were equally solid, including a record cumulative booked position (the firm’s booking measurement) for the remainder of 2024, both in terms of price and occupancy, while the cumulative booked position for full-year 2025 is currently even higher than this year in both categories! Carnival said it’s encouraged by the consistent growth (up 10%) in both repeat guests and new guests within each of its segments in Q2. What’s more, this isn’t just a post-Covid recovery story: The delivery of two Excel-class ships in 2027 and 2028 will be the firm’s eighth and ninth new ships to hit the water since 2019, bolstering capacity by a whopping 50% during that time. The continued strong demand trends prompted management to raise guidance and expect EBITDA to increase 40% for 2024. Analysts see the top line perking up 14% this year, with significant improvements in the bottom line and free cash flow over the next couple of years as the company’s initiatives pick up steam.

Technical Analysis
CCL had a strong recovery from a record low at 6 in October 2022, shooting up over 13 points in the nine months that followed before peaking last July. The going since then has been quite tumultuous, with shares zig-zagging between 11 and 20 over the last year. However, the stock has established a rising series of lows since April, with trading volume picking up significantly after last week’s earnings release ... before today’s sloppy decline after the stock was rejected from resistance. Like many stocks in today’s issue, we’ll set our buy range up from here.

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Stock 3

Carpenter Tech (CRS)

Why the Strength
A recurring theme this summer is the continuation of pent-up travel demand following the cabin fever-inducing Covid years, with U.S. airports hitting new daily TSA travel records. Expectations for a multi-year pickup in travel are a big reason for the big increase in backlogs across multiple aerospace submarkets, as supply chains ramp up to meet the accelerating demand. Carpenter (covered in the May 6 issue) is a major player in the aerospace market (about 60% of revenues excluding surcharges) and other fields—including defense, medical and electronics—by way of its provision of specialty metals like titanium, stainless steels and powder metals, as well as additives and metal powders and parts. Last week, a major Wall Street bank initiated coverage in Carpenter with a “buy” rating (the reason for the latest strength) based on Carpenter’s potential for “significant growth” due to its unique position in the industry, which combines exposure to early-cycle original equipment manufacturing (OEM) along with the pricing power of a commercial aftermarket supplier. Additionally, the bank said Carpenter is likely to benefit from a “mismatch” between the recent increase in OEM production rates and capacity constraints for certain specialty metals, allowing the company to maintain its pricing power while passing on higher costs to customers. In fiscal Q3 (ended March), Carpenter’s aerospace and defense segment revenues grew an astounding 57% from a year ago excluding surcharges, contributing to total surcharge-adjusted growth of 13%, EPS of $1.19 that more than tripled from a year ago and free cash flow that was a bit higher than that. Also helping the cause are defense customers, who remain “highly concerned” with long lead times and are asking for more capacity to serve them, which is expected to further boost full-year results. Elsewhere, medical and industrial sales each make up about 15% of revenue and each grew about 15% from a year ago, so this isn’t solely an aerospace story. In the wake of the bullish results, the top brass pulled forward by a year its goal of reaching $500 million in adjusted operating income by 2026, while Wall Street sees earnings booming this year and next.

Technical Analysis
CRS spent seven months stuck in neutral starting last September, alternating in a sideways range between roughly 60 and 75. The stock broke out in April after resisting the broad market’s weakness, rallying over 35 points in a six-week period. Shares pulled back earlier this month and looked pretty iffy, but finally found strong support near the 50-day line and last week’s bounce sets up a good risk/reward situation. We’re OK buying some here or on modest dips with a stop just under the century mark.

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Stock 4

CyberArk Software (CYBR) ★ Top Pick ★

Why the Strength
The ongoing migration to the cloud and reliance on third-party systems brings with it heightened risks of cyberattacks for enterprises of all sizes. This fact was illustrated recently when automotive data and technology provider CDK Global suffered a massive cyberattack, crippling operations for thousands of auto dealerships around the country, but this creates a big opportunity for companies like CyberArk. The company offers a mix of identity verification software solutions, and it recently acquired competitor Venafi, which helps some of the world’s largest organizations automate, manage and protect their machine identities (everything from robotic factory equipment to software-based bots that help with company automation). The deal, which is due to close in the second half of this year, is expected to add about $150 million in annual recurring revenue (ARR), as well as boost CyberArk’s free cash flow generation and profit margins. Moreover, the company expects Venafi’s complementary solutions to expand CyberArk’s total addressable market by 20% to approximately $60 billion. Another CyberArk offering, the Ekata Identity Verification (IDV) solution, is a subscription-based service that applies pattern recognition, predictive analytics and machine learning to assess overall risk for new users—a technology in great demand as cyber risks relating to increasing cloud and artificial intelligence use grow. On that score, a major investment bank just listed CyberArk as a potential beneficiary of the growing risks of cyber threats, based on the firm’s focus on zero trust security and secure service edge technology (a reason for the recent share price strength). In Q1, CyberArk saw its revenue of $222 million jump 37% from a year ago, with per-share earnings of 75 cents up from a loss last year. Significantly, the subscription portion of ARR increased 54%, while total ARR grew 34%. Wall Street sees mid-20% revenue growth and surging earnings and free cash flow (CyberArk sees $120 million of free cash flow this year, or about $2.75 per share) for at least the next few quarters.

Technical Analysis
Like most stocks, CYBR broke out last November and had an excellent run, moving ahead to the 280 level in early February before a big wobble on earnings. That led to a 21%-deep correction and consolidation that nearly saw the stock join up with the 40-week line, but June brought the buyers back in, with CYBR gliding higher (just two down days all month!) on good volume, approaching its prior highs. If you’re game, we’re OK starting small here or (preferably) on dips, and possibly averaging up on a clear breakout north of 280.

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Stock 5

Datadog (DDOG)

Why the Strength
While technology stories can often give you the proverbial ice cream headache, Datadog’s has always made sense: As firms put more and more stuff in the cloud and use more and more varied apps for their business, it creates enormous complexity when it comes to making sure each tool, app, code and platform is working and interacting with others as it should. That’s where Datadog comes in, with a unified platform that takes on infrastructure monitoring (about half of recurring revenue), application performance/security management (one-quarter) and log management (gathering and parsing through data from different IT devices; makes up the other quarter of recurring revenue), giving clients of all sizes an easier way to make sure the ever-growing tech stack is operating at max efficiency. In terms of the platform aspect, it reminds us a bit of CrowdStrike in that part of the attraction is the one-stop-shop aspect of having an integrated platform that can do it all—and indeed, customers that come in initially not only end up staying (95% retention rate, including 98%-plus for enterprises) but spending much more over time (those that arrived in 2020, for instance, have already tripled their recurring subscription values, on average). And yet Datadog thinks it has just 5% of the market, not to mention 60% of its current user base is “only” taking just one or two of its three pillars mentioned above. Revenue growth is actually slightly accelerating, and analysts see the top line up in the low-20% range for the next couple of years (might be conservative) and free cash flow is very strong (52 cents per share in Q1, up 61% from a year ago and a 31% margin). It’s a solid tech story that should have a long runway of growth ahead of it assuming management continues to pull the right levers.

Technical Analysis
DDOG had a beautiful earnings gap up last November that kicked off a solid run, but like many software names, shares began to wobble in February and slipped into a mild correction soon after, with the selling intensifying in May; all in all, the stock retreated 23% in 17 weeks and shook out below the 40-week line. But now DDOG is rebounding, first to the 50-day line, and now up into resistance near 130. Like some other setups in this week’s issue, a small buy here or on modest weakness, a tight stop and aiming to buy more on decisive strength makes the most sense.

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Stock 6

Jefferies (JEF)

Why the Strength
A revival in dealmaking volume—thanks in part to the bull market’s persistence and gradual increase in big-picture sentiment—is expected to boost the earnings and sales outlook for the major investment banks. That’s good news for Jefferies, one of the world’s leading full-service investment houses and a classic Bull Market stock, whose business (and stock) should thrive as asset prices rise and (ideally) money becomes looser, which should goose M&A and IPO activity. Indeed, this is playing out on schedule as the rally from last year’s major low (around Halloween) is pushing results higher, prompting analysts to raise share price expectations for Jefferies and many of its cohorts (a reason for the stock’s strength). Last week, Jefferies delivered a great fiscal Q2 report (ended May) that saw key metrics improve on both a sequential and year-on-year basis, highlighting the building strength across its investment banking and capital markets business. Revenue of $1.7 billion increased 60% from a year ago, while earnings of 64 cents a share were in line with estimates but were up from just five cents in last year’s Q2. Advisory revenue improved 12%, equity underwriting revenue jumped 70% and debt underwriting revenue soared by a whopping 130% as firms raised capital as rates have held at somewhat lower levels. Meanwhile, asset management had a “reasonable performance,” as market conditions for trading in certain strategies normalized after a strong first quarter. Other highlights in the quarter include the closing of the sale of specialty finance company Foursight Capital and continued investments in technology that management said will support future growth. Looking ahead, the top brass expects continued margin improvement and sees the momentum building in the investment banking segment, while the market share gains it has achieved across the advisory, equity underwriting and leveraged finance businesses are expected to continue. Analysts expect earnings this year to more than double with more big gains in 2025, boosted by surging investment-grade credit demand. The sanguine results prompted the company to hike the dividend (a 2.8% yield), which adds to the appeal.

Technical Analysis
JEF isn’t a go-go stock, but it’s gradually built up a head of steam as the market has improved. Shares had a rough correction early last year, falling 30% after the regional banking crisis, but it changed character with everything else last November and marched to new highs near 47 in March. Shares were up and down after that, but after nearly three months of consolidation, last week’s quarterly report kicked JEF to a new high. We’ll set our buy range down a bit given round-number resistance near 50 and the tricky market environment.

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Stock 7

Light & Wonder (LNW)

Why the Strength
Las Vegas-based Light & Wonder (L&W) is the leading cross-platform global gaming provider, with offerings that include casino slot machines, tabletop games, lottery systems and digital gaming solutions. A big part of their business (around 70%) is land-based casino gaming, but the company is placing more of its focus on its large (and growing) social and mobile casino business through its SciPlay business. During Q1, revenue of $756 million increased 13% year-on-year, while earnings easily surpassed estimates and free cash flow came in just over $1 per share, up 26% from a year ago. Gaming revenue increased 14%, led by global gaming machine sales growth (which increased 30%), with growth achieved across all areas of the gaming operations and systems segment. But SciPlay was part of the story in Q1, with segment revenue achieving a record $206 million (up 11%), driven by the core social casino business, which L&W said continues to “outpace the market and gain share on strong payer metrics.” Moreover, the company said it has expanded its footprint in the social casino area for the last nine quarters and now owns an 11% market share, which management attributes to strong user acquisition and a growing portfolio of games. iGaming was another strong contributor in Q1 and remains one of the fastest-growing segments in the U.S. and international arenas, with sales growth of 14% there as well. Meanwhile, average monthly revenue per paying user reached new highs in the quarter, thanks in part to newly launched marketing campaigns. In the wake of the strong metrics, L&W just announced a new three-year, $1 billion share repurchase program after its prior buyback authorization expired (a reason for the stock’s strength; share count down just over 1% in Q1). Wall Street sees consistent, high-single-digit revenue growth and expanding free cash flow for the next several quarters.

Technical Analysis
LNW chugged its way higher starting last summer, gaining nearly 40 points before running into strong resistance around 110 in in late March. A 21% shakeout in just four weeks followed, but support appeared at that point and shares began to repair the damage, chopping slightly higher into mid-June. But the past two weeks have seen the buyers return, with LNW spiking back toward its prior highs before a reasonable exhale. We’re OK starting small here or on dips with a tight stop.

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Stock 8

Palantir Technologies (PLTR)

Why the Strength
To us, Palantir as a stock is all about if and when investors’ AI focus shifts somewhat from the infrastructure (chips, networking gear, servers, even cybersecurity) to the actual software platforms running large AI models that can help businesses (or government agencies) dramatically boost productivity. That’s what the story here has been all about: Palantir has a long history of leveraging machine learning and systems that can mine through everything from messages to video or audio to provide advanced software and analytics to the likes of the U.S. (and other Western-friendly) militaries in a safe, secure manner—and that put it in pole position to develop AI-related platforms that help businesses streamline operations and boost productivity. Thanks in part to hundreds of “boot camps,” where the firm shows specific use cases of its AI platform to a client (using that client’s own data), adoption among U.S. businesses has been big: In Q1, Palantir’s U.S. commercial revenue lifted 40% from a year ago (and 14% from the prior quarter), while the customer count lifted 69% and the remaining deal value was up a huge 74%! And since then, the firm has announced some new and expanded deals, too, with the likes of United Airlines, AARP, Lear and Wendy’s joining the fray, and most analysts see rapid growth in this area ahead. The issue for the stock is that the U.S. commercial business is only about a quarter of business—the international and government areas that make up the rest are growing, but at slower rates, which is why total revenues were up “only” 21% and earnings (while up from a year ago) are taking their time to really power ahead; indeed, analysts see more good-not-amazing growth for the next few quarters. Even so, there’s little doubt Palantir is the lead dog in building actual AI platforms that are proving their worth today, and as the U.S. commercial side of the ledger becomes a bigger piece of the pie (and as government agencies step up their own efforts), upside surprises could come.

Technical Analysis
PLTR appeared to have a coming-out party in the spring of 2023, but since August of last year (when shares hit 20), progress has been extremely choppy, with a couple of false starts; the attempted breakout in November failed quickly and even the huge earnings move in February quickly ran out of gas, leading to prolonged rest period. Now PLTR is showing some signs as it rounds out a new launching pad, with five weeks up in a row as it approaches the top of a 16-week structure, though to be fair, it has seen some selling on strength lately. We’re OK with a small buy on dips and averaging up on a move above 27 or so.

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Stock 9

Reddit (RDDT)

Why the Strength
Social media giant Reddit bills itself as a network of communities where people can dive into pretty much any topic imaginable while starting discussions with those who have similar interests. Users (who are entirely anonymous) can post links to online content relevant to their interests, then other users can “up” or “down” vote the posted links, causing them to appear more or less prominently. In a sense, the firm has become the world’s largest message board platform, which has attracted a huge hoard of users: In Q1, the firm had 83 million daily unique users (up 37%) and an amazing 306 million weekly unique users (up 40%) that are producing ever-more content and advertising opportunities—ad sales were up 39% in the quarter (including more rapid growth among small- and mid-sized businesses as well as from industries like financials and pharma), the main driver of the firm’s 48% revenue bump, and analysts see a lot of upside there for greater ad placements in different nooks and crannies of the site, as well as improving the site itself through AI and machine learning (which should keep user growth strong). There’s also the data angle here, with Reddit’s hoard of authentic, human-generated posts having lots of value to other firms, producing optimism surrounding its emerging data licensing business. Relatedly, last month, the company just announced a partnership with OpenAI to bring ChatGPT content to its platform and new products, while Reddit will create new AI-powered capabilities for its platform using OpenAI’s technology. Back to the numbers, we like the fact that, while earnings were in the red in Q1, that was due to some one-time factors; EBITDA and free cash flow were positive, and Wall Street sees solid 20%-plus revenue and faster bottom line growth for a long time to come.

Technical Analysis
RDDT came public in late March at 45 and jumped to 75 on an intraday basis a few days later before the typical post-IPO droop, which saw shares dip to 37 during the market’s April correction. However, impressively, that was the end of the selling—the stock powered back to the low 60s by mid-May on some very heavy buying volume (bolstered in part by the meme stock frenzy), and now we’ve seen some choppy action with support near the 50-day line. It’s wild and wooly, but if you’re game, you could buy some RDDT on dips of a couple of points with a stop near the recent low.

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Stock 10

SharkNinja (SN)

Why the Strength
SharkNinja designs and sells household electronics under the Shark and Ninja brands, with the former brand known for its floor care line (mainly vacuums), while the latter is the bigger of the two (55% of sales) with a focus on kitchen appliances and cutlery. The company has grown brand awareness in recent years through steady innovation of new “craveable” consumer products that are in high demand; in fact, its offerings consistently rank as the top brand in kitchen appliance sales on Amazon (including most recently the second-most purchased blender). In recognition of the brand leadership, a Wall Street bank lately initiated coverage of SharkNinja with a “buy” rating (a reason for the recent share price strength), while a major ratings agency said SharkNinja continues to gain share in six of its seven top categories, with the firm achieving the accolade of being the nation’s top floor care brand, as well as having the best-selling product among hair stylers and ice cream makers. To further its reach, SharkNinja is also expanding into outdoor recreation and sporting goods with the introduction of its Ninja FrostVault cooler (direct competitor with Yeti) currently sold at Dick’s Sporting Goods. In Q1, the company posted revenue of $1.4 billion that increased 25% from a year ago (second straight quarter of accelerating growth), driven by a 28% rise in cooking and beverage appliance sales and a 74% jump in food preparation appliance sales; per-share earnings of $1.06 beat the consensus by 9% (another reason for the strength). The company said that market share gains should continue with existing categories and geographies, thanks to a “robust pipeline” of products in new categories, and management said emerging international market growth represents a “significant opportunity” (overseas sales grew 42% in Q1 versus 22% in North America) and thinks it could exceed the domestic business longer term. Analysts, meanwhile, expect earnings to grow nearly 20% this year and in the low to mid-teens in 2025.

Technical Analysis
SN went public back in July and, after some initial volatility, has enjoyed a steady advance since then. The only notable dips in the past few months have been relatively shallow and found support at either the 50-day line (in October-November and January-February) or the 25-day line (in April), all the while continuing to make new highs. To be fair, the advance might be a bit ripe in the intermediate term, but the stock’s recent five-week rest appears normal and support is close by—we’re OK buying some around here with a stop under 70.

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Previously Recommended Stocks

The next Cabot Top Ten Trader issue will be published on July 8, 2024.

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