Cabot Top Ten Trader Issue: March 4, 2024

The Story Remains the Same

As we plow into March, the overall story remains mostly the same as it has since the turn of the year—the primary evidence remains strong, with the trends of the major indexes up, most leading stocks in good shape (having survived a couple of wobbles last month) and with hundreds of stocks hitting new highs, all alongside big-picture sentiment that’s still tepid. That’s our main focus, of course, but not to be ignored is the near-term froth seen in many names and the fact that few leaders are at high-odds entry points, standing very extended above moving averages after having been on the run for months. Thus, our advice is unchanged: We’re riding our strongest stocks higher, but are taking some partial profits here and there and are picking our spots on the buy side, aiming to find earlier-stage stocks that can run. We’ll again leave our Market Monitor at a level 7.

This week’s list has many stocks that have emerged in recent weeks that seem worth a shot, especially if we see a normal retreat in the market. Our Top Pick is Axon Enterprises (AXON), which has a great story and has transformed into a well-sponsored name (nearly 1,500 funds own shares!) as it’s the clear leader in a unique sector.

Stock 1

ASML Holding (ASML)

Why the Strength
ASML last week achieved “first light” on its new chip etching system, High NA EUV lithography, meaning the company has achieved yet another breakthrough in creating very small imprints on computer chips by using focused light beams. It’s a sign ASML will retain its leadership in the rarified world of building highly sophisticated chip equipment—the firm uses extreme ultraviolet light (EUV) lithography for printing highly advanced semiconductors because EUV uses a lower wavelength of light, allowing the printing of finer circuitry. ASML is the unquestioned leader in making chip-imprinting equipment, well ahead of competitors Canon and Nikon, and it charges nicely for the ability: Its top-end systems go for a cool $350 million a piece. The recent tech advancement news comes on the heels of another quarter (Q4, reported in January) that beat Wall Street expectations, posting sales of €7.2 billion with very strong new order bookings of €9.2 billion. Driving bullishness, too, are hopes that the strength in demand for AI chips means an expected slowdown in Asian demand won’t come to fruition. Basically, the argument goes that since Nvidia just reported a blow-out quarter, that implies that one of its main suppliers, Taiwan Semiconductor, must be seeing better-than-expected demand. Taiwan Semiconductor is, in turn, a major buyer of ASML equipment and that firm’s forecast of continued slow times in the chip sector a few months ago is the reason ASML management has been predicting a flat 2024. But any uptick from Taiwan means 2024 for ASML should come in better than the expected €27.5 billion sales and earnings per share of €20 or so. Either way, ASML has been predicting 2025 to be a huge sales year, with 20% growth predicted, an outlook that probably improves if 2024 goes better than forecast, too.

Technical Analysis
ASML etched a very nice-looking launching pad from July into January and then broke out after earnings—and, importantly, that move came on its heaviest weekly volume in many years, a sign of great strength that usually persists. And it’s acted pristinely since then, with a run to 950 or so, three weeks of tight closes and then a move toward the millennium mark on Friday. ASML should be early-ish in its overall run, though right here we’d look for dips of a few percent, allowing the moving averages to catch up.

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Stock 2

Axon Enterprise (AXON) ★ Top Pick ★

Why the Strength
Axon isn’t a household name, but the firm has a unique position in a very big market: The company is effectively the next-generation technology (and, increasingly, weapons) for a growing number of law enforcement agencies (mostly state and local, but it’s moving into other areas too) in the U.S. and in other English-speaking countries, not just boosting efficiencies but also cutting down on unnecessary deaths and improving evidence collection/use via a range of offerings. It all started with Tasers, the firm’s electrical weapons that have gotten more effective over the years (the latest release has more range and 10 probes), but the big draws these days are Axon’s cloud and sensor products—the firm has a slate of cameras and sensors (body, dashboard, etc.) that record mountains of video that’s eventually uploaded into its Evidence.com software suite, which makes it much easier to review, analyze and share, which in turn leads to quicker court cases, too. (Amazingly, Axon says it uploads more video to its systems every month than YouTube!) The firm also has cloud software for other key functions like dispatch, record keeping and even drone-based evidence collection, all of which is sold on a subscription basis. All told, Axon sees a market of $50 billion or so, and the stock is strong today because the top brass continues to crank out terrific results: In Q4, sales (up 29%, led by cloud service revenue that was up 44%), earnings (up 60%) and EBITDA (up 38%) lifted beautifully, but as always, the forward-looking indicators were even better, with annualized recurring revenue of $697 million rising 43%, same-customer revenue growth of 22% and total future contracted revenue of $7.14 billion, up 54% from a year ago and up a whopping 23% from the prior quarter! Guidance for this year was solid, too (20%-plus revenue and EBITDA growth) with expanding margins. The valuation is up there, but there’s little doubt this growth story has a long way to run.

Technical Analysis
AXON came all the way back to new all-time highs by last March, but that was the beginning of another long, tedious consolidation; it wasn’t until November that shares saw some consistent buying pressure, with the stock up eight weeks in a row to marginal new highs. AXON, though, again hit resistance at that point, but instead of pulling back, it essentially went straight sideways—until earnings last week brought a decisive move to new price and RP peaks. We’ll set our buy range down a few points.

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Stock 3

Diamondback Energy (FANG)

Why the Strength
Oil stocks have been out of favor for a while, but some are beginning to percolate due to lots of actual and rumored M&A in the group, as well as resilient oil prices, last seen hovering near $80 per barrel. Diamondback Energy has always been one of the most efficient operators in the group, and a bold acquisition announced in early February has investors excited: The firm announced the purchase of privately held Endeavor Energy for a total consideration of $26 billion, which brings with it a huge 344,000 net acres in the Midland Basin, about doubling Diamondback’s stake and creating the preeminent play in the larger Permian. There are tons of attractive facets to the merger, including a 10% uplift to free cash flow in 2025 (and more beyond), a 60% bump in wells that have breakeven prices south of $40 per barrel (6,100 in total!), massive drilling efficiencies (Diamondback expects Endeavor’s drilling costs per foot to decline nearly 20% by 2025) and overall synergies (eventually $550 million annually), too. It’s a big move and is expected to take time to be finalized—likely not until Q4—but in the meantime, Diamondback itself is doing just fine, with excellent Q4 results (free cash flow of $5.09 per share, leading to 90 cents per share of share buybacks in Q4 and a $2.90 per share dividend) and a solid outlook for 2024 (at $80 oil and $3 gas, the firm should produce about $19 of free cash flow this year) as it keeps CapEx in check and returns at least 75% of cash flow to shareholders (buybacks and dividends). Even so, the Endeavor deal is the main attraction, setting the firm up to be a legitimate blue-chip energy play in the top basin in the U.S.

Technical Analysis
FANG has been showing terrific relative strength compared to the rest of its sector for months, hitting new dividend-adjusted highs in October of last year and pulling back only modestly (13% deep at its worst) and holding its 40-week line for the few months after that. And now we see the change in character, with FANG soaring on the acquisition news two weeks ago and following through to higher highs last week before today’s retreat. Further near-term dips are possible, but we’re OK entering here or on a bit more weakness.

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Stock 4

Freshpet (FRPT)

Why the Strength
When drilling into a firm’s fundamentals, we like to look for the three R’s (a long runway of rapid and reliable growth), and Freshpet has always had plenty of that—and now the latest quarterly report seems to be confirming that the firm’s handful of hiccups in recent years are behind it. The fresh pet food maker has gotten most of the tough work out of the way (getting costs in line, spending on new production facilities, raising prices and embarking on a big national ad campaign), and now it’s starting to reap what should be multi-year benefits. In Q4, sales lifted 30% (25% from higher volumes, 5% from higher prices) while EBITDA boomed 66%, both well ahead of estimates, and margins boomed (EBITDA margins up 3.2 percentage points) as logistics, input and quality control costs faded. Moreover, just about all of the sub-metrics impressed: Freshpet saw a 19% bump in household penetration (now 11.6 million households are customers, though the firm thinks it still has just 3% of the dog food market) as the number of stores selling its wares rose 6%, with 22% of the total having more than one refrigerator stocked with its goods (up from 15% a year ago). Moreover, the company’s newest plant is ramping up, with construction of a new line ahead of schedule and likely to begin production in Q3, which should continue to help margins. All told, the quarter gave big investors confidence that the firm is on track to meet its bullish 2027 projections released last year (EBITDA up five-fold from 2023 to 2027), while 2024 guidance (sales up 24%, EBITDA up 57%) looked good as well. It’s a good, consumer-led growth story that should go far.

Technical Analysis
We just wrote up FRPT about a month ago, and for the following three weeks, there wasn’t anything different when it came to the chart—the stock had done nothing for months and dipped sharply into the October market low but gapped on earnings in November and rallied to marginal new highs. And then came 10 straight very quiet, very calm weeks, but the end result was another powerful gap up last Monday following earnings. We’re OK entering here or (preferably) on dips.

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Stock 5

Light & Wonder (LNW)

Why the Strength
Light & Wonder (L&W, covered in the November 13 report) is a leading cross-platform global gaming provider, with offerings including casino slot machines, tabletop games, lottery systems and digital gaming solutions. Last week, the Las Vegas-based company reported Q4 results that turned heads on Wall Street, led by revenue of $770 million that increased 13% from a year ago and earnings of 73 cents a share that beat estimates by a nickel, while free cash flow for the year as a whole came in around $3.25 per share. The solid top-line results were driven by double-digit growth across all three of L&W’s business lines and represented an 11th consecutive quarter of year-over-year revenue growth. By segment, Gaming revenue increased 13%, driven by another quarter of “robust” growth in gaming machine sales (up 31%), while SciPlay (mobile and social gaming) sales reached another quarterly record (up 12%) and iGaming (online casino games) sales held at a record level (up 13%). L&W’s digital business also had a historic quarter, with software sales contributing to market share momentum and higher revenue in the social casino space (mostly free-to-play games that imitate the gambling experience without offering a real cash payout). Average monthly revenue per paying user was around $114 and average revenue per daily active user increased 15%, both quarterly records. Management attributed the stellar results to the strategic investments it made last year, which the firm expects will drive “long-term sustainable value” and allow it to reach the goal of $1.4 billion in EBITDA by 2025 (up 27% from last year). Going forward, L&W plans to focus mainly on the fast-growing U.S. gaming market this year but is optimistic that Brazil will be a future growth driver based on recent legislative developments in that country. It’s not growing like a weed, but expect Light & Wonder to crank out high single-digit revenue growth and faster EBITDA and free cash flow growth over the next two years.

Technical Analysis
LNW enjoyed a choppy uptrend last year, hitting multi-year highs in July and, after a slip in the fall, moving to a peak near 90 in December. Then came a normal base-building effort, with the stock correcting and consolidating over the next 10 weeks with a maximum drawdown of just 14%. LNW began perking up early last month, but the noteworthy action started just before (and carried through a few days after) earnings, with the stock not only moving to new highs but doing so on five straight days of big volume. We’ll set our buy range down a bit, though given the strength, we’re not expecting a huge retreat.

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Stock 6

Okta (OKTA)

Why the Strength
Identity access management (IAM) vendor Okta boosted the number of million-dollar (annual revenue) clients it has by more than 30% last quarter, a huge leap in what has been a somewhat difficult environment, with big corporate clients still pinching pennies for a lot of their tech spending. The large-contract deals headlined a fourth quarter that saw Okta beat revenue and earnings estimates handily, posting earnings per share of 63 cents on $605 million sales. Okta is a leader in IAM, a form of workplace security that benefits from the growth in remote and hybrid work situations, where network security can’t be as tightly controlled as in the office; Okta’s cloud-based software verifies the user and the device and allows access to a business’ systems in a less cumbersome manner than alternatives, a service for which it charges a subscription fee. It’s a field with a lot of competitors, including giants like Microsoft and Oracle, but Okta is a leader, especially with mid-sized enterprises—which means there’s still a lot of growth to be had by tapping into larger, global companies. A new deal integrating its identity management suite into Softbank’s new business device management offerings in Japan should help, given Softbank already has 16,000 customers signed up. The global corporate IT spending environment hasn’t been as robust as it had been, but (a) it should pick up in the quarters ahead and (b) Okta’s management feels confident access and identity security will still be a priority for IT teams. This year, the company foresees sales rising 16% to 17%, to around $2.64 billion, well ahead of previous expectations and likely conservative. Investors are also heartened that a data breach at the firm last year (obviously a bad look for the firm) doesn’t appear to have caused much financial harm and is in the past.

Technical Analysis
OKTA has not been a leader in the cybersecurity space, with lots of jagged ups and downs during the past year, but with no net progress to show for it. But last week’s earnings report might have finally changed investor perception, with shares following up on a well-controlled eight-week range (a character change from the prior dips) with a 20% upside gap on nearly 10x average volume. If you’re game, we think dips of a couple of points would be tempting, with a loose stop in the low 90s.

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Stock 7

Quanta Services (PWR)

Why the Strength
A report from the International Energy Agency (IEA) has warned that electricity grids are too weak to sustain the transition from traditional energy to the alternative energy sources that many governments worldwide are mandating. This is creating a massive opportunity for Houston-based Quanta, which provides end-to-end solutions in the electric power sector, building generating stations and substations as well as transmission lines for pipeline, industrial and telecom customers. Through its ownership of Blattner Holdings, it also offers utility-scale renewable energy infrastructure solutions, providing Quanta with sizable exposure to the ongoing transition to renewable energy. (For instance, Blattner has one of two big Quanta contracts for the planned SunZia wind project in Arizona and New Mexico, which would bring 3,000 megawatts of power to Western states upon completion.) In fact, a big reason for Quanta’s growth in recent years is the firm’s renewable energy-focused business, which boasts a sizable backlog (the firm’s total backlog stood at $30 billion at the end of the year!) of multi-year, large-scale projects and which Quanta says “evidences the momentum we see for 2024.” In Q4, Quanta noted that customer demand for its energy transition solutions was strong, leading to record sales, profits and cash flow: Revenue of $5.8 billion soared 31% from a year ago, and earnings of $2.04 a share beat estimates by 11 cents. Other metrics were just as solid, including EBITDA of $550 million which increased 22% and free cash flow of $915 million which nearly doubled from last year’s Q4. The top brass said it’s positioning the company for what it sees as decades-long demand for the infrastructure investment necessary for the energy transition, and it guided for continued revenue growth in 2024 along with double-digit growth in adjusted EBITDA and a 24% uplift in free cash flow (which should total nearly $10 per share this year). Wall Street expects low- to mid-teens earnings growth for the next three years.

Technical Analysis
After a 25% correction last autumn, PWR established strong support at 160 and stormed back to life in November and December, achieving a nominal new high in the process. But after the straight-up recovery, shares needed another rest, which led to a shallower (15% deep), nine-week consolidation. And now the buyers are stepping up, with a clean breakout after earnings that sent the stock to all-time highs. If you want in, we’re OK nabbing some shares on a pullback of a few points.

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Stock 8

Robinhood (HOOD)

Why the Strength
After disrupting the brokerage business and lighting a fire under its competitors with offers of commission-free transactions, financial services platform Robinhood fell out of favor with investors during the bear market year of 2022 as revenues dropped while active users sharply declined. But with the bull’s resurgence last year, Robinhood has seen a steady return of customers—a big reason for the share price strength, while the firm is also making moves to bolster its positioning. Robinhood’s platform allows clients to buy and sell stocks, options and cryptocurrencies with a user-friendly app and also offers some kickers to attract new clients (like a 1% match on all IRA contributions) while expanding overseas (launched in the U.K. last November and now offers crypto trading in Europe, too). In Q4, the company reported revenue up 24% from a year ago and per-share earnings of three cents that beat estimates by four cents. Significantly, new clients and account transfers from competitors fueled strong net deposits of $4.6 billion in the quarter, with an average of over $100,000 per transfer, further extending a trend of Robinhood taking market share in the industry. Moreover, assets under custody finished Q4 back over $100 billion for the first time since 2021, while net deposits grew at a 21% annualized rate. Other metrics were equally impressive, with net interest income (a boon to all brokerages as rates have moved up) increasing 41% to $236 million and transaction-based revenue rising 8% to $200 million (options are the biggest draw here, making up 60% of transaction revenue). Moving forward, management said 2024 is off to an even better start than last year’s unusually strong Q1 and that Robinhood has already brought in more funded customers and net deposits through the first half of Q1 than it did in all of Q4. The firm further plans on launching new products, including credit cards, with a focus on expanding into international markets. Obviously, if the market keels over, all bets are off, but if this is a new bull market, Robinhood should capture more than its fair share of new investors as big-picture sentiment improves.

Technical Analysis
HOOD has spent most of the past year in a volatile trading range between 8 and 13, with buyers and sellers fighting it out and lots of jagged moves (including on earnings) during that time. That all changed with last month’s Q4 report, as shares blasted out of the range on monster volume and, impressively, it’s followed through nicely on the upside to two-year highs. HOOD is a bit stretched from support, though we do like the power—we’re OK nibbling here though we’d prefer to jump on a dip of a few dimes, along with a liberal stop.

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Stock 9

Texas Roadhouse (TXRH)

Why the Strength
Recent news headlines have drawn attention to the fact that Americans are spending their biggest share of income on food in three decades, making dining out something of a luxury for many consumers. But not all restaurants are suffering from the slowing nationwide sales trend, and Texas Roadhouse is one of a few major chains experiencing a growth spurt. The company owns and franchises eateries under the Texas Roadhouse, Bubba’s 33 and Jaggers names in 49 states and 10 foreign countries. More importantly, the Roadhouse chain, which is known for its high-quality steaks and Western-themed diners, is currently in expansion mode with 44 new locations opened in 2023—a record year for system-wide new store openings—bringing the total of company-owned and franchised stores to 741 (up 6% from the prior year). Roadhouse saw a 15% year-on-year total revenue increase in Q4, to $1.2 billion, and a 21% increase in per-share earnings of $1.08. Importantly, comparable restaurant sales increased 10% and rose by 9% at domestic franchise restaurants (so the growth angle isn’t just about new locations), while restaurant margin dollars jumped 21%, mainly due to stronger sales and higher foot traffic (not just from raising menu prices). Growth is expected to continue this year, with Roadhouse’s plans to open around 30 company-owned restaurants across the three brands, including the opening of 14 domestic and international locations by its franchise partners. To increase store capacity, the company will also install “digital kitchens” in 200 locations this year, which will help boost to-go orders and should contribute to higher profits and margins. The top brass also guided for 2024 comp sales growth to benefit from higher menu prices (starting in March), while Wall Street expects full-year sales and earnings increases of 14% and 24%, respectively.

Technical Analysis
TXRH rose from 90 at the start of last year to almost 120 by late July, then gave back all those gains during the 12-week, market-wide correction into the start of Q4. But the October earnings report brought in the buyers, and after a pullback to the 10-week line in early January, shares broke out on the upside—with the latest earnings release leading to a strong gap higher. We wouldn’t chase TXRH here, but a pullback of a few points would be tempting.

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Stock 10

Trip.com (TCOM)

Why the Strength
China’s travel and tourism industry—both inbound and outbound—is one of the world’s largest, and after suffering heavy losses from severe and prolonged Covid-related travel restrictions, the sector turned around last year. The return of China’s travel industry strength is expected to accelerate in 2024, with domestic hotel bookings already exceeding pre-pandemic 2019 levels by a significant margin. This is but one reason for the strength behind Shanghai-based Trip.com, an international travel booking website offering customers deals in over 1.2 million hotels across more than 200 countries, with China its most important market. Indeed, China’s travel industry is expected to continue to normalize this year, with international outbound travel now a big focus for Trip.com—the firm’s international travel segment recently recovered to around 80% of pre-pandemic revenue, so there’s still some room to catch up. The company also just released Q4 results that showed some head-turning improvements to the top and bottom lines, namely consensus-beating revenue of $1.4 billion that doubled from a year ago and per-share earnings of 56 cents that surprised estimates by 34 cents (another reason for the strength). Trip.com said that both its domestic and international businesses continued to show “robust” recovery during the quarter, with domestic hotel reservations growing by 130%, while total booking on the firm’s global online travel agent (OTA) platform increasing by over 70%. Also noteworthy in Q4 was a 130% year-on-year increase in corporate travel (up 7% sequentially), which Trip.com said was due to “substantial recovery” of the overall travel market. Looking ahead, management expects growth to continue and is seeing customers prioritizing travel expenditures over other daily expenses, indicating a “shift towards experiential spending.” Analysts foresee a 20%-ish sales bump in 2024, with continued mid-teens percentage growth in the next two years.

Technical Analysis
TCOM was early out of the gate after making its low in 2022, rallying to 18-month highs in January of last year. But that was it for the year—shares essentially went back and forth between 30 and 40 for many months after that. TCOM started to show improvement a month ago, with a quiet move above 40 that gained steam soon after, including a big two-day post-earnings boom to its highest level since 2019. The retreat from the recent highs isn’t pleasant, but looks normal so far—we’ll set our buy range up above today’s high, looking to enter on a resumption of the post-earnings rally.

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Previously Recommended Stocks

The next Cabot Top Ten Trader issue will be published on March 11, 2024.

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