February 10, 2020

Still Bullish, but Expecting Further Volatility

Current Market Outlook

There’s nothing bad to say about the market’s quick rebound two weeks ago and its ability to hold those gains—at the very least, such action from the big-cap indexes and many leading stocks is a good longer-term sign. But it’s also important to look at all of the evidence, and on that front, things are mixed—broader indexes are still hanging around their 50-day lines (acceptable, but not overly powerful) and the number of names hitting new highs has dried up. That doesn’t necessarily portend doom, but it does describe an environment that’s a bit more hit-and-miss, especially with a ton of earnings reports set to be released. Overall, you should remain bullish, but be a bit discerning on the buy side, looking for names that have shown excellent recent strength and volume.

This week’s list has many stocks that meet that criteria, including a few that have popped after earnings. Our Top Pick is Lumentum (LITE), which recently came out of a very long launching pad and, after a four-week rest, has taken off after earnings.

(AAXN)

Why the Strength

Axon Enterprise has had a great story for well over a year now, though the stock has been harder to handle (more on that below). However, we think shares are perking up because big investors are slowly becoming more comfortable that management (which has a so-so record) has gotten its act together, and that the firm’s newer business model can crank out growth for many years. As we’ve written before, Axon (used to be known as Taser) is making hay as it’s (a) steadily moved away from lumpy sales of its stun guns and toward things like body cameras and in-car video systems, and (b) moved to a recurring revenue model as it sells subscriptions to its Evidence.com video management platform—indeed, while stun gun sales still make up a bit more than half of revenue, cloud and sensor revenue is growing nicely (up 45%-ish in Q3), while the firm’s annualized recurring revenue under contract was up 39% as of the end of September. Longer-term, there’s huge potential here as law enforcement agencies all over the world adopt Axon’s solutions and ink longer-term contracts. The trick, again, is management, who occasionally veers into odd territory; it started 2020 by announcing a lawsuit vs the FTC for violating the constitution in an effort to get that agency off its back regarding a proposed acquisition. Even so, investors seem mostly focused on the core growth story, which remains very promising. Earnings are likely out in late February.

Technical Analysis

That lawsuit caused a good-looking setup heading into the New Year to turn sloppy, with AAXN getting hit on big volume for a couple of days. But shares steadied themselves at that point and, impressively, have pushed higher since, moving to new price highs and mostly ignoring the virus-related waves of selling we’ve seen during the past couple of weeks. Earnings are always a risk, but we’re OK starting a small position here or (preferably) on dips.

AAXN Weekly Chart

AAXN Daily Chart

Bilibili (BILI)

bilibili.com

Why the Strength

We wrote about Bilibili last month, explaining how the company’s unique 3C strategy (commercialization, community and content) was driving revenues in multiple channels: mobile games, display advertising, membership subscriptions, e-commerce, live streaming and even offline performance activities. Bilibili has moved into the leadership spot in entrancing China’s generation Z’ers with its videos, live broadcasting, comics, anime and mobile games. A constant influx of new content (27 newly-commissioned anime series) plus its emphasis on exclusivity with a 100-question geek test (covering media, music, culture, and animation) before you can be an ‘official member’ on its site has caught the attention of the 20 to 25 year old age group, pushing its monthly active users to 127.9 million (forecast to grow to 220 million next year). The company has 7.9 million paying customers and more than 54 million “official members.” Usage has soared more than 65% in the past year, with 27.4 million folks playing on its website every day. BILI is setting its sights high, with COO Carly Lee recently projecting that “by 2022, the output and quantity of Chinese creations will be several times that of Japanese productions, becoming the mainstream of the animation market and the film market in China.” And now, Bilibili is enlarging its music landscape, inking a deal to partner with QQ Music, Tencent’s (which owns 12% of BILI) music streaming platform, to promote and support independent artists. Growth is solid, and Bilibili looks like one of the new-age Chinese Internet leaders.

Technical Analysis

BILI built a huge post-IPO base from June 2018 through December of last year, then broke out on good volume right before the turn of the year. It did pull back for a few weeks, especially during the market’s virus-induced selloff, but it never broke support, and last week the stock exploded to new highs on big volume. Expect volatility, but we’re OK grabbing some shares here or on dips.

BILI Weekly Chart

BILI Daily Chart

Bill.com Holdings (BILL)

bill.com

Why the Strength

Now here’s a newly public stock with a great, easy-to-understand growth story. Even today, the vast majority of small- and mid-sized businesses (SMBs) handle invoices, pay bills, locate contracts and the like no different than they did a couple of decades ago—but Bill.com is helping them digitize those efforts, providing a cloud platform that lets clients streamline approvals, store documents and send/receive payments, all while syncing up with their accounting software. The potential market is gigantic, including a whopping six million SMBs (revenue potential of around $9 billion in the U.S. alone), more than 90% of whom still rely on paper checks. Bill.com has succeeded in large part by integrating their service with big accounting firms and financial institutions these SMBs already use. All of it has been a huge success—in the quarter reported last week, total revenue leapt 50%, while core revenue (subscription plus transaction revenue) was up 61%, as the firm counted 86,000 SMBs as customers that, in total, are approving more than 2.4 million bills per month. Even better, the top brass guided estimates for 2020 nicely higher (revenue up 57% or so) and, while the bottom line is in the red, it’s not far from turning positive. The valuation is big ($4 billion market cap, $122 million in revenue last year), but the story is big.

Technical Analysis

There’s not too much of a chart to analyze for BILL, which came public in mid December. Shares consolidated for the first month or so before breaking out near 42 and rising rapidly to 53. There was a pre-earnings shakeout, but BILL has surged back since releasing earnings. As with all IPOs, this one is likely to be extremely choppy, so if you’re game, start small and enter on pullbacks.

BILL Weekly Chart

BILL Daily Chart

DocuSign (DOCU)

docusign.com

Why the Strength

One theme we harp on when looking for (and writing about) great growth stocks involves the “three Rs”—companies that can combine rapid growth that’s also reliable, and yet have a very long runway of growth opportunities ahead of them, tend to be like catnip for institutional investors. (Yes, we’re thinking of a snazzier name for that combo.) DocuSign has been a great example of that, as the firm’s leading position in the emerging e-signature market (as well as its move into a broader systems of agreement platform) has produced an enviable record of growth (35% to 40% top line growth, expanding earnings) over the past few years. And that growth has been very reliable as management has steadily expanded among its own customer base (same-customer revenue growth is regularly in the 12% to 18% area; 95% of revenues are from subscriptions) and attracting new users (562,000 total customers, up 18% from a year ago, while big enterprise customer growth is even faster). Plus, there should be years of excellent growth ahead—management believes it’s playing in a $25 billion market for e-signatures alone, not to mention newer areas like contract creation and management. There is some competition (Adobe is one), but DocuSign is the leader and big investors (713 funds own shares, up from 296 a year ago!) are growing increasingly comfortable they’ll stay on top. Earnings are likely out in early- to mid-March.

Technical Analysis

DOCU didn’t lead the October-January market rally, but it also didn’t do anything wrong, effectively crawling higher without getting too far above its rising 50-day line. Shares did get hit during the initial virus selloff, but that now looks like a shakeout—after dipping just below that key 50-day line, DOCU has surged to new highs on solid volume during the past two weeks. Aim to enter on minor weakness of a point or two.

DOCU Weekly Chart

DOCU Daily Chart

GDS Holdings Limited (GDS)

gds-services.com

Why the Strength

One of our favorite China growth stories, GDS Holdings, continues to make a name for itself as one of that country’s best high-performance, carrier-neutral data center providers. It provides colocation, managed hosting and managed cloud connection services, and boasts an ever-increasing customer base that includes large cloud service providers (makes up 73% of its 615 customers), big Internet providers and other large entities. The company’s physical presence is also growing, with total capacity in Q3 2019 rising 48% compared to the year before. It’s also attracting increased analyst coverage, while institutional ownership of its shares has risen dramatically since first being listed on the Nasdaq in November 2016. Although the company’s debt is high (liabilities equal to three times equity), that’s not unusual as it spends massively to build data centers, which produce years worth of recurring revenue once completed—indeed, GDS’ EBITDA (a measure of cash flow) rose 45% in Q3. More important, Wall Street sees the company’s growth trend continuing without a hitch (sales expected to rise 43% in 2020, on top of a 47% gain last year), with continued solid gains in EBITDA as well. While anything China-related has risk due to the coronavirus situation, GDS’s growth looks both rapid and reliable, which, along with a blue-chip client base, should continue to attract big investors. Earnings are likely out in three weeks or so.

Technical Analysis

We missed out on GDS in December (it didn’t hit our suggested buy range), but the stock is one of the strongest Chinese names out there, which demands another look. Moreover, we like the general setup here—after GDS shook out to its 50-day line during the initial virus selloff, it’s surged to new highs on solid volume since, just the action you want to see. A dip of a point or two would be tempting.

GDS Weekly Chart

GDS Daily Chart

Insmed Inc. (INSM)

www.insmed.com

Why the Strength

Insmed is another developmental-stage biotech that’s in favor thanks to some great recent trial results. In this case, shares got a boost following the release of its Phase 2 WILLOW study for INS1007, the firm’s therapy for lung disease. Specifically, INS 1007 treats inflammatory diseases such as non-cystic fibrosis bronchiectasis, a chronic condition in which the walls of the bronchi (extensions of the windpipe) become thick from inflammation and infection. That leads to breathing difficulties, as well as chronic coughs and lung infections. The results showed that INS 1007 met both primary and key secondary endpoints in a 256 patient, 24-week study, extending the time before a patient first experienced a pulmonary exacerbation and reduced the frequency of exacerbations. Non-cystic-fibrosis bronchiectasis affects 340,000 to 520,000 people in the U.S., and there are currently no approved treatments that specifically target the condition. Insmed has additional drugs, including ARIKAYCE, which is approved in the U.S. for the treatment of a certain kind of lung disease which can prove fatal. Insmed also produces INS1009, an inhaled formulation of a treprostinil prodrug (a prodrug is a medication or compound that, after administration, is metabolized into a pharmacologically active drug) for rare pulmonary disorders. Obviously, it’s speculative, but if the next phase for INS 1007 is as positive as this one, the shares have great potential. Analysts are projecting revenues up nearly 60% this year.

Technical Analysis

INSM has been all over the map in recent years, with a sharp slide in 2018, a nice rebound in early 2019, and then another dip to the 15 area in the middle of last year. It had made up a little ground through January, but the real action came last week, when the stock exploded higher for a few days after the INS1007 results. It’s not for the faint of heart, but we’re OK sharpshooting a token position here or on dips.

INSM Weekly Chart

INSM Daily Chart

Lumentum (LITE)

www.lumentum.com

Why the Strength

Lumentum is a networking firm that’s had a few ups and downs in recent quarters, but the stock is strong today because the future is bright for a couple of key areas it plays in, with some company-specific catalysts helping, too. First, as with many in the industry, it looks like 5G is starting to boost demand—in Q4, the firm’s telecom and datacom business was up 29% from a year ago as its various transmission-related products sold well. Meanwhile, while telecom revenues struggled, management sees business picking up there going forward, while Lumentum’s 3D sensing lasers are becoming more commonplace in smartphone, computing and gaming applications, all of which should lead to good results during the next couple of years. Finally, the company’s acquisition of optical component maker Oclaro in late 2018 is leading to plenty of synergies. The end result: Business is good and should get better while margins are expanding in a big way, leading analysts to meaningfully hike estimates—Wall Street now sees Lumentum’s earnings up 23% this fiscal year (ending in June) and 15% next, with both of those up nicely since last week’s quarterly report. (The $6.05 per share estimate for next year is up 35 cents since the report.) There’s nothing crazy revolutionary here, but it looks like the company is in the right place at the right time as many of its end markets begin to pick up steam.

Technical Analysis

LITE had a very long consolidation from March 2018 through mid October 2019, but the Q3 earnings report got the stock moving—it broke out in November near 64 and kited as high as 85 around the turn of the year. Shares pulled back after that, but held their 50-day line, and then last week’s earnings report led to a big-volume rebound to new highs. We like the setup here or (preferably) on minor dips.

LITE Weekly Chart

LITE Daily Chart

Nuance Communications, Inc. (NUAN)

nuance.com

Why the Strength

In the field of speech recognition software, Nuance Communications is a pioneer with plenty of room to grow. The company is known for its Dragon Naturally Speaking software package, which makes dictation faster and nearly as accurate as typing. It also allows users to control computer programs and send emails by voice command. Relatedly, the company’s biggest growth engine looks to be its cloud-based Dragon Medical documentation software. Last week, Nuance announced fiscal Q1 results, and while growth wasn’t fantastic, the numbers topped forecasts while delivering margins in-line with expectations. Total Q1 revenue was down 5% due to restructuring activities, but the company reported record Enterprise segment revenue of $139 million (+7%), plus Dragon Medical delivered 51% yearly revenue growth in Q1. Nuance boasts excellent customer retention levels (a key metric for software companies), with high renewal rates on its maintenance and support agreements. And some key partnerships (like with Microsoft) are only going to help. Just as important as anything, Nuance’s management sees healthcare-related annualized recurring revenue (driven by Dragon Medical, which it sells on a subscription basis) to grow 30% this year and then 20% to 25% every year through 2023! There are many moving parts, but Nuance’s best days are definitely ahead of it.

Technical Analysis

After rounding out a long-term base, Nuance’s share price broke out last October following the Microsoft partnership announcement. Shares tightened up around 18 in December, reached 20 in January, and after a quick shakeout with the market on virus fears, NUAN catapulted to new highs last week following earnings. We think buying on dips makes sense.

NUAN Weekly Chart

NUAN Daily Chart

Old Dominion Freight Line Inc. (ODFL)

www.odfl.com

Why the Strength

While the U.S. trucking industry has generally enjoyed good times in recent years, it suffered a setback in 2019 due to trade war-related uncertainties; the key ATA truck tonnage index actually slipped into negative territory late in the year, but freight levels have rebounded and, with faster economic growth likely, the future looks bright, and Old Dominion is positioned to take advantage of the industry’s upmove. The company offers less-than-truckload (LTL) regional, inter-regional and national shipping services across the country and is the world’s second-largest trucking company overall. On February 6, the company released Q4 results, and as you’d expect, they weren’t great—revenue (-2%), net income (-10%) and LTL tonnage (-4.5%) were lower on a year-over-year basis, while earnings per share slipped 8%. Still, in a cyclical industry, it’s all about the future, and the fact that earnings snuck in above estimates and that analysts see better times ahead is what counts—current quarter earnings are expected to turn up, with growth gradually accelerating throughout the year (Wall Street sees earnings up double digits both this year and next). It’s not changing the world, of course, but Old Dominion is a direct play on a pickup in U.S. economic growth this year.

Technical Analysis

ODFL broke out last October with the market, and while it hasn’t been a smooth uptrend, shares have made good progress—there was a pullback into early December, and another with the market in January, but both found support near their 50-day line. And then last week, the stock shot ahead to new highs following the Q4 results and outlook, albeit on so-so volume. We wouldn’t chase it here, but buying on pullbacks of a few points should work.

ODFL Weekly Chart

ODFL Daily Chart

Scotts Miracle-Gro (SMG)

scottsmiraclegro.com

Why the Strength

Scotts isn’t an unknown entity; it’s been around since 1868, and most of us have bought its potting soil, plant boosters and insecticides, or used the company’s services to attend to our lawn needs. Scott’s green and white trucks are a fixture in most neighborhoods throughout the growing season. But what you may not know is that Scott’s has recently entered the “other grass” business—marijuana! Last year, the company bought Sunlight Supply, the largest hydroponic distributor (products that help plants grow without soil) in the U.S., and combined it with its Hawthorne Gardening Company subsidiary to target professional growers, including cannabis producers. Scotts predicted that this new division would garner annual sales of $600 million from more than 1,800 hydroponic retail stores in North America. And that forecast now looks conservative! For 2019, Hawthorne’s sales rose by an astonishing 95%, to $671 million, and while that kind of growth isn’t likely to continue, Wall Street is looking for solid expansion going forward. For its fiscal first quarter, Scott’s easily surpassed analysts’ estimates (it lost money, but that’s the norm for this seasonal business). Sales also beat estimates, coming in at $366 million, 23% higher than a year ago. For 2020, Scott’s is projecting sales growth of 5% or so, while analysts see the bottom line rising 15% (which is likely conservative). A solid share buyback program (up to $750 million) and tidy dividend (1.9% annual yield) also help. Scott’s looks like a more conservative way to play the boom in marijuana production.

Technical Analysis

SMG bottomed with the market in late 2018 and had a great, persistent advance through July of last year. The stock went on to build a nice-looking launching pad, with some tightness in December just off its prior highs. The breakout on earnings was powerful and, importantly, lasted four straight days. SMG has been tight since then despite the market’s day-to-day gyrations, another good sign. We’re fine taking a swing at it here.

SMG Weekly Chart

SMG Daily Chart

Previously Recommended Stocks

Below you’ll find Cabot Top Ten Trader recommended stocks. Those rated HOLD are stocks that traded within our suggested buy range within two weeks of appearing in the Top Ten and still look good; hold if you own them. Stocks rated WAIT have yet to dip into our suggested buy range … but can be bought if they do so within the next week.

Those stocks rated SELL should be sold if you own them; they will no longer be listed here. Finally, Stocks in the DROPPED category are those that failed to trade within our buy range within two weeks of our recommendation; that’s not a bad thing, we just never got the price we wanted. Please use this list to keep up with our latest thinking, and don’t hesitate to call or email us with any questions you may have. New recommendations each week are in green.