Time for Caution
Current Market Outlook
The month-long rebound that began in early February clearly cracked last week, with the major indexes falling below key support and with some indexes (like the S&P 500 and NYSE Composite) retesting their February closing lows. There are still many stocks holding up well, including most of the growth-oriented names that exploded higher on big volume in February; however, as we saw last week, good stocks can go down in a hurry when the market hits the skids. Overall, we’re shifting our Market Monitor back down to neutral, and the onus is on the bulls to change that—a few strong days could make all the difference, but this downturn may continue until enough investors have thrown in the towel after the market’s huge run last year. We still advise holding strong, profitable stocks, but new buying should be limited and holding a good-sized chunk of cash on the sideline makes sense.
This week’s list still has a lot of good stories and solid charts, and includes a few newer names. Our Top Pick is ServiceNow (NOW), which remains exceptionally resilient. Just remember to keep new buys small given the market.
| Stock Name | Price | ||
|---|---|---|---|
| Chegg (CHGG) | 74.21 | ||
| Continental Resources (CLR) | 66.19 | ||
| Floor & Décor (FND) | 68.03 | ||
| Fortinet Inc. (FTNT) | 137.53 | ||
| HealthEquity, Inc. (HQY) | 70.70 | ||
| Netflix, Inc. (NFLX) | 423.92 | ||
| PagSeguro Digital (PAGS) | 35.09 | ||
| Penumbra Inc. (PEN) | 173.25 | ||
| Red Hat (RHT) | 0.00 | ||
| ServiceNow (NOW) | 341.86 |
Chegg (CHGG)
Why the Strength
Education is a major industry, with 47 million students from middle school through college, representing about 7% of U.S. GDP. And a full 2.2 million of those students use services or required materials (like texts) supplied by Chegg (up from 1.5 million in 2016). Chegg offers services like study aids, writing tools and tutoring that made up almost three-quarters of 2017 revenue, with the remainder coming from rental and sales of textbooks and other required materials. A 2015 deal with Ingram Content Group allowed Chegg to shed its textbook inventory, with Ingram taking responsibility for new book investments. After the deal, Chegg exited its warehouse operations, but continues to market texts under its own brand, earning a 20% commission on every transaction. The company’s revenue history isn’t impressive, with declines in 2015 and 2016 and zero growth in 2017, but that’s mostly because of the revenue loss from those books—the company’s transition away from textbooks into higher-margin educational services has made for great bottom-line numbers. Earnings were up 88% in 2015, 400% in 2016 and 211% in 2017, with analysts calling for 64% growth in 2018 and 37% in 2019. With the text business generating a ton of brand awareness (and leading the market program for study aids and tutoring), Chegg guided for $295 million to $300 million in revenue in 2018 (up about 17% from last year) with services contributing $240 million to $243 million of that total. This looks like a good way to play the digital revolution in education.
Technical Analysis
CHGG fell from its late-2013 IPO at 11to 3 in February 2016, but had worked its way back above 8 in May 2017 when a great quarterly report blasted the stock to 12 in one day. The stock took a break from August 2017 through early February, when another great quarterly report on February 13 keyed a major surge. CHGG is now consolidating its gains after topping 23 earlier this month, so far holding its 25-day line. The market environment is certainly a risk, but we won’t argue with a small position here or on dips, with a stop near the 50-day line.
CHGG Weekly Chart
CHGG Daily Chart
Continental Resources (CLR)
Why the Strength
After the market’s February plunge threw a wrench into the group’s uptrend, energy stocks are showing signs of life again as oil prices firm up and drilling activity does the same. Continental is an emerging blue chip in the sector and should be one of the leaders of any new uptrend that gets underway. The company operates in the Bakken (800,000 acres in North Dakota and Montana; 61% of production) and the Scoop and Stack formations in Oklahoma (1.1 million acres; 39% of production), with 59% of output oil and the rest gas and liquids. The company took a hit along with all of its peers during the oil bust of 2015-2016, but the firm is not just growing rapidly again (Q4 production rose 37% from a year ago) but morphing into a cash cow—management sees production up about 21% this year, and it’s not only funding all of its drilling program internally, but expects to produce $850 million or so of free cash flow that, along with the occasional non-core asset divestiture, will likely be used to pay down debt. (Analysts see earnings more than quadrupling this year off a low base.) Obviously, a lot depends on the price of oil, but with the economy strong and the U.S. dollar relatively weak, most big investors are thinking oil’s downside is limited. The combination of growth, cash flow and excellent management make Continental an institutional favorite in the sector.
Technical Analysis
CLR is at the top of a huge cup-with-handle base, with the left side starting in early 2017 near 60, the bottom occurring in July at 29, and then a rally back to 59 in January of this year. The “handle” is actually a base in and of itself—CLR has etched a 10-week, 20% deep zone since mid-January, and last week shares actually kissed new high ground on a nice pickup in volume. If you’re game, nibbling on dips makes sense.
CLR Weekly Chart
CLR Daily Chart
Floor & Décor (FND)
Why the Strength
Floor & Decor is probably the best cookie-cutter story that few investors have heard of. As we wrote in early January, the company looks like a category killer in the flooring business—the firm’s 83 warehouse-style stores offer much more square footage (70,000 square feet on average), product selection and lower prices than the competition (more than three times as many flooring products as Home Depot, for instance, and management says its stores that are located near competitors do better than average as customers comparison shop), which have made them increasingly attractive to both individual and professional buyers. The growth potential is enormous, both in terms of the store count (management expects 20% annual store growth for many years, with a long-term goal of 400 locations!) and in terms of boosting comparable store sales—that key metric was up a whopping 16.6% last year and 24% in the fourth quarter (!). There’s likely more where that came from given that professionals (who account for 60% of the company’s revenue) only give Floor & Decor 10% of their overall flooring spend. It’s a simple concept that’s produced excellent growth for years—sales regularly grow north of 25% (including a 40% boom in Q4), with earnings advancing faster than that, and management’s initial outlook for 2018 is for sales to grow 23% and earnings to advance 33%. The valuation (51 times estimated earnings) is big, but so is the long-term potential. We like it.
Technical Analysis
FND has set up a nice looking IPO base-on-base pattern. The initial base lasted from June through December, before the stock kicked to new price highs. But since then the stock went on to form another, shallower base during the market’s two-month correction, and it’s now showing intriguing strength—last week, FND actually nosed out to new highs on excellent volume despite the market’s plunge. It’s definitely worth watching, and if you want in, would be tempting.
FND Weekly Chart
FND Daily Chart
Fortinet Inc. (FTNT)
Why the Strength
As the range and severity of cyberattacks rise, enterprises are turning to integrated solutions that simplify operations and consolidate IT spending budgets. Many are embracing solutions from Fortinet, which sells a portfolio of security software products covering everything from network, multi-cloud and email security to advanced threat protection and secure unified access. The company has been growing faster than the industry, and shares continue to outperform after fourth quarter results (reported in early-February) beat expectations (revenue was up 15% and EPS was up 7%, to $0.32). The results showed encouraging traction with larger enterprises and suggested a healthy environment for firewall replacements in the year ahead. Also, free cash flow (a key metric for many cloud-based software and security providers given that revenue is recognized over the life of long-term contracts, but the cash is paid up front) was almost twice as good as analysts had forecast. With profit margins expanding Fortinet should be able to pump cash into R&D, sales and marketing to drive revenue growth, plus fund more share buybacks. The story hasn’t changed in the weeks since Fortinet reported, though we’ve noticed that consensus estimates have ticked a little higher. Analysts now see 14% revenue growth and 37% EPS growth (to $1.42) in 2018. News of a new CFO hire (the previous one recently resigned) would be an incremental positive to the story.
Technical Analysis
FTNT chopped around for most of 2017 in the 35 to 42 range, but the stock has changed character in recent months. A test of overhead resistance in late-November, followed by a breakout above 42 just before the holidays, set shares up for a modest gain in January. But fourth-quarter earnings in February were well received and helped push the stock up to 55 by mid-March. It’s been taking a breather during the past couple of weeks, but the damage from the market’s dip has been limited. You can nibble on weakness.
FTNT Weekly Chart
FTNT Daily Chart
HealthEquity, Inc. (HQY)
Why the Strength
HealthEquity is the U.S.’s largest non-bank custodian of health savings accounts (HSAs), the savings tool that goes along with high-deductible health insurance plans (deductible must be at least $2700 for a family), which are becoming increasingly popular as everyone (customers, health insurance providers and companies) looks to cut costs. The company has a 15% market share today thanks to its extensive network of 40,000 employers and 124 network partners (including Anthem, Blue Cross Blue Shield and the Health Plan Alliance) and because of its end-to-end platform that easily allows users to pay bills and invest what’s left over. The runway for growth here is huge (management sees industry-wide HSA accounts rising 150% in the long-term, while assets in those accounts boom 15-fold), and HealthEquity has been riding the wave by charging service, custodial and interchange fees for every account. Growth has been rapid, and the recent Q4 report continued that trend—not only did sales (up 29%) and earnings (up 57%) top expectations, but the sub-metrics looked good too, with custodial assets of $6.8 billion (up 35%) and total HSAs under management of 3.4 million (up 24%). The top brass sees sales and earnings up 22% and 46% (respectively) this year, which could prove conservative. All in all it’s a great short- and long-term growth story.
Technical Analysis
HQY had a solid run into early 2017 but stalled out, partly due to the back-and-forth in Congress concerning the Affordable Care Act. Whatever the reason, the stock built a series of three multi-month bases, with shares making no net progress for 13 months. But the buyers have shown up during the past month, with HQY rallying to 60 earlier this month, then surging as high as 69 following earnings last week. If you want to nibble, you can do so here, with a stop in the mid-50s.
HQY Weekly Chart
HQY Daily Chart
Netflix, Inc. (NFLX)
Why the Strength
Since its debut in Cabot Top Ten Trader in 2003, Netflix has made a record 47 appearances here, earning a spot among the best-performing stocks at least once in every year but four (2004, 2006–07 and 2012). The company has had a consistent business plan of providing digital entertainment to subscribers, with major changes coming only in delivery (shifting from mailed DVDs to online delivery) and production (producing more and more of its own content). The company has expanded worldwide, with domestic streaming providing 53% on 2017 revenue, with international streaming and domestic DVD delivery making up the rest. The company has over 117 million members in over 190 countries and grew revenue by 32% in 2017. The company expects to spend a whopping $7.5 billion to $8 billion on the production or acquisition of new content in 2018, which will keep members happy and provide added impetus for non-members to join. The plan is clearly working, as subscriber growth remains strong, with two million new U.S. signups and 6.4 million international memberships in Q4 alone. As long as Netflix can keep coming up with compelling hits like The Crown, 13 Reasons Why, Stranger Things and Bright, the future looks rosy despite increasing competition from Amazon, Apple, Facebook, YouTube and Disney. Netflix remains a liquid growth stock leader.
Technical Analysis
NFLX is hardly a secret, with well over 1,000 institutional sponsors. But the stock has tended to rebase every few years rather than correcting in a major way—the last time that happened was the stock’s 2011–2012 meltdown. NFLX’s latest rally started at the beginning of the year after about six months of no progress; shares soared to 287 following earnings, held its 25-day line during the market’s February dip, ripped to 335 earlier this month before again dipping to its 25-day line. We’re OK with nibbling here or on dips, with a stop near the 50-day line.
NFLX Weekly Chart
NFLX Daily Chart
PagSeguro Digital (PAGS)
Why the Strength
PagSeguro Digital is putting online payment technology into the hands of small- and medium-sized Brazilian companies. Like Square, the U.S. company whose dongle attachments turned smartphones and tablets into cash registers, PagSeguro is revolutionizing Brazil’s online payment universe, taking on MercadoLibre’s MercadoPago system and outside competitors like Paypal. PagSeguro (roughly “secure pay” in Portuguese) was formed in 2006 and moved into electronic payments with a 2010 takeover. But the real foundation of the company’s success was the 2013 introduction of its MINI system, a handheld credit and debit card reader that uses WiFi to connect to the internet and is catching on fast. PagSeguro has been growing revenue at an accelerating rate, with sales up 53% in 2015, 85% in 2016 and125% in 2017. And earnings have been growing at triple-digit rates for seven straight quarters, culminating in EPS growth of 367% in Q3 and 350% in Q4 2017. Analysts are forecasting 111% EPS growth this year and 42% in 2019. PagSeguro has the useful backing of its parent company, Universo Online, which runs the biggest internet portal in Brazil, and Grupo Filha, a media conglomerate that owns both PagSeguro and Universo. While Brazil isn’t as big a market as China, its economy is thriving and the build-out of its digital network is enlarging the target audience for PagSeguro every day.
Technical Analysis
PAGS is still a very young stock, having come public in late January at 21.5. The stock formed a four-week base around 28, then started to rally strongly in the middle of February, running to 38 earlier this month. PAGS was pulled back to 33 by the general weakness in the market, but, impressively, has quickly snapped back over the past week. There’s likely to be continuing volatility in this young stock, but the outstanding numbers and strong chart are strong factors in its favor. A small buy on pullbacks with a loose stop around 33 could work out well.
PAGS Weekly Chart
PAGS Daily Chart
Penumbra Inc. (PEN)
Why the Strength
Penumbra is a small company that sells minimally-invasive medical devices for neuro and peripheral vascular conditions, including critical ones like ischemic stroke, brain aneurysm and hemorrhagic stroke. Penumbra’s devices remove clots to restore blood flow, treat aneurysms, and clear out blocked vessels. Business has been good, and the stock is doing well because Penumbra just wrapped up a record year in which revenue grew by 27% (to $334 million) and operating income swung to $1.2 million (from a loss of $1.4 million). Growth was solid across the board, with sales of peripheral vascular products up 30% and sales of neuro products up 25%. The company has a history of delivering better-than-expected results, but a big selloff late in the year caught many investors off guard since there wasn’t a clear reason for the stock to fall (Q3 results released in November beat by a wide margin). Bullish sentiment has resumed after Q4 results were released on February 27, most likely because management guided for around 20% revenue growth in 2018 (and based on their history this is likely conservative). The company has a stellar growth profile, and with specialty products that address huge market needs, there’s no reason growth won’t continue for a long time to come.
Technical Analysis
PEN has had a few dips here and there since going public in September 2015, but only two pullbacks (late-2016 and late-2017) have really been noteworthy. In both cases shares found support near their 200-day line and after a month or so to digest the dip, shares resumed their upward trajectory. That’s what’s happened since the stock’s tedious retreat into early February—after that low, PEN advanced persistently to new highs for a month, and has barely pulled back during the market’s recent plunge. Further weakness would be tempting.
PEN Weekly Chart
PEN Daily Chart
Red Hat (RHT)
Why the Strength
Red Hat develops open-source application software and started out as a “good to better” story when we covered it last July. It’s since graduated to a “good to great” story! That’s because the company’s low-cost open source platform, subscription-based pricing model and growing product portfolio is powering sustained double-digit revenue growth. Red Hat is probably best known for its Red Hat Enterprise Linux business (RHEL), which is relatively mature at this point. But the company is turning heads because growth is accelerating in its emerging business segment, which includes products such as OpenStack, OpenShift, Ansible and CloudForms. Collectively, traction on these newer offerings paints a picture of a big market within large enterprises, which Red Hat is steadily capturing. And that big-picture potential has analysts bullish on the company’s future. That said, the stock’s next major move will likely come down to earnings, which are due out tonight—analysts expect 21% revenue growth in the quarter and earnings to rise 33%. The stock’s trajectory after reporting will likely depend more on the setup for fiscal 2019 (which began in March), when analysts forecast 16% revenue and EPS growth. Long-term, the story is great, but short-term, perception will center around the numbers and management’s commentary tonight.
Technical Analysis
RHT performed well last year and into early-2018. While there were a couple of dips in December, January and February, none extended much below the stock’s 50-day moving average line. Notably, RHT weathered February’s volatility relatively unscathed, then went on to rally up to 155 in the second week of March. It pulled back around five points last week to just below its 25-day line before bouncing, which we view as a great sign of resilience. As for buying after earnings, a modest dip would do the trick, but a plunge toward 140 would be abnormal.
RHT Weekly Chart
RHT Daily Chart
ServiceNow (NOW)
Why the Strength
ServiceNow isn’t a company that touches a lot of consumers, but for big businesses it’s becoming an increasingly critical part of their infrastructure—the company’s software is becoming the go-to platform to boost productivity within the enterprise, allowing workers to better organize and respond to employee and corporate fixes. It started out years ago serving IT departments, but it’s proven so successful that it’s spreading to all departments. The company’s track record of growth is as impressive as any firm (revenues have lifted from $425 million in 2013 to $1.9 billion last year!), and the stock is one of the leaders of the still-resilient cloud software sector as investors anticipate continued rapid growth (ServiceNow had a whopping $3.9 billion of billed and unbilled deferred revenue at year-end, about twice last year’s revenue), especially as huge clients open their wallets for productivity-enhancing products. In Q4, ServiceNow had 840 Global 2000 clients (up 14% from a year ago), revenue per customer was up 18%, the number of customers with more than $1 million of annual spending rose 43% and renewal rates were a whopping 97%. And management expects 30%-ish growth to continue for sales, earnings and cash flow at least through 2020. It’s a good story that’s become an institutional favorite.
Technical Analysis
NOW has been in a choppy uptrend since its major low in early 2016, with plenty of pauses, shakeouts and corrections along the way. However, shares have trended more persistently in recent months. Shares gathered amazing momentum in January and, after a quick dip to its 50-day line in February, ripped to around 175 two weeks ago. It’s since been yanked down toward its 50-day line again with the market—we’re not opposed to a small buy here, or just watch to see if the buyers show up again.
NOW Weekly Chart
NOW 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.
