Top-Down vs. Bottoms-Up
Current Market Outlook
From a top-down perspective (looking at the major indexes and overall trends), last week wasn’t a big deal—most indexes remain in their three-month trading ranges, and all of them are above their longer-term moving averages. But there’s no question that the sellers pulled out the bazooka on many high relative performance stocks, cracking many uptrends in the process. So, combined with the tedious trading during the past few weeks, we’re pulling in our horns a bit more by moving our Market Monitor down two notches to a level 4 out of 10. It’s still best to hold your resilient stocks, especially those that have reacted well to earnings (of which there are many). But you should also limit new buying and be holding plenty of cash until the market firms up.
This week’s list has another batch of earnings winners from last week; if the market can find its footing, many should do well going forward. If you’re looking to nibble on something, our Top Pick is ServiceNow (NOW), an emerging blue chip in the cloud software sector that has a huge runway of growth ahead of it.
| Stock Name | Price | ||
|---|---|---|---|
| Arch Coal (ARCH) | 82.27 | ||
| Cirrus Logic Inc. (CRUS) | 0.00 | ||
| Ellie Mae (ELLI) | 0.00 | ||
| Expedia Group (EXPE) | 0.00 | ||
| Mastercard Incorporated (MA) | 0.00 | ||
| New Oriental Education (EDU) | 113.97 | ||
| ServiceNow (NOW) | 341.86 | ||
| Tesaro (TSRO) | 0.00 | ||
| US Silica Holdings, Inc. (SLCA) | 0.00 | ||
| Western Digital Corporation (WDC) | 0.00 |
Arch Coal (ARCH)
Why the Strength
You won’t find a sector more hated than coal, but the fact is the stocks have actually been acting very well this year after a horrific five-year decline. Arch Coal is the largest producer of metallurgical coal (used to make steel) in the U.S. and the second largest producer of thermal coal (for electricity). And it’s an interesting turnaround situation—the company recently came through a major court-led restructuring that dramatically de-levered its balance sheet, eliminating a whopping $5 billion in debt and reducing its interest expense to just $33 million (from $362 million), and cut costs elsewhere too. And, on the demand side, prices for metallurgical coal have surged (up more than 120% from their February lows) thanks to general production cuts (U.S. production has fallen by a third) and a better environment for steel. The combination of the two means that Arch’s various operations are now solidly cash-flow positive and, with costs cut to the bone, the bottom line could surge if industry trends continue to improve; analysts see earnings north of $2 per share in 2017. This isn’t a long-term growth story as steel demand is cyclical and thermal coal power plants are slowly being replaced by natural gas. But Arch has great potential in the months ahead as it emerges from its near-death experience.
Technical Analysis
ARCH doesn’t have much of a chart to analyze, as it re-emerged from its restructuring on October 5; it’s best to ignore all prior trading before that point. And this month, despite a wobbly market, ARCH has put on a great show, dipping to 60 early on and then surging as high as 80 last Monday before backing off. Shares are very volatile, moving about three points per day on average, so if you want in, you can nibble here but use a loose stop in the lower 60s.
ARCH Weekly Chart
ARCH Daily Chart
Cirrus Logic Inc. (CRUS)
Why the Strength
Apple’s (AAPL) earbuds have been music to Cirrus Logic investors’ ears. The audio chipmaker and Apple supplier is reaping the rewards of the new iPhone 7 and 7 Plus, the first Apple phone to abandon the headphone jack in favor of earbuds, which were made with Cirrus Logic chips. And those are just the basic earbuds—Apple will eventually release more advanced, noise-cancelling headphone options to go with its iPhone 7s, which according to Cirrus CEO Jason Rhode, sell for roughly 2.5 times as much as the basic headphones. So the future looks even brighter for Cirrus Logic, especially as Apple and other smartphone makers roll out more headphone jack-free versions in the coming years (though Apple is far and away Cirrus’ biggest customer, accounting for 78% of revenue). In the meantime, Cirrus’ present looks pretty bright too; the company easily beat earnings estimates in its fiscal second quarter, the results of which were announced last week. After four quarters of a shrinking bottom line, Cirrus’ EPS more than doubled on the strength of a 40% sales bump, its fastest in a year. The company expects another 40% sales increase in the current quarter. Investors had already been pouring into Cirrus Logic stock on the mere promise of its involvement in the iPhone 7 and 7 Plus. So far, Cirrus hasn’t disappointed.
Technical Analysis
CRUS has been stair-stepping higher all year long, jumping from 25 to 34 in January, gapping up to 49 in July, then pushing above 55 in September. With 51 acting as the new floor, the stock bounced off that support level after earnings were released last week and is trying to hold those gains. You can start small around here with a stop near 50. If it breaks above 58 and the market is bullish, add to your position.
CRUS Weekly Chart
CRUS Daily Chart
Ellie Mae (ELLI)
Why the Strength
Ellie Mae is a mortgage processing software company whose one product—the Encompass software package—can process loans, control marketing, communicate with customers and connect with lenders, investors and service providers using the Ellie Mae network. Using Encompass, clients can automate the mortgage process, including compliance with all regulations, giving banks, mortgage companies and credit unions an efficient way to originate, process and close high-quality, compliant loans. As the company puts it, they want “to automate everything automatable in the residential mortgage industry.” This commitment, plus the company’s acquisition of smaller rivals and the steady increase in real estate transactions, pushed the company’s revenue up by 57% in 2015. And last Friday’s earnings report brought Ellie Mae’s first quarter with over $100 million in revenue. That Q3 report also featured 60% earnings growth and a nearly 24% after-tax profit margin. And the company’s optimistic guidance for Q4 and the full year came in well ahead of expectations. Ellie Mae’s constantly updated software and national network provide a substantial barrier to entry for potential rivals, so continuing improvements are almost guaranteed to benefit directly. It’s a good story.
Technical Analysis
ELLI made a big run from late June 2016 to early July, then inched higher until July 29, when it booked a big selling day just before Q2 earnings. After three months of volatile trading but a generally mild uptrend, ELLI again sold off just ahead of earnings, then rallied strongly on heavy volume, soaring from 103 to 110 before closing at 107 last Friday. The company’s strong guidance is likely to keep the gains coming, so we see a buy below 106, with a stop at 97 as a good bet.
ELLI Weekly Chart
ELLI Daily Chart
Expedia Group (EXPE)
Why the Strength
Expedia is the largest online travel agency in the world with over 20 brands and $8.4 billion of annual revenue. The company’s reach covers air travel, lodging, car rentals, destination service providers and cruise lines. The stock has been on our radar because two of its brands, HomeAway and Trivago, have the potential to significantly move the growth needle. HomeAway is a home rental platform that competes with Airbnb, and which was acquired last year for $3.5 billion. After acquiring the company, Expedia decided to cancel the subscription offering for property owners, and move to a pure commission-based model, which generates higher fees. The brand grew by 61% in the latest quarter, and the longer-term profit potential is catching Wall Street’s attention. Trivago, a relatively new offering for online hotel search, grew by 57% in the latest quarter. The bottom line is that these two brands helped Expedia deliver third-quarter revenue growth of 33% (to $2.6 billion) and EPS growth of 16% to $2.41. That performance was good enough to keep the stock’s rally intact, and expected earnings growth of 34% in 2017 should keep investor interest high. That said, it is worth mentioning that the stock already trades at a premium valuation, and that many analysts think the stock is trading close to fair value right now. But that hasn’t stopped money managers from accumulating shares.
Technical Analysis
EXPE has spent most of the year moving sideways in a wide trading range between 100 and 120, with two notable dips lower during the February and late-June market retreats. Momentum turned positive at 114 in mid-September when the stock crossed above both the 50-day and 200-day moving average lines. Shares paused for a breather around 118 in early October, then rallied to 126 before last week’s earnings report, which sent them 4% higher. You can nibble on shares on the next dip, and keep a stop below 116.
EXPE Weekly Chart
EXPE Daily Chart
Mastercard Incorporated (MA)
Why the Strength
As the global economy continues to distance itself from the crippling 2008-09 recession, consumers have become increasingly comfortable breaking out the plastic again. Mastercard’s third-quarter results were the latest reflection of that comfort. The global credit-card giant saw an 18% jump in the number of processed transactions, a 9% increase in worldwide purchase volume, and a 14% sales improvement, its best year-over-year revenue boost since the first quarter of 2014. During last week’s earnings call, CEO Ajay Benga highlighted the slow-but-steady growth in the U.S., declining unemployment rates in Europe, and strong growth in countries such as Australia and Mexico as the primary drivers behind his company’s big quarter. With nearly $7 billion stockpiled, the company spent $591 million on stock buybacks last quarter, on the heels of $462 million in buybacks during the second quarter. The company plans to buy back another $2.1 billion of its own stock as part of its ongoing share repurchase program. With new initiatives such as an artificial intelligence option instead of card swipes at checkout, Mastercard is trying to lead the technological charge for consumer transactions as well. Between the improving climate for consumers, the sales growth, the huge buyback program and the technology, there’s a lot for investors to like about Mastercard right now—especially as a fairly defensive play in an uncertain market.
Technical Analysis
MA’s recent run began in July, when the stock bounced off four-month support at 86 and kited to 96 within a month. After some base building, the stock jumped again in September, breaking to new all-time highs at 99 and continuing on to 102 early this month. It was still hovering right around there last week when the earnings beat spurred another gap to new highs, this time above 106. Given the market, it would be wise to wait for a little weakness before taking out a small position. Sell on any move below 101.
MA Weekly Chart
MA Daily Chart
New Oriental Education (EDU)
Why the Strength
New Oriental Education is the largest private educational services provider in China, a country in which success in education is seen as the surest path to success. New Oriental specializes in after-school language training and test preparation for K–12 students. Investors like the company’s steady growth and profitability, but are probably looking to the end of China’s one-child policy as a catalyst for increased future growth as a new wave of second children comes along. While revenue growth slowed to 9% in fiscal 2015 (ended May 2015), it more than doubled to 19% in fiscal 2016. In the company’s latest quarterly report on October 25, the company reported a 31.2% jump in total enrollments versus just a 7% increase in its number of schools and learning centers. This increase in enrollments is the result of a successful summer promotion that offered experiential courses in different subjects at low prices. The promotion was aimed at grade 7 students, and the company believes that as these new students approach their upper grades they will become heavier users of private educational services. And if the Chinese economy continues its steady growth, the future for New Oriental Education is bright.
Technical Analysis
EDU came out of a 20-month correction with a double bottom at 18 in January and August 2015. But when the stock began its new rally in September 2015, its advance was rapid, reaching 33 by the end of 2015. The stock’s advance in 2016 has been strong, but punctuated by a big one-day correction in June and a tumble through the entire month of August. After EDU’s rally in September, the stock traded in a tight range until the good earnings news blasted it to new all-time highs. EDU has corrected for four days, but still hasn’t filled that earnings gap. We think you can buy a little around here, with a stop around 46.
EDU Weekly Chart
EDU Daily Chart
ServiceNow (NOW)
Why the Strength
We’ve been following ServiceNow off and on for three years and we’re as convinced as ever that the company is an emerging blue chip. The firm’s cloud-based software is increasingly considered best-in-class in helping day-to-day activities in various corporate departments (IT service management, human resources, customer service, app development, field services, etc.) operate more efficiently by defining, structuring and automating work flow. Management believes the addressable market is a mind-boggling $60 billion, and it’s obvious that customers (especially big ones) think the firm’s offerings are fantastic—the renewal rate is consistently north of 95% (including a crazy 99% in the third quarter), while Fortune 2000 companies beat a path to the company’s door (703 are now customers, up from 636 a year ago) and sign up for more of its offerings (301 customers spend more than $1 million per year with ServiceNow, up from 206 a year ago). Sales and earnings growth has slowed but remains rapid, and because the company offers its software via subscription, earnings actually understate free cash flow, which is exploding and could total $500 million next year (and, long-term, $1.2 billion in 2020). The valuation here is big (the market cap is north of $14 billion), but so is the story and the runway of growth. We like it.
Technical Analysis
NOW reached 91 late last year, but the market’s plunge in January and February dropped it to 46. The stock snapped back to 76 by April, but then began a long choppy phase; NOW was still hovering at 73 in early October, about six months of no progress. But that changed last week when the third-quarter earnings report kicked the stock to new highs on excellent volume (nearly seven times average). If you want in, you can nibble here or on dips with a stop near the 50-day line.
NOW Weekly Chart
NOW Daily Chart
Tesaro (TSRO)
Why the Strength
Making its debut in today’s Top Ten, Tesaro is a Massachusetts biopharmaceutical company specializing in cancer treatments. The company has one approved product, a treatment for chemotherapy-induced nausea called Varubi. But the news that’s caught the attention of investors is the June 29 announcement of a late-stage clinical trial triumph for Tesaro’s candidate drug Niraparib, which targets recurrent ovarian cancer. The drug showed excellent results in extending patients lives, while soundly outperforming two established rival treatments. Tesaro had no revenue at all until Q3 2015, and isn’t expected to be profitable at least through 2017. But approval for Niraparib—which is in three Phase III clinical trials, and two each of Phase II and Phase I trials—would be a big deal. Tesaro’s stock got a second, smaller boost on October 10 from additional good news from a Niraparib clinical trial. Tesaro will announce its Q3 earnings results on Thursday (November 3). Like all biopharmas with negative earnings, Tesaro is a bit of a shot in the dark, but Thursday’s quarterly report has the potential to move the stock if results are good and if there are any bullish tidings from clinical reports. And the longer-term outlook is positive.
Technical Analysis
TSRO came public in June 2012 and the main trend of the stock is up, although two corrections—September 2013 through September 2014 and July 2015 through February 2016—would have been hard to hold through. TSRO shows one huge gap up from 37 to 81 on June 29, followed by a general uptrend through late September. Another gap up from 99 to 118 on October 10 has also been followed by a continuing uptrend. Buying an unprofitable company this close to earnings is a risky proposition. Best to watch the results and jump on if the chart shows a positive reception from investors. A relatively tight stop, say 10% below your buy price is a good idea until you get a little profit cushion.
TSRO Weekly Chart
TSRO Daily Chart
US Silica Holdings, Inc. (SLCA)
Why the Strength
We continue to see meaningful signs that the fundamentals of the energy sector are slowly rebounding. Oil prices have remained relatively stable in the $45 to $50 per barrel range, and combined with high-return wells in certain basins, that’s led to a slow increase in the U.S. rig count from historic lows. That pickup in drilling should directly increase demand for U.S. Silica’s fracking sand. (Some of the firm’s sand goes to industrial customers, but it’s the energy sector that drives results.) That’s the main reason this stock remains one of the most resilient in the entire market. The amount of sand shipped fell just 1% in the second quarter, and most analysts are expecting a return to growth in the quarters to come. Throw in a healthy balance sheet ($454 million in cash on the books) that’s allowed for some prudent acquisitions (including a logistics firm that should increase delivery efficiencies) and the ability to quickly adapt to any surge in demand that comes. The company was making about $2.50 per share before the bust, and while nobody is looking for a quick return to that level of profitability, analysts see earnings next year of 63 cents per share, which we think will prove very conservative if oil can hang around $50 per barrel (or more) in the months ahead. The next update will come from U.S. Silica’s quarterly report, which is due out Friday morning (November 4).
Technical Analysis
SLCA remains in its impressive, persistent uptrend that kicked off in March of this year. There have been a couple of tests of the 50-day line during that time (one just after earnings in early May, another just before earnings in early August), and it could be heading for another test soon should the market remain weak. If SLCA holds the 44 level and reacts well to earnings, it could provide a nice entry point. And if you’re aggressive, you could nibble on dips and see what earnings brings.
SLCA Weekly Chart
SLCA Daily Chart
Western Digital Corporation (WDC)
Why the Strength
Western Digital makes data storage solutions, including hard disk drives (HDD) and solid-state drives (SDD), for datacenters, enterprises and consumer electronics. These are cyclical markets, as evidenced by the stock’s 2015 meltdown, when it fell by over 60%. The entire industry finally bottomed this past spring (shares of Seagate and Micron displayed similar patterns to Western Digital’s). And now investors are looking for a bull market similar to the one that powered Western Digital 250% higher from 2013 through 2015. Indeed, Western Digital has been in comeback mode. The company acquired SanDisk in May, effectively doubling its addressable market overnight at the bottom of the cycle. It worked on its capital structure to reduce debt. And it reorganized internally to focus on the three core areas of Client Devices, Client Solutions and Datacenter Devices and Solutions. Boring details you say? Perhaps. But when coming out of a harsh cyclical low, Wall Street needs to see a lean and mean company ready to capitalize on new growth opportunities. That’s what Western Digital is doing now. Last Wednesday, the company reported revenue growth of 40% to $4.7 billion, beating estimates by almost $200 million. EPS of $1.18 was $0.13 better than expected. Even better, management raised forward guidance, saying that tight HDD supply for the rest of the year should help pricing. Analysts love the stock, and price targets are going up.
Technical Analysis
WDC fell from 107 to 35 between January 2015 and May 2016. But since then, shares have been building a solid uptrend with only three notable pullbacks. The latest of these occurred in early October after the stock lost momentum at 60. Several days of selling brought shares back to 52 where they paused heading into last week’s earnings call. That event catalyzed a rally back to 60. Despite the weak broad market, this looks like a buyable rally given the improving fundamentals. You can add a few shares here or on dips, with a stop beneath the recent low.
WDC Weekly Chart
WDC 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.
