Cabot Growth Investor Issue: August 8, 2024

Patience for Now

One thing we’ve found over the years is that, while not perfect (nothing is), our system puts the odds in our favor—and so when it’s hard to make and keep much money even when big-cap indexes look fine (as was the case in June and July), experience tells us something is amiss. That’s a big reason we didn’t chase things higher and had been paring back during that time frame, resulting in a big cash position.

And it turns out that was the right general move: While you can point to yen carry trades, recession fears or whatever other reason, the market’s weak underpinnings have led to the big-caps giving up the ghost during the past month, cascading into a mini-panic this Monday, taking everything else along with it. Looking at the overall picture, we have three main thoughts.

The first is that, put plainly, the market is in a correction now; most of the timing indicators we look at are pointed south, especially on the growth side of the equation—our Growth Tides and Aggression Indexes are clearly negative, and most leaders have cracked after big runs, especially the popular names in the AI-related fields of chips, networking, storage and the like.

Second, near term, the odds favor the market is going to need some time to repair the damage. Sure, there’s always a chance we see a V-recovery (such as what came after the pandemic crash), but given the size and speed of the downturn (Nasdaq down 13% on a closing basis, 15% for the IBD 50 Index over just 18 trading sessions), and the fact that it came after a big run and a big divergence, it’s likely institutional investors will need time to reposition their portfolios out of some former leaders and into fresher areas. Yes, today was obviously encouraging (two of our five stocks were up 10% on the day!), this is the old bike vs. motorcycle analogy—if you fall off a bike, you might be able to get right back on and keep going, but falling off a motorcycle going at full speed (like the market just did) will probably require plenty of time on the couch.

Our third thought is that, longer term, most of the evidence is still bullish—our Cabot Trend Lines are positive, and while there has been some abnormal action in a few AI names, we’re actually seeing a lot of base-building in other growth titles (software and biotech are two sectors to watch; see more later in this issue); the snapback from the lows in many names has been encouraging. It also doesn’t hurt that some short-term sentiment measures have quickly turtled as fear rises, and let’s not forget the Fed is likely to start cutting rates soon, which is a tailwind for stocks.

So where does that leave us? We’ve been staying close to shore for a few weeks now, and that remains the best course of action—we want to preserve actual and mental capital during what’s likely to be a hectic, volatile period. But we also aren’t sticking our head in the sand, with many stocks actually shaping up (there have been more than a few positive earnings reactions this week) and with a great, sustained advance likely once this correction ends.

What to Do Now

Tonight, then, we have no changes—we’re going to hold our five remaining positions and a cash position of around 60%. That said, we’re keeping our eyes open: While we’re not going to have a major buying spree until things like our Growth Tides (see more later in this issue) turn up, we could make some moves around the edges if the market and growth stocks stabilize. For now, we advise remaining in a cautious stance while keeping your eyes on the prize—the next sustained upturn with real, fresh leadership.

Model Portfolio Update

The major indexes have finally hit an air pocket, declining sharply the past couple of weeks, lowlighted by Monday’s panicky decline. Growth stocks had been meandering at best for weeks before that and, of course, got caught up in the decline with everything else. We had been paring back because of that growth stock sluggishness and were sitting on a cash position of around 60% coming into this week.

It’s definitely possible that Monday brought some sort of low, but as we wrote above, it’s also more likely than not that, even if that’s the case, some bottoming action is coming—as the saying goes, bottoms are usually a process, not an event. With most of our market timing indicators negative (including the growth-heavy Growth Tides and Aggression Index), we’re remaining patient and holding our cash.

However, we do have some legitimate encouraging news: While the chip, networking and other AI-centric plays have mostly cracked, we’re seeing many other growth titles (which had already been correcting for a few weeks) hold up well—and now are seeing a few pop on earnings. Our watch list is actually expanding here, and while good stocks can go bad in a hurry in a bad market, we could have a small move or two if the market’s continues to find its footing for a few more days. Tonight, we have no changes.

CURRENT RECOMMENDATIONS

AppLovin (APP)—AppLovin continues to fire on all cylinders, as its Q2 report last night showed. Total revenues rose 44% from a year ago, while software revenues (from its Axon 2.0 advertising engine) rose 75%, producing EBITDA of $601 million (up 80%) and earnings of 89 cents that crushed estimates and were up four-fold from a year ago; free cash flow came in at a whopping $1.33 per share (around $2.50 in the first half of the year!), more than twice last year’s figure. But even better was the CEO commentary in the conference call, where he said AppLovin can grow 20%-plus for a few years just from continuing to expand within the mobile gaming area (where its advertising engine works now), cranking out even larger margins and free cash flow, while moving to other areas (it’s been piloting Axon with e-commerce and Internet advertising for a few months now, with encouraging results) a cherry on top. Frankly, the company has about as a good a growth story as you’ll find out there, and while we’re not valuation-centric investors, the valuation here is more than reasonable. The question in our mind is simply: Will the market reward this, or will this be a Shift4 (FOUR)-type situation, where the the firm can crank out solid results quarter after quarter, yet the stock languishes. We’ll simply see what comes, but a potential breakdown yesterday after the close turned around to a very solid gain today as the numbers and conference call were digested. At this point, APP is “only” back into resistance, so we’re not celebrating, but having already gone over the falls, the post-earnings move is a good sign. We’ll continue to hold our remaining shares. HOLD

Cava Group (CAVA)—CAVA doesn’t report earnings for another couple of weeks (August 22), so we’ll have to wait a while to get clarity on results—so far, its peer group has reported fairly solid numbers, though earnings reactions have been mixed (Wingstop, Chipotle) to poor (today, Dutch Bros. was clobbered). As for CAVA, we find it encouraging that the stock’s closing low so far was actually back on July 24 and shares have bounced fairly well since then, though like everything else, there’s still work to do. Our thoughts fundamentally here haven’t changed: CAVA looks like relatively rare merchandise, with not just strong growth (including solid profits) but a story backed by a proven top brass that’s succeeded with the cookie-cutter business model before (the founder of Panera Bread is the lead investor in Cava and Chairman of the Board), which certainly adds credibility and should entice more big investors over time. At this point, shares are in a tedious but normal five-week consolidation, and the longer it can hold up in this environment, the better the odds it can round out a launching pad and resume its longer-term advance. Having already taken partial profits, we’re sitting tight with the rest, giving the stock some room to maneuver. HOLD

On Holding (ONON)—On will report earnings next Tuesday morning (August 13), with analysts looking for around 18 cents per share, though because it’s a foreign (Swiss) firm, there’s often more focus on the currency-neutral growth rates regarding sales, earnings and the full-year outlook. The stock was rounding into form nicely, with some solid accumulation, before the recent three-day selling storm; even so, ONON has held its prior closing lows from early July, and the nine-week structure looks sound so far. A decisive break through the lows on earnings (or because of general market weakness) would be hard to ignore, but right here we’re holding our shares, as the story and numbers are as good as ever and the base-building effort remains reasonable. HOLD

ProShares Ultra Russell 2000 Fund (UWM)—While they’re still much more resilient than the big-cap indexes (not that far from their 50-day line), small-cap stocks ended up suffering yet another rug-pull, with UWM falling sharply during the recent selling, with just a modest bounce during the past three days. Given our big cash position, our small position and that there’s lots of support in this area, we’re going to hang on and see how this bounce develops; big picture, we still think small-caps could help lead the next rally, but we’re not going to play around if the fund shows much more weakness. HOLD

Robinhood (HOOD)—HOOD has a very nice, tight setup and began to emerge when we took a swing at it—but, obviously, the market environment turned in a hurry, with the risk-off move causing the stock to decline … and then to unravel late last week and Monday, which isn’t surprising given its leverage to stocks and crypto. Business here remains solid (Q2 results saw revenues up 40% from a year ago while earnings breezed past estimates) and eventually a broad bull market should see Robinhood’s stock do well—but at this point, HOOD is broken, and there should be better names to own when this market correction finishes up. SOLD

TransMedics (TMDX)—If the market’s correction is mostly over and it’s a matter of bottoming out over the next few weeks, then all signs continue to point toward TMDX having some enticing upside. The firm’s Q2 report once again thrashed estimates, with revenues rising 118% and earnings of 35 cents a share up from a loss a year ago and topping forecasts by 14 cents, with growth seen across all facets of the business (liver continues to be by far the biggest area, but heart saw an encouraging step up, too). And these profits are happening despite heavy investments in new clinical programs (to boost the lung side of the business) and build out its aviation fleet (15 at the end of June, added two more in July and the firm is targeting 20 by year-end; 59% of the firm’s transplant volumes were flown by its own fleet in Q2, up from 49% in Q1, but still shy of its 80% target), with its logistics business representing a huge opportunity in itself. The stock has been resilient overall, though it’s getting tossed around when the sellers hit the market—and bouncing back when the market does, with TMDX notching new closing highs today. Hold on if you own some, and if you don’t, we’re OK nibbling here or (preferably) on shakeouts. BUY

Watch List

• Arista Networks (ANET 333): AI stocks are unwinding, and ANET has taken its lumps—but shares were actually up last week and are up again this week and stand about 12% off their highs. Arista’s best AI growth is likely ahead of it, which should have big investors remaining interested.
• Axon Enterprises (AXON 371): AXON leapt out of a five-month base this week after its Q2 report, thanks to continued adoption of its Tasers and suite of software offerings, and management talked up some newer products (dispatch services, AI-produced reports) that should boost growth going ahead.
• Freshpet (FRPT 130): It’s not changing the world, but Freshpet’s healthier dog food continues to gain share, and with a few post-pandemic convulsions behind it, cash flow is surging and earnings are set to take off. The stock has ripped back to its old highs after the Q2 report.
• GE Aerospace (GE 165): GE never really had any shakeout after its giant run into May—but now it has, and it’s possible that cleared the air. The underlying engine business (as well as the monstrous recurring revenue after the sale) should produce steady growth and huge cash flow for years. Let’s see if the modest snapback so far can pick up steam.
• Halozyme (HALO 54): Halozyme’s Q2 results were solid, and the firm essentially reiterated its multi-year royalty (20% annual growth through 2028) and earnings (north of $7.50 by 2028) outlook. The stock has been trending along its 50-day line.
• Neurocrine Biosciences (NBIX 146): Neurocrine is growing and profitable now thanks to one big-selling drug and should get approval for another solid seller later this year—and it has some blockbusters in the pipeline, too. See more later in this issue.
• Palantir (PLTR 29): PLTR was caught up in the AI selloff, but its Q2 report has brought in big-volume support and buying. We like the accelerating revenue growth here (17%, 20%, 21%, 27%) and expanding earnings thanks to its rapidly growing AI platform business for U.S. firms. Shares are already back toward new high ground.
• Samsara (IOT 38): We’ve been watching IOT for about a year, during which time it’s hacked around wildly. But after a big re-set, shares have been peppy (albeit volatile) and have already recouped most of their recent shakeout. We think the underlying story here oozes emerging blue chip.
  

Other Stocks of Interest

Clearwater Analytics (CWAN 23)—Salesforce.com kicked off the cloud software era years ago, but as time has gone on, new players have tended to focus more and more on certain niches—be it certain types of businesses (such as those with tons of physical assets, like Samsara (IOT)), or solving problems for certain industries. Clearwater fits in the latter category, targeting its software suite at the investment industry, which, because of regulations, a much larger emphasis on alternative assets (CLOs, mortgage-backed securities, private shares, etc.) and the global nature of markets (dozens of currencies), is facing an avalanche of complexity when it comes to accounting, reconciliation, reporting, risk management and analytics. Clearwater’s offerings dramatically reduces complexity for everyone from asset managers to pension funds to big corporations (it just released a commercial paper issuance tracker), automatically ingesting, aggregating and reconciling all data, while having one central accounting hub for all asset classes, as well as a centralized location for risk management and performance metrics, too—a big contrast to the norm today, where firms usually are forced to take tons of different point solutions that are patched together. Not surprisingly, Clearwater has been steadily taking share in the industry, and perhaps the most impressive metric is that, going back to 2019, its quarterly gross revenue retention rate has never been below 98% (!), which means those who sign up, stay signed up, and they usually buy more services (same-customer revenue growth of 10% in Q2) over time, too. (The firm also says it wins 80% of the deals it goes after.) The company has been growing at steady 20%-ish rates in both sales and recurring revenue, while earnings have been growing faster and margins (EBITDA margins of 32% this year!) are big. We doubt it will ever be a rocket ship, but there’s a huge, huge opportunity in the U.S. and overseas (now 18% of revenue), and given that everyone who signs up sticks around, it’s easy to see Clearwater growing nicely for years to come. CWAN came public near the market top in 2021 and languished for two and a half years, but after etching a nice six-month base this year, the stock broke out powerfully on earnings and has held up despite the recent market drop. As we write later in this issue, we think software could be an early leader of the next uptrend, whenever it begins, and CWAN is a newer name with a steady story that could be “growing up” in terms of sponsorship.

Neurocrine Biosciences (NBIX 146)—In a sector filled with speculative lottery tickets, Neurocrine offers real sales, earnings and strong growth today, as well as the upside of a likely approval later this year and, down the road, an intriguing candidate in trials. As its name suggests, the firm focuses on neurological diseases, and its claim to fame is Ingrezza, a blockbuster treatment for tardive dyskinesia and chorea due to Huntington’s Disease, both of which cause sudden, involuntary movements in the face or body. Growth has been strong for a while and continues to crank ahead, with the top brass recently hiking expectations, seeing revenues north of $2.25 billion this year, up 24% from a year ago, and analysts see sales expanding at a mid-teens rate in 2025. Ingrezza accounts for all of Neurocrine’s sales right now, but that should change next year: The FDA gave priority review for Crinecerfont, a treatment for congenital adrenal hyperplasia (CAH), a genetic condition where the body doesn’t make enough cortisol; current treatments last for years and are very inexact, so this looks like a big step forward for kids and adults—while it won’t be as big as Ingrezza, analysts see peak sales for the drug in the $500 million to $1 billion range a few years down the road. And then, in the pipeline, the company has one potential treatment for major depressive disorder; the drug showed very positive Phase II results earlier this year (it’s partnered with Takeda on it, with Phase III trials upcoming) as well as a schizophrenia drug that’s even earlier stage (data likely out later this quarter). Obviously, there will be some event risk for the stock, but Neurocrine has solid potential just from Ingrezza and Crinecerfont alone, and big investors (a whopping 1,600 own shares) agree. Interestingly, the stock has been whisper quiet in recent months—a high-to-low range of just 12%!—but we always thought it could be playing possum, and it showed signs of getting going after earnings when it popped to new highs before being yanked back down by the market. If it starts to show some power with an improved environment, we think NBIX could surprise on the upside.

Carvana (CVNA 134)—If you had told us a couple of years ago that we’d be writing positively about Carvana today, we’d have never believed it. While the core story was always enticing: An online used car dealer with rapidly expanding reach and many tools (360-degree views of every car) and guarantees (no cars in reported accidents; 7-day money back guarantee, etc.) that made it easy to buy or sell with them (I actually sold a car to them a few years back, and it was a snap). The firm was losing money at a rapid pace, and when interest rates soared, Carvana’s business tanked and the firm nearly went under … and even after it got off its knees, this was essentially a meme stock with little real sponsorship. Today, though, it’s an entirely different situation: The firm has slashed costs while still offering the same core promise, and the result has been steadily improving results. In Q2, Carvana marked its second straight growth quarter, with revenues up 15%, but the more you dig into the details, the more impressive it gets. Carvana sold north of 100,000 cars in Q2 (up 33% from a year ago), making it the second largest used car dealer, gross profit lifted 43% (and gross profit per unit was up 8%) and EBITDA not only more than doubled, but EBITDA margin was north of 10%, which the firm believes isn’t just the largest in the dealership industry today, but the largest for any public automotive retailer ever! To be fair, the breakneck growth is likely over, but analysts see mid-teens (probably conservative) revenue growth going forward, even as used car prices come down from the stratosphere, while cash flow grows much faster thanks in part to continued cost cuts and efficiencies. Stock-wise, CVNA has already had a huge recovery over the past couple of years, but we’re watching it now given the market—if the stock can hold firm during what has already been a very tough growth stock correction, it would indicate there’s more upside in the tank.

Software and Medical: Hunting for Fresh Leadership

We think the AI infrastructure boom has legs, which is why we’re not going to rule out the chip, networking and related sectors once this correction is over. In fact, we wouldn’t be surprised if this decline—which is sharper than any seen in those areas since the AI theme really got going in the spring of 2023—serves to “reset” the big-picture advances of some of these stocks.

Just looking at the semiconductor index, it’s fallen as much as 25% from its highs on a closing basis and has nearly undercut its April low; it will likely require plenty of repair work, but this sort of maelstrom could easily kick out enough weak hands (and probably some strong ones, too) to clear the way for higher prices down the road. We’ll be watching.

In the meantime, though, we’re hunting for names that are showing some resilience and aren’t as obvious to everyone. It’s early, but we’re thinking software and medical names could be a great source of leadership into year-end. Software, of course, has been a source of leadership on and off for years, especially in the cloud area, so we wouldn’t say it’s necessarily underplayed. But note that the group is more advanced in its consolidation phase than the AI plays—it topped out a few months ago and never really kicked into gear during the narrow June/July upmove in the Nasdaq.

ServiceNow (NOW) is a blue-ish-chip name we’re watching, with steady 20% to 30% growth in sales and earnings, and with the stock having consolidated for six months before gapping to new price highs on earnings two weeks ago. It’s been wild since then due to the market but has held up fairly well; it’s in pole position to get moving if growth stocks can get moving.

Samsara (IOT) is another name we’re keeping a close eye on; we’ve written about it a few times, including in the last issue, so we won’t rehash it here—suffice it to say that we love this story and think the company has a rapid, reliable growth profile. Palantir (PLTR) is another name in the software field we like, with its pop on earnings this week a good sign of support, and Clearwater Analytics (CWAN; see earlier in this issue) is another, though it’s a bit thin for our tastes.

Medical stocks in general, and biotech in particular, is the other space we’re thinking could attract big money from institutions; we’ve mentioned how biotechs have essentially made no net progress for many years at this point, and yet there are more and more names out there with real drugs, real sales and, in some cases, big earnings growth, too.

Here, there are an increasing number of choices, two of which—Halozyme (HALO) and Neurocrine Biosciences (NBIX; see our writeup earlier in this issue)—are on our watch list, while names like Argenx (ARGX) and Alnylam (ALNY) also look tidy.

Now, it’s important to remember that, in a weak market, good-looking stocks can go bad in a hurry; that’s why we’re watching these names and not advising plowing into them. But, while nobody likes market declines, the good news is that weakness actually makes it easier to spot future leaders (great story, numbers and resilient charts), so if/when the market does get moving again, it’s looking like software and medical names should help lead the way.

Growth Tides: Now More than Ever

OK, so we have some early idea of where leadership could come from. But given the hectic and crazy market action, what’s likely to be our most reliable indicator of when to lean heavily into the buy side? We’ll be watching everything, of course, but with the market having been so divergent, we’re keying more than ever off our Growth Tides, which is a loose collection of growth indexes, that give us a cleaner insight into the action of the type of stocks we go after.

We do continue to tweak our Growth Tides in terms of the indexes and funds it tracks, but things like the IBD 50 index (shown here), the IBD Mutual Fund Index and the Equal-Weight Nasdaq 100 (QQQE) are three we watch every day. Like most things, they need to repair the damage—we want to see these indexes get above their 25-day line down the road (that’s the green line in the chart below), and for that moving average to turn up. That would tell us the intermediate-term trend is turning positive and should coincide with lots of fresh leadership emerging.

Obviously, right now, there’s a ways to go for that to happen, so patience is key. But now more than ever, we think focusing on the Growth Tides will tell us how long to stay cautious—and when to get aggressive on the buy side.

Cabot Market Timing Indicators

After levitating in recent months, the big-cap indexes have finally hit an air pocket, cracking their intermediate-term uptrends while growth stocks—which were already lagging—fell further. So far, the bounce from Monday’s panic lows has been solid, especially among individual stocks, and with the long-term trend up, this weakness should set up a new, sustained advance down the road … though some repair work is likely needed in the near-term. Right now, we advise remaining cautious, but don’t stick your head in the sand.

Cabot Trend Lines – Bullish
After getting very stretched to the upside, our Cabot Trend Lines are undergoing their first test—both indexes dipped below their respective 35-week lines during Monday’s early meltdown, but both are now back above those key trend lines. For a fresh sell signal, both indexes need to close two straight weeks below their respective 35-week lines (it’s intentionally meant to be slow to prevent whipsaws), so that’s still not right over the horizon. As always, we take the evidence at face value: Today, the long-term market trend remains up, so the odds favor this being a correction within an overall bull move.

Cabot Tides – Bearish
Our Cabot Tides took on enough water in recent days to flash a new sell signal. We’re still seeing some relative strength from the broad indexes, but most measures (including the Nasdaq, daily chart shown here) are clearly south of their 50-day lines. Moreover, as we write about elsewhere, we’re keying off our Growth Tides as well these days, and those are singing the same cautious tune. Right here, the intermediate-term trend continues to point down.

Two-Second Indicator – Negative
Our Two-Second Indicator had a nice stretch into August, but the market’s latest weakness has brought six starigth plus-40 readings (including today), including what was the largest reading since the fall of 2023. Overall, we see this backing up the other evidence: Nothing at this point screams major market top, but near-term, there’s no doubt sellers are lurking and many stocks are in questionable shape.

The next Cabot Growth Investor issue will be published on August 22, 2024.

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