Cabot Growth Investor Issue: November 14, 2024

Super Strong, but Keep Your Feet on the Ground

If you could draw up a script for the market’s post-election reaction, it would be hard to put together anything stronger than what we’ve seen, either from a top-down, index-focused perspective or among leading stocks, especially leading growth titles.

Looking at the indexes, we did see some pre-election wobbles to the point which, combined with the fact that many measures never truly got going above their summer- or spring-time highs, actually put our Cabot Tides back to neutral two weeks ago. But as we write about later in this issue, not only has the recent rush higher turned the intermediate-term trend up, but it brought nice-looking breakouts in many measures, which should bode well.

And then there are individual stocks. I’ve been around for a few market cycles and have seen some hot markets—the 2020 pandemic boom was obviously crazy, and when I first started at Cabot, the 1999-2000 Internet romp was unmatched in history. But the past couple of weeks are certainly up there, with tons of names not only racing higher but many staging jaw-dropping earnings gaps higher and, for the most part, holding those gains, which is obviously very encouraging.

With all of that said, it’s important to keep your feet on the ground: The past two weeks have come after what was a very profitable prior couple of months (really since the August low), so there’s no question things are hot and heavy here. That doesn’t mean they can’t keep going or that the market is set for a tumble—we’re trend followers, not trend predictors—but it does mean that if something comes on the scene, it could lead to some potholes.

And what might that be? Interest rates are the thing we’re watching closest when it comes to secondary measures: While the Fed has now cut 0.75% from their short-term target, long-term rates are up nearly the same amount since mid-September. We’d also note that the broad market (our Two-Second Indicator) is far from pristine here, so there are some lingering selling pressures.

All in all, though it’s hard to argue with the primary evidence: The market’s intermediate- and longer-term trends are up, growth measures are hitting new highs, defensive stocks are lagging and, of course, leading stocks are peppy.

What to Do Now

Thus, we remain overall bullish, but given the moonshots seen among individual stocks, managing what you have (again, we write more about this later in this issue) is also key. In the Model Portfolio, we sold one-third of our AppLovin (APP) position last week, and tonight, we’re going to sell one-third of Cava (CAVA), which is much more extended time-wise than a lot of leading stocks. That will leave us with around 20% in cash, which we’ll hold onto tonight—but if we see some normal slippage from here (which should produce better entry points), we’ll be looking to put some of that to work.

Model Portfolio Update

While the election absorbed most of the headlines during the past week-plus, the Model Portfolio has been more focused on earnings, as most of our holdings have reported of late—and for the most part, it’s been mostly buoyant, with many big earnings gaps on the upside among stocks we owned and others we’ve watched. Put simply, it’s been a great couple of weeks.

Right now, we’re mostly riding with what we have, though we did take partial profits in one name (AppLovin) last week and are shaving off some shares in Cava after a big reversal. Overall, though, we continue to think we own some real leaders and are focused on managing them properly.

The trimming of CAVA will boost our cash position to around 20%, give or take, though that’s a bit deceiving—but we also have three half-sized stakes, so if we averaged up in all three (obviously a big if), we’d basically be all in. Tonight we’re holding the cash but will likely be putting some back to work soon-ish assuming the market’s good vibes continue.

CURRENT RECOMMENDATIONS

AppLovin (APP)—AppLovin continues to execute flawlessly, trashing Wall Street estimates while continuing to say rapid growth is sustainable for a long time to come. In Q3, the firm’s advertising engine (which is still just being used in the online gaming area) saw sales rise 66%, with sequential revenue growth re-accelerating to 17% as the system improved; the top brass still thinks 20% to 30% annual expansion just from the gaming sector is likely, with higher growth (like this quarter) coming when there’s the occasional step-function improvement in its AI-enabled algorithms. As for the move into e-commerce, the talk is mostly bullish regarding its current testing phase and the firm expects a launch there next year. Add in a continued buyback program (another $2 billion authorization approved) and, of course, huge free cash flow ($1.63 per share in Q3, up 180% from a year ago), and the stock went into outer space on the news. As we wrote last week (and discuss a bit later in this issue), we decided to take partial profits on the move, partly because our position size was big for us (something like 22% of the portfolio), so paring back made sense. That said, APP remains super strong, so we’re holding on tightly to our (still sizable) remaining stake. HOLD

Argenx (ARGX)—ARGX looks totally fine, having moved to new price highs after earnings, and with the stock tightening up just south of round-number resistance near 600. Fundamentally the Q3 report was excellent, with Vyvgart sales easily passing estimates and with the recent launch in CIDP off to a good start; indeed, analysts see next year’s earnings around $9.40 per share (up from $6.50-ish before the report) with much higher totals in the years after. However, we’re still looking for a bit more strength before averaging up—the relative performance line (not shown here) is still shy of its old highs, while round-number resistance near 600 has capped the stock. A decisive move above that area would be very encouraging and would probably have us averaging up, but for now, we’ll sit tight. HOLD A HALF

Axon Enterprises (AXON)—Axon throttled expectations when it reported last week, with sales up 32%, earnings up 34% and EBITDA up 54%, and with all of the sub-metrics also cranking ahead, including annualized recurring revenue (up 36%), same-customer revenue growth (23%) and future revenue under contract (up 33%). Moreover, within the conference call, the top brass said bookings in the quarter were the highest in history next to last year’s Q4, and that it’s working on a largest-ever pipeline of potential orders, too—both obviously boding well for the quarters to come, partly due to excitement about the firm’s various AI products that are being integrated into its existing offerings, including transcription, response and many others. (They also said four of the 10 largest deals in the quarter were with U.S. federal departments as that area picks up steam.) Shares mushroomed last Friday and have held those gains so far this week. If you want to book some partial profits, we wouldn’t argue with it … and it’s possible we decide to do just that in the days ahead. But for now we’re holding our reasonably sized position (12% or so of the portfolio) given the strength and resilience—and if you’re not yet in, we’ll stay on Buy, though you should keep it small and ideally look for some shakeouts of a few percentage points. BUY

Cava Group (CAVA)—Cava had elevated expectations heading into its quarterly report, but to its credit, it was able to exceed even the most optimistic views. Total sales boomed another 39%, with same-store sales up an incredible 18% and, just as impressive, 13% of that same-store gain was from traffic (not just pricing or mix), even as many in the industry are struggling with that metric. Meanwhile, earnings (15 cents, up 150%, four cents above estimates) and EBITDA (nearly doubled) boomed, with the top brass hiking the Q4 outlook and saying new stores are showing higher returns than expected (they see the store count growing north of 15% in 2025, too). Perhaps most bullish of all was the top brass’ view that they’re the clear leader in Mediterranean fare, which looks like the next big cultural cuisine category. Thus, longer term, the growth story has a ways to play out … that said, after a huge, prolonged run (both from its lows about a year ago, and from its breakout in March of this year), we’re mixed on the stock’s next intermediate-term move, especially as shares have been hit hard since its earnings gap yesterday morning. We don’t have a huge position, but given the action, we’re going to sell one-third of our remaining stake, putting a little more profit in our pocket. That will leave us with a small-ish holding and we’ll see what comes from here. SELL A THIRD, HOLD THE REST

Flutter Entertainment (FLUT)—Like Cava, Flutter also reported earnings Tuesday night, and they were great, flying past expectations—currency-neutral revenue rose 26% while adjusted EBITDA was up around 70%, led by FanDuel, which saw a 51% sales gain (62% growth in sportsbook, 46% in iGaming), and while Q4 has seen some bad luck so far (meaning good luck for sports bettors) in terms of outcomes, the underlying economics here (18-month payback for new customers; 10% increase in new customer acquisition totals leading to a 28% gain in active customers) continue to improve. The firm also is beginning to execute on its share buyback program that was announced at September’s Analyst Day, with $350 million likely through the end of Q1 2025. As for the stock, it’s been a tedious ride in recent weeks with tax threats causing volatility, but at day’s end FLUT etched a fresh seven-week launching pad that sat on top of its prior 16-month foundation—and now shares have broken out on the upside. If you own some, hang on, and if not, you can buy a position around here or (preferably) on dips. BUY

On Holding (ONON)—ONON has been all over the place since reporting earnings on Tuesday morning, but to our eyes the report did nothing to dispel the growth story. Currency-neutral sales lifted 33% overall, and just like in Q2, the growth was seen everywhere, including a 51% gain in direct-to-consumer revenue; a huge 86% sales gain in the Asia Pacific region along with a 35% gain in the Americas; and, when it comes to product lines, On saw footwear up 33%, apparel up 35% and accessory sales rising 56%, all while brand awareness is growing quickly but still at relatively low levels vs. some of On’s huge peers. (To be fair, the non-footwear categories make up just 5% of total revenues at this point, but that’s up from zero a few quarters ago.) Some of the earnings metrics were messed up by currency movements, but EBITDA rose 48%, so everything appears on track. As mentioned above, ONON has been volatile since the release, first tanking, then surging to new highs, then dipping back a bit—but, at this point, the stock is trading near its prior highs (and near where it was before the report). We’re going to stay on hold a bit longer, but if the stock can stay up here or advance further, it should provide a decent entry point. HOLD

Palantir (PLTR)—PLTR remains super strong since its earnings report, with a powerful five-day volume cluster (five days in a row of big-volume buying) propelling it well out to new highs. There hasn’t been any substantial news since last week’s earnings (it expanded an AI deal it had in place with Rio Tinto and teamed with an AI outfit to bring its platform to U.S. defense firms), but it’s obvious that big investors agree with our take from a few months back—that Palantir is in pole position to become the Microsoft of AI platforms for enterprise and (western-friendly) governments. Short term, of course, the stock could easily wobble 10% or 15%, so if you want to lighten up, we can’t argue with it. But for our part, we’re holding what we have here and are seeing how it goes. We’ll keep our Buy rating intact, though new buyers should keep it small and aim for a bit of weakness. BUY

ProShares Ultra Russell 2000 Fund (UWM)—We tried our hand with UWM in the summer to no avail, as the rotational burst higher fell flat during the market’s brief, sharp correction in July and early August. But this time we’re feeling more bullish: As we write about later in this issue, the post-election romp higher brought more than a few indexes (including small caps) out above their summertime highs after months below them, which ups the odds of this move having legs. (The Russell 2000 also is trying to lift out of a three-year consolidation, too, which adds to the attraction.) Of course, there are no sure things in the market, so we’re not complacent; maybe higher Treasury rates will crimp the move and bring in some sellers (we’ve some of that this week), in which case we won’t let a big loss develop (mental stop in the 43 to 44 area). But we think it’s worth the risk: We started a half-sized position in the ProShares Russell 2000 Fund (which moves about twice the underlying index, up or down, each day) last week and will look to fill out the position if the breakout follows through on the upside. BUY A HALF

Samsara (IOT)—We’ve been following and writing about Samsara for a few quarters now, and the underlying growth story oozes emerging blue chip, with the firm’s cloud platform to help firms manage, track and optimize the use of physical assets a straightforward idea that’s been a hit. After endless ups and downs, IOT’s three big-volume weeks after earnings in early September marked a change in character, and the six-week rest that followed was normal, with shares hitting new highs this week before pulling back today. We followed our usual plan, starting with a half-sized (5% of the portfolio) position and will look to buy more if the buyers remain in control. Earnings are due out on December 5. BUY A HALF

Shift4 Payments (FOUR)—Shift4 released a mixed quarterly report on Tuesday morning, with gross payment volume missing estimates (though it was up 56% from a year ago, bolstered by some acquisitions) and with revenues less network fees “only” hitting the low end of guidance (up 50%), though EBITDA, margins and free cash flow were solid, and the top brass actually nudged up its Q4 guidance. On the conference call, management was very optimistic, saying it had one of its strongest quarters of new logo sign-ups while also relaying that it’s #1 in end-to-end hospitality payment systems (handling everything from reservations to dinner to spa bookings and more) and #2 in cloud-based point of sale systems for restaurants. Even so, the miss has seen the stock wobble since the report ... though, at this point, shares haven’t even touched their 25-day line (near 95). We’re open to anything, but right now, the trend is up, and the overall numbers remain excellent—we’ll stay on Buy though will keep an eye on how things go in the days ahead. BUY

Watch List

• Astera Labs (ALAB 89) or Credo Tech (CRDO 42): Both stocks are hot potatoes and Credo still has earnings coming up in a couple of weeks, but ALAB and CRDO look like fresh leaders in the networking field as AI and data center demand goes wild.
• DoorDash (DASH 174): DASH remains extremely “under control,” stepping higher nine weeks in a row (could be 10 this week), with most closing at or very close to the top of the weekly range, both signs of persistent accumulation. It certainly quacks like a liquid leader, and the next pullback should be buyable.
• Duolingo (DUOL 322): DUOL has gyrated a bit after another solid earnings report (sales up 40%, earnings easily gliding past expectations), but it hasn’t bent, holding north of its 25-day line and within shouting distance of new highs. As with many names, a rest period for a couple of weeks would be tempting.
• Reddit (RDDT 132): Yes, it’s extended here, but the stock just had its initial coming-out party and the story here is one of a kind. We’re looking for some sort of shakeout or brief rest to start a position. See more below.
• Rubrik (RBRK 45): RBRK remains very strong, continuing its post-breakout advance from a month ago. The stock still has some growing up to do (just 190 funds own shares), but it’s liquid and we’re enamored with the story.
• Shopify (SHOP 109)—SHOP built a huge, deep base during the past nine months before blasting off this week on gigantic (9.5x average) volume following a great (sales up 26%, earnings up 167%) quarterly report.
  

Other Stocks of Interest

Twilio (TWLO 97)—We obviously have many official rules and tools, from what we’re looking for in a stock (both fundamentally and on the chart) to market timing indicators and more. But we also have a few “sticky note rules,” which come from observations made over time—and one of those is to never underestimate a liquid, well-sponsored stock that goes wild on earnings. That’s our thought with Twilio, the new-age communications outfit that was a huge winner in the pre- and post-pandemic era, currently powering over one trillion (with a T) emails and billions of messages for clients each year. That said, the stock was crushed and business slowed down to a crawl after the pandemic move ran out of gas, but management has made some bullish moves of late that have re-energized the company’s fortunes: First, it got costs in check, but second, it’s been aggressive in integrating AI into its platform, which is paying off big for its clients—one client uses the system to better personalize what products to advertise in their emails to each user, resulting in a huge uplift in sales, but there are tons of applications that are attracting new clients and seeing current customers buy more. That’s helped growth to stabilize, and the AI tools are driving a slight acceleration, with Q3 revenue lifting 10%, which is up from 4% to 5% in the prior four quarters, while earnings are taking off on the upside (up 76%, topped estimates by 19%) as margins grow. Also helping the cause is an aggressive share buyback program the top brass put in place when the stock was lower; the firm’s share count is down 12.5% from a year ago, with at least a bit more likely to come off by year-end. To be clear, nobody expects Twilio to return to hypergrowth—upper single digits and faster earnings growth seems reasonable—but the stock’s reaction to earnings makes us wonder if Wall Street thinks that outlook is way too conservative: TWLO has mushroomed since its earnings report for many days in a row on huge volume, a clear sign that big investors are buying in before some selling near the century mark was seen today. Clearly, a pullback will come, though given the tidal wave of buying, we’re thinking dips will be controlled.

Dutch Bros. (BROS 47)—Dutch Bros. came public in late 2021, and we’ve pretty much been following it ever since, enamored with the firm’s gigantic cookie-cutter opportunity. But as with so many growth stocks, it’s spent years correcting (2022) and mostly bottoming out (past two years)—but we’re thinking the Q3 report could be the catalyst for a new uptrend. To review, the firm is a leading beverage outfit with 950 locations (up nearly 20% from the year-ago quarter) that serve a variety of hot and cold drinks (cold has historically made up most of the sales). Business has been growing for a while but the top brass is obviously going national, thinking there’s the potential for 4,000 locations in the U.S. down the road. The problem was on the cost side, as expenses rose even faster than sales, and while there are still some issues there, the overall margin profile has improved (company-operated stores, which make up two-thirds of locations, see 20%-plus gross margins by the third quarter after opening) and the firm has many levers to keep that going, including a move into mobile ordering (which was only rolled out earlier this year!) that should increase transactions (Q3 growth in that metric was the second highest in two years). As for store openings, they’ll remain rapid, with 15% to 20% growth likely in the store base for both 2025 and 2026. Put it together and there’s little doubt the firm’s top and bottom line is going to increase many-fold in the years ahead, and after a couple of false starts, BROS might finally be starting to discount that, as shares exploded higher last week following the earnings report, hitting multi-year highs and challenging round-number resistance near 50. To be fair, the stock could still use some added sponsorship, but we think the stock is likely leaving the long bottoming area behind. As with many stocks these days, some tightness or weakness could provide a decent entry.

Reddit (RDDT 132)—It depends on what stock you’re looking at, but we’re seeing a lot of leading growth names show ridiculous strength during the past couple of weeks, leaving them hugely extended to the upside in the short term—but many also “should be” early in their overall run when you step back and look at the overall chart. That’s pretty much our feelings with Reddit, the recent IPO that went bananas on earnings and remains in the stratosphere, but we’re monitoring it for a potential entry on its next pullback or period of tight trading. As for the story, it remains outstanding, with a differentiated offering that has huge barriers: The firm is effectively the largest set of message boards in the world that cover almost any topic imaginable, allowing like-minded people to ask, share and learn more about whatever interests them; indeed, “Reddit” is the sixth most Googled word in the U.S. so far this year, so it’s obvious more people are turning there for answers, discussions and what-not than ever before. Along with the massive scale in topics (138,000 active ones) is a huge and growing user base—in Q3, there were 97 million daily active users (up 47% from a year ago), with weekly active users a mind-boggling 365 million (up 53%)—which is driving a big pickup in advertising (up 56%) from firms that love the ability to target specific topics. (Ads are also becoming more interactive, including the ability to host “ask me anything” events to engage with the audience, too.) There’s a small but rapidly growing data licensing revenue stream as well, based on the fact that Reddit owns by far the largest collection of real, unique conversations on the planet. Best of all, the firm has turned profitable on an earnings and (especially) EBITDA basis, and the blowout Q3 report caused the aforementioned eruption in the stock; coming into this week, RDDT has been up 12 of 13 weeks on big volume, momentum that doesn’t usually up and die. Bottom line: We’re not chasing it here, but we think big investors will be building positions in what is becoming one of the most desirable online properties out there.

Handling Big Winners

We read a study years ago that compared investors’ emotions given four different scenarios: First, the stock you bought falls sharply; second, it falls gradually; third, it rises gradually; and fourth, it skyrockets. Interestingly, in the two losing scenarios, the average investor thinks about buying more, since it’s “cheaper,” while the third option (a gradual advance) is actually the least stressful in this study.

But when a stock takes off on the upside, it actually causes more stress than the other scenarios! And the reason isn’t panic but because it forces a decision—investors realize the stock is acting great, but they also don’t want to lose the profits that have quickly come their way … which causes indecision and angst.

There’s no perfect way to handle these stocks, which can move quickly further up or back down the chute, but besides the obvious (how far a stock is above its moving averages, etc.), we like to consider two factors.

The first is how big of a position you have in a stock compared to your “normal” position size—we’re not going to math you to death here, but in the Model Portfolio, a 10% stake for us is normal and 13% or 14% isn’t a huge deal, but 20%-plus is certainly getting up there … and gives us more reason to trim or cut back on a surge higher.

That, in fact, was a big reason why we decided to cut back on AppLovin (APP) last week—after its monstrous gap, the stock was about 22% of the portfolio, not to mention more than 100% above its 50-day moving average. By comparison, Axon Enterprises (AXON) and Palantir (PLTR) were “only” 11% to 12% of the portfolio, so any retrenchment would be less painful. (To be clear, we could still trim some AXON or PLTR if we feel that’s what’s best, but our point is the situations are different compared to our hoard of APP.)

The other thing we like to look at is the time factor—specifically, how long the stock has been running in the intermediate term, since its last breakout. There’s no set time limit that a stock can go up, of course, but usually we prefer fresher situations. Shopify (SHOP) is one example, as it just catapulted out of a huge base this week on giant volume; in fact, it lifted off on nearly 10 times average volume on the breakout, which is rare for such a well-traded and well-sponsored security.

However, if a stock’s been running for six to nine months or longer, the odds are greater that the stock is ready for a longer rest and possibly a deeper correction. That’s a reason (along with the post-earnings selling since yesterday morning) why we’re trimming back on Cava (CAVA) despite it not being a big position; the stock broke out from its IPO launching pad back in March and has mushroomed since, meaning there could be lots of late buyers that need to be shaken out.

Back to big winners, it’s obviously a good problem to have, but having a couple of guidelines in terms of time and portfolio weighting can help you decide how best to handle them.

Simultaneous Index Breakouts = Bullish

When it comes to individual growth stocks, big, powerful moves—like those seen after, say, an earnings report—above resistance (or below key support) can often alert you to a character change for that security. However, the same doesn’t usually hold true when you’re talking about the major indexes; we’ve long put little weight in breakouts/breakdowns in things like the Dow, S&P 500 or Nasdaq. Why? Because these indexes are extremely well followed, which makes any move fairly obvious to the crowd—and in the market, the obvious rarely works that well.

However, there are exceptions to every rule, and we think the post-election action could be one of them: When looking at indexes like the Nasdaq, the S&P 600 SmallCap and the IBD 50 Index, all were above key moving averages in recent weeks, but none were able to get above their summertime peaks ... and then they fell back a couple of weeks ago. (Even the S&P 500, not shown here, dipped back to its July high.) Since then, of course, we’ve seen a rush of buying, with each of these indexes (and some others we watch, like the IBD Mutual Fund Index) breaking out on the upside.

If only one index moved to new highs or the recent lift wasn’t decisive, that wouldn’t carry much weight to us—and, to be very clear, we can never rule out a quick reversal. Indeed, we’ve seen some sloppiness this week in some indexes, likely because interest rates are testing multi-month highs.

But while we’ll continue to follow everything on a day-to-day basis, this everyone-back-in-the-pool action across the growth complex and other areas certainly looks like a bullish market-wide character change that has a good chance to carry the indexes nicely higher.

Cabot Market Timing Indicators

The post-election action has been excellent, with leading stocks racing higher (including many big earnings winners) and many indexes breaking out—though, to be fair, the broad market is still languishing and, near term, there’s little doubt things are a bit hot and heavy. We’re focused on handling our big winners and looking for fresher leaders to buy at solid entry points.

Cabot Trend Lines – Bullish
Our Cabot Trend Lines have strengthened along with everything else of late: With the two big-cap indexes surging to new highs, the longer-term trend remains up, with the S&P 500 and Nasdaq 9% and 11% (respectively) above their 35-week lines. Of course, when things get stretched like this after a few months of up action, the market is often vulnerable to a pullback, but none of that changes the fact that the longer-term trend remains firmly up.

Cabot Tides – Bullish
Our Cabot Tides are clearly bullish, with all five indexes we track (including the S&P 500, daily chart shown here) nicely above their lower (50-day) moving averages and hitting new high ground earlier this week—and all of this goes for growth-oriented funds and indexes, too. That doesn’t guarantee anything, of course (a big reversal of the recent breakout, for instance, would be iffy), but going with what we see, there’s no doubt the intermediate-term trend is pointed up.

Two-Second Indicator – Neutral
While the major indexes have spurted ahead over the past two weeks, our Two-Second Indicator has actually started to lean negative, with many plus-40 readings mixed in with some tamer days, which is disappointing action. We consider the indicator neutral here—but another few days of plus-40 readings would tell you the broad market selling pressures that had been tame for a while are picking up again.

The next Cabot Growth Investor issue will be published on November 27, 2024.

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