The market hit a pothole today, which isn’t totally unexpected given the recent run-up; in fact, in the short-term, we don’t see much of an edge either way, as earnings season is underway and growth stocks have generally been lagging.
However, longer-term, the evidence remains piled up on the bullish side of the ledger, both via our trend-following indicators and with a growing number of bullish studies. Thus, we remain heavily invested, though we remain choosy on the buy side given the market’s short-term uncertainties.
Cabot Growth Investor 1379
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Longer-Term Outlook Remains Great
When you get down to it, investing is all about finding an edge and exploiting it. Some people try to do that over a very short time period (swing traders), though we’ve always found that challenging.
Indeed, from a growth investor’s point of view, we don’t see much edge right now when it comes to the short-term, which is the main reason we’ve been hesitant on the buy side during the past three weeks. Earnings season is the main reason for the lack of an edge, as most stocks we own or are considering buying are reporting within a two-week span.
Another reason for some short-term hesitation: Growth stocks are lagging. The chart here shows the relative performance of the Nasdaq vs. the Dow Industrials—you can see the good-sized slide since early September, bringing the RP line to its lowest levels since March. This is more descriptive than predictive, but it does show that money is flowing toward old world, industrial-type names.
All of this shows why we’re stepping lightly. However, our main focus is on the intermediate- and longer-term, and on that front, we continue to see plenty of opportunities going forward for the bulls.
Most important, of course, is that our trend-following market timing indicators are both clearly positive. Then there’s the fact that breadth has been great; the advance-decline lines of both indexes have recently hit all-time highs. And we continue to see numerous studies point to higher prices in the months ahead.
For instance, Ryan Detrick of LPL Financial recently showed that, since 1950, when the S&P 500 is up at least 5% from May through October, as it’s likely to be this year, the market has risen during the following six months (November through April) 19 of 22 times for an average of 9.2%. There’s also a study by Charlie Bilello of Pension Partners that said when the Dow Industrials have become as overbought as they are today, the index has actually averaged a 9.6% gain in the following six months.
The upshot: It’s a bull market, and the odds strongly favor higher prices in the months ahead. That’s where our main focus is. But in the short-term, we’re stepping carefully as we wait to see what earnings season brings.
[highlight_box]WHAT TO DO NOW: Remain heavily invested. We’ve made no new buys or sells since our last issue. Our cash position remains around 14%.[/highlight_box]
Model Portfolio Update
We’ve stood pat in the Model Portfolio during the past two weeks, partly because we’re doing just fine (we’re up more than twice the S&P 500’s return this year), but mostly because we’re waiting to see what earnings season brings, both good (new emerging leadership) and bad (any breakdowns from our stocks).
All told, though, we’re not changing our strategy—we’re following our plan with our stocks in earnings season (we have many stocks reporting earnings within the next couple of weeks, including GRUB this morning and NOW tonight), and on the buy side, we’re ideally looking for “fresh” growth stocks that have just recently blasted off on earnings.
Current Recommendations
HOLD—Alibaba (BABA 170)—As growth stocks have begun to lag, we’ve seen BABA show a change in character—after months of barely dipping below its 25-day line, the stock tested its 50-day line twice in the past four weeks before falling below that support line today. That said, we’re not hitting the panic button, as shares were certainly due for a rest, and fundamentally, there’s little doubt Alibaba is one of the top liquid leading growth stocks. On the news front, another company-backed stock went public this week (Qudian, which offers short-term loans), leaving it with a market cap of more than $7 billion. (It appears Alibaba owns around 10% of Qudian post-IPO, though exact figures are hard to come by.) Earnings are due out November 2, which will probably tell BABA’s intermediate-term tale. That said, given the chart, we’re going back to Hold until we see some decisive signs of accumulation, which have been absent in recent weeks.
BUY—Exact Sciences (EXAS 49)—EXAS will report earnings on Halloween (next Tuesday); analysts are looking for $64.7 million in revenue (up 130% from a year ago) and a loss of 30 cents per share. Given the stock’s big run this year, there’s obviously risk that, should results or the outlook appear soft, shares could get whacked. But we continue to see giant potential from Cologuard, and many analysts (a couple have upgraded shares based on bullish reorder rates) and management (which is set to rapidly expand Cologuard production capacity) agree. A drop all the way down to 40 or thereabouts would crack the uptrend and have us cutting our loss, but right now, EXAS is within shouting distance of all-time highs. We’ll stay on Buy, but the usual caveats apply—keep any new position small ahead of earnings.
HOLD—Facebook (FB 171)—A week ago FB was hitting new price highs and was looking ready to resume its longer-term advance. But, while we hate to quickly switch ratings, the stock’s recent decline (as well as those of its big-cap tech peers) has us going back to Hold. FB hasn’t made any net progress since late July, which is a worry, though we’re not forgetting the fact that shares started the year down at 115, so the major trend is still clearly up. Like most other stocks, FB’s next big move will probably be determined by earnings, which are due out next Wednesday (November 1). Analysts are certainly optimistic, with one hiking his price target last week due to upside for ad demand at Facebook and Instagram, and as Messenger monetization accelerates next year. If you have a big profit, sit tight.
BUY—Five Below (FIVE 56)—Five Below won’t be reporting its next results until after Thanksgiving. If you’re looking for something to worry about, it could be that the fidget spinner craze (ask your kids or grandkids if you want to know more), which likely boosted the company’s results during the past couple of quarters, has probably cooled off, which could affect investor perception. But that same fear temporarily hit the stock after each of the past two quarters, only to see FIVE perk back up. Our eye remains on the bigger picture, with the company likely to increase its store count by near 20% next year and, long-term, grow from around 600 stores today to more than 2,000 in the U.S. alone. There’s no reason earnings can’t kite higher at 20% rates for many years to come. With the stock perched near its highs, we’ll stay on Buy.
HOLD—GrubHub (GRUB 58)—GrubHub reported third-quarter results this morning, and they were terrific—revenues rose 32%, earnings were up 22% and EBITDA (a measure of cash flow) rose 21%, all matching or topping expectations. Moreover, the firm’s fourth-quarter outlook easily topped expectations, while the sub-metrics (9.81 million active diners, up 28%) also impressed, helping the stock to pop higher. Even before this upmove, we’ve been encouraged by GRUB’s resilience despite a never-ending stream of news regarding increased competition (Facebook, Amazon and even some talk of McDonald’s expansion of delivery services). Thus, we’re optimistic, but looking at the chart, today’s move still leaves the stock just shy of its old highs. Thus, we’ll stay on Hold for now.
BUY—PayPal (PYPL 71)—PayPal’s growth story continues to crank ahead, as the firm’s third-quarter report topped on just about every metric: Sales rose 21%, earnings rose 31%, payment volume lifted 29% on a currency-neutral basis (to $114 billion!), active accounts rose 8.2 million (now totaling 218 million, up 14% from a year ago) while each account performed an average of 33 transactions (up 9%). Also encouraging was the fact that money-transfer service Venmo saw volume rise 93% in the quarter, and PayPal cranked out $841 million of free cash flow (about 69 cents per share), up 32%. Combine all of those figures with a sanguine early look at 2018 and the stock popped to new highs. A pause or pullback is certainly possible (the stock has repeatedly tested its 25-day line, which is now just above 66), but the trend is up and we continue to think the fundamental growth story has a long way to run. Hold on if you own it, and if you don’t, try to buy on dips.
BUY—ProShares Ultra S&P 500 Fund (SSO 100)—There’s nothing much new to report with our position in SSO, which continues to trend higher with the S&P 500. Volatility has picked up a bit recently, which, after a steady run, could signal that sellers are becoming more willing to take some profits. But that’s nitpicking—SSO remains above even its 25-day line (which is now around 98.5) and our trend-following market timing indicators remain bullish. Sit tight if you own some, and if you don’t, you can buy around here.
BUY—ServiceNow (NOW 125)—NOW has shown some solid action in recent days, bouncing nicely off its 25-day line to new highs this week. (It did have a wild reversal on Tuesday after an upgrade-induced morning spike but it’s hard to read much into one day.) We believe ServiceNow has as good a chance as any tech firm to post excellent, foreseeable growth for another few years, as the company’s workflow software is top notch and doesn’t have much competition in many fields. That said, because we don’t have much profit cushion, the stock’s reaction to earnings (due out tonight) will guide our thinking—analysts are looking for 37% revenue growth and 32 cents of earnings per share, but bookings and guidance will be closely watched. A drop all the way back to 110 or so would likely have us pulling up our stakes and moving on, but if NOW holds up or advances, we feel a sustained advance can get underway.
HOLD—Shopify (SHOP 103)—SHOP isn’t strong enough for a Buy rating, as the stock remains below a good amount of overhead and is below its (sideways moving) 50-day line. But given the big, short seller-inspired plunge earlier this month, the stock has bounced back impressively. While we don’t expect a straight-up move from here, our general view is that the longer SHOP can hold itself together (and show some upside movement, as it has recently), the greater the chance the recent dip was “only” a big pothole on the way to higher prices. The next big event will come on earnings (due out next Tuesday, October 31). If you own a small position with a good profit, hang on.
BUY—Universal Display (OLED 133)—OLED continues to get pushed and pulled by rumors surrounding Apple’s iPhone X production and sales (most agree there have been delays), even though the story is much bigger than that. Eventually, investors should refocus on the general growth opportunity for organic light emitting diodes, which should drive Universal’s earnings much higher in the quarters ahead. That may already be happening, in fact, as we placed the stock back on Buy last week after shares enjoyed a big-volume rally. Still, like most other growth stocks, OLED’s next quarterly report (due November 2) will probably make or break the uptrend. We’ve already taken partial profits in OLED, and will ride the rest into earnings; if you don’t own any, you could nibble ahead of the report.
Watch List
AbbVie (ABBV 92): ABBV has the look of a new liquid leader in the biotech space, though the group’s action isn’t ideal. Even so, we could take a swing at the stock if the right setup emerges. Earnings are due Friday morning (October 27).
Atlassian (TEAM 48): Atlassian is a smaller player in the cloud software field, with a unique business model (very little sales or marketing) and a leadership position in team productivity-boosting products. See more on TEAM in our discussion of earnings gaps in this issue.
Autodesk (ADSK 120): ADSK remains perched near new price and RP peaks—a decisive move higher from here could have us buying.
Other Stocks of Interest
The stocks below may not be followed in Cabot Growth Investor on a regular basis. They’re intended to present you with ideas for additional investment beyond the Model Portfolio. For our current ratings on these stocks, see Updates on Other Stocks of Interest on the subscriber website or email mike@cabotwealth.com.
Box (BOX 21) — Box is a cloud enterprise software company, which, in English, means that it’s built a platform that lets any size organization share and manage information on any kind of device. The company has over 76,000 customers (including 65% of the Fortune 500) and is bringing artificial intelligence and machine learning to bear on making stored information more accessible and analyzable. Box’s usefulness has driven revenue growth averaging 29% in the three most recent quarters and the firm is moving ever closer to profitability. The stock’s RP line is creeping higher and the stock is working on a possible breakout.
LPL Financial Holdings (LPLA 53) — While LPL Financial isn’t a household name, this smaller brokerage and investment advisory company is one of the fastest growing custodians for registered investment advisors and the nation’s largest independent broker-dealer. The company’s assets are growing, and much of the added revenue is falling right to the bottom line, with the prospect of rising interest rates acting like a favoring wind. Analysts see LPL Financial’s earnings rising 21% this year and 37% in 2018. This bull market stock will report quarterly earnings tomorrow (October 26), with expectations for revenue of $1.08 billion and earnings of 58 cents per share. LPLA has paused under resistance at 53 for a couple of weeks, so there’s a short base for advances if the news is good.
Nutanix (NTNX 27) — Nutanix, like Box, is a player in the enterprise cloud computing business, which tries to make the trick of connecting a company’s entire computing capability to remote servers and back to each individual machine look easy. Nutanix calls its solution set “hyperconverged infrastructure,” which means that everyone can run whatever hardware and software they want and Big Data can be accessed, analyzed and profited from with complete transparency. The company has a blue-chip client list and has a reputation for delivering radically simplified performance with less downtime and quicker deployment. The company’s success drove revenue up by 72% in fiscal 2017 (ending July), and the stock has been moving higher after a huge post-IPO crash. Some top-performing funds have been buying.
Skechers (SKX 34) — Led by its status as the unofficial shoe supplier to the skateboard generation, Skechers has built an international chain of retail stores that sell men’s, women’s and children’s casual, dress and athletic footwear. SKX made a memorable run from 4 in January 2012 to 55 in August 2015. After a 14-month correction to 19 in October 2016, SKX made a mediocre rebound that was mostly sideways. But the company’s blockbuster earnings report last week blasted the stock from 24 on Thursday to 34 on Friday. Earnings gaps of 40% are rare, and the follow-on effects can be substantial. Skechers’ 16% gain in revenue and 40% bump in earnings in Q3, combined with the excellent outlook for sales growth outside the U.S., make SKX a stock to keep an eye on. (And see below for more information on how big earnings gaps change a stock’s character.)
Identifying New Leadership Using Earnings Gaps
Ever since Regulation FD went into effect in the early 2000s, earnings season has been something of the Wild West for growth investors, as stocks often gap up or down depending on a company’s quarterly numbers and future guidance. While the volatility is tedious, the good news is that earnings season often launches new leadership.
Of course, buying stocks that have just made a big upside move involves plenty of risk, so we’ve put together some guidelines to determine whether it’s worth taking the plunge. Starting with our buying guidelines, we first want to make sure a stock has all the required fundamentals; we’re not aiming to just chase a strong chart.
With that in place, we’re looking for four things: An earnings day rise of at least 6% (for a big-cap) to 10% (mid-cap), to new multi-month (highs), on at least triple normal volume (the bigger the better), and for the stock to have made little net progress (admittedly a subjective measure) in the few months prior to its gap. When a stock meets all of that criteria and the market is healthy, the gap is usually buyable and has a good (we’ll say two-thirds) chance of heading higher—and, believe it or not, the bigger the gap, the greater the chance it continues to rise.
That said, you can also garner clues to the stock’s potential in the week or two after the gap—the best earnings gappers tend not to pull back much at all after the initial surge, holding relatively close to the gap’s closing price, or at least not falling much below the low of the gap day. Said another way, the gaps that fail tend to do so relatively quickly. Thus, if you’re hesitant to take the plunge, you could always nibble initially and add more shares a few days later if the stock holds its gains.
Let’s look at some examples, starting with a “bad” one: PayPal (PYPL) from last fall. The stock’s earnings day gain was 10% on volume four and a half times normal, and the move pushed the stock out of a long post-IPO base. We took a swing at it in the Model Portfolio—but notice how the stock immediately began to fade after the earnings move. It broke the low of its earnings day five days later and kept sliding after that, a sign PYPL wasn’t ready to go.
On the flip side, we have a classic earnings blastoff. Facebook’s (FB) July 2013 quarterly report resulted in the stock soaring 30% on volume that was eight times average; the stock moved to multi-month highs after a good-sized post-IPO drought. After the gap, you can see that FB really never looked back, soaring another few points within a few days of the move.
As for a current example, we’re intrigued by Atlassian (TEAM), a British cloud software firm that specializes in boosting team productivity—the company says it’s aiming to do for team productivity what Microsoft Office has done for personal productivity. And it’s succeeding in a big way, with steady 30%-plus sales and earnings growth, with big cash flow, too.
The stock came public in late-2015, just in time for the market plunge, but it finally climbed out to new highs in May of this year. That led to another, very tight launching pad, which the stock left behind last week—TEAM soared 25% on nine times average volume. So far, it’s pulled back a bit, but not unreasonably so given last Friday’s move. We have TEAM on our Watch List.
By using a few simple, time-tested guidelines, you can turn the volatility of earnings season to your advantage. TEAM is one possible new leader, and we’ll have our eyes open for more in the weeks ahead.
Cabot Market Timing Indicators
The Nasdaq and growth stocks have been underperforming lately, earnings season is here and the market hit a pothole today. But our indicators are in unison: The trends are up and the broad market is in good shape, so we expect the bulls to remain in control.
Cabot Trend Lines: Bullish
It’s now been a year and a half since our Cabot Trend Lines gave their major Buy signal in April of last year, and the indicator shows no signs of reversing to the downside. At the end of last week, the S&P 500 and Nasdaq were 5.9% and 7.0% above their respective 35-week moving averages. Pullbacks will come, of course, but with the Trend Lines firmly bullish, the odds favor higher prices in the months ahead.
Cabot Tides: Bullish
Our Cabot Tides are also clearly bullish, with all five indexes we track (including the S&P 600, shown here) holding well above their lower (50-day) moving averages. It’s true that, after leading for most of the year, the Nasdaq is beginning to lag, but that doesn’t change the overall stance of the market—with the intermediate- and longer-term trends pointed up, you should remain heavily invested.
Two-Second Indicator: Healthy
Our Two-Second Indicator had been pristine since early September, but the action this week has us raising an eyebrow—today was the third straight day of greater than 40 new lows on the NYSE, mostly due to energy stocks and interest-rate sensitive securities. That said, three bad readings isn’t the end of the world, and the indicator has been on again/off again this year. Conclusion: The broad market remains healthy, but we’ll be watching the action closely in the days ahead.
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All Cabot Growth Investor’s buy and sell recommendations are made in issues or updates and posted on the Cabot subscribers’ website. Sell recommendations may also be sent to subscribers as special bulletins via email and the recorded telephone hotline. To calculate the performance of the portfolio, Cabot “buys” and “sells” at the midpoint of the high and low prices of the stock on the day following the recommendation. Cabot’s policy is to sell any stock that shows a loss of 20% in a bull market (15% in a bear market) from our original buy price, calculated using the current closing (not intra-day) price. Subscribers should apply loss limits based on their own personal purchase prices.
Charts show both the stock’s recent trading history and its relative performance (RP) line, which shows you how the stock is performing relative to the S&P 500, a broad-based index. In the ideal case, the stock and its RP line advance in unison. Both tools are key in determining whether to hold or sell.
THE NEXT CABOT GROWTH INVESTOR WILL BE PUBLISHED NOVEMBER 8, 2017
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