August 18, 2022

Where Do We Go From Here?
We had a one year old in 2013 and took a trip to Nevis, an island in the West Indies where my grandfather had retired in the 1980s.

There is a funny picture of me, holding our son and standing with my extended family soon after we arrived. We’re at an outdoor market. Everyone is facing in different directions, not at all sure where to go next.

The current market environment reminds me of that picture.

The S&P 500 has come up 18% off the June low. It’s now 11% below all-time highs and on Tuesday the index kissed – but didn’t break above – it’s 200-day moving average line.

Market technicians will tell you a break above that trendline is needed for an official bull market to begin, whereas failure to do so could signal a deeper pullback.

On a more fundamental note, Bank of America recently theorized that the market hasn’t yet bottomed because the Rule of 20 hasn’t yet been satisfied. This happens when the sum of CPI and trailing P/E is below 20 (it’s at about 25 now).

If that’s too obscure the bank also notes stocks are not cheap, especially now that the market has rallied 18%.

But there’s always an “on the other hand.”

Right now, the other hand says that outlier situations do occur, especially when in unchartered territory. If there’s one thing we can all agree on it’s that we’ve been navigating unchartered territory since the pandemic broke out.

Of special significance to us right now is the fact that small caps continue to trade at a discount to large caps. The S&P 600 Index trades with a forward P/E of just 12.7 whereas the large cap forward P/E is 18. This chart from Yardeni Research shows how low the small cap P/E is relative to history.

On top of being attractively valued small caps tend to have much less exposure to all the messes overseas. With more business coming back to the U.S. due to geopolitical conflicts, supply chain issues and ESG matters, homegrown companies stand to be significant beneficiaries of a potential U.S.-focused investment cycle. For example, the CHIPS Act includes $53 billion for U.S. semi production and R&D.

Bottom line is we don’t know where the market is going in the short term. But the evidence suggests a pause in the broad market rally is likely (probably even good, or the Fed may think more aggressive rate hikes are needed to cool things off).

That said, even when the broad market cools there are opportunities to thread the needle. And I think small caps look pretty good for the next 12 months—not that they can’t pull back as well (they probably will if the broad market does).

If we’re splitting hairs … the S&P 600 Index is poking its head above its 200-day moving average line. That’s something neither the S&P 500 nor the Nasdaq can claim (yet).

Recent Changes
Procept BioRobotics (PRCT) Moves to HOLD

Updates
Avalara (AVLR) announced a buyout from Vista Equity Partners a few weeks ago. While a better offer could come in we elected to sell our remaining stake for a 130% gain and look for other opportunities for that capital. SOLD

CS DISCO (LAW) reported earnings last week with quarterly results that were OK but not great and forward guidance that fell well below expectations. The issue is that new modules aren’t selling as well as expected and since they carry a high ticket price a few lost or delayed deals have a significant impact on quarterly revenue. This variability in the business model isn’t acceptable in the current market environment. We elected to step aside from LAW and look for fresher opportunities. SOLD

DigitalOcean Holdings (DOCN) delivered Q2 results last Monday with revenue up 29%. The full-year revenue outlook was left unchanged but the profit outlook was raised. It was a decent quarter for a company that is receiving mixed coverage. Goldman and Morgan Stanley are a little bearish on it while JPMorgan, KeyBanc and Piper Sandler are a bit more bullish. In my view the story could go from “fine” to “good” and maybe to “great” in 2023. BUY HALF

Flywire (FLYW) reported last Tuesday with revenue of $57 million up 53%. EPS of $0.22 missed by $0.06. Payment volume grew 49% to $2.9 billion. Management gave full-year revenue guidance of $283 - $294 million (an increase of $14.5 million and more than the Q2 beat, and also reflects some contribution from the Cohort acquisition) and revenue less ancillary services guidance of $260 - $269 million (an increase of $11.5 million). Full-year adjusted EBITDA guidance is $13 - $17 million (an increase of $3 million). Management is investing in growth, salesforce, etc. Short version: it was a good quarter and confidence in the business remains high. BUY HALF

Ingles Market (IMKTA) reported Q3 fiscal 2022 results a couple weeks ago. Revenue rose 14% to $1.46 billion and diluted EPS dipped 6% to $3.57. Shares of IMKTA had a normal looking pullback after the report (failed to break above resistance at 102). We’ll stick with buy as a breakout seems likely in the coming weeks/months. BUY

Inspire Medical Systems (INSP) beat Q2 expectations with revenue rising 73% to $91.4 and EPS of -$0.53 beating by $0.07. Full-year guidance range was raised by $10 - $18 million to a range of $354 - $362 million (+52% to +55%). All signals still point to “go” as management is working on improved tech (like Inspire V) and is steadily growing new centers and utilization. A secondary offering (1 million shares priced at 215) seems to have been absorbed (stock trading at 2015 today). We’ll continue to let INSP marinate on the hold list. HOLD

Procept BioRobotics (PRCT) reported Q2 revenue of $16.7 million (+97%) and boosted full-year guidance by $7 million to a range of $66 - $68 million. This continues a steady string of beat and raise quarters. Shares have been acting well near all-time highs but have yet to break out to new highs above the 45-47 range. Moving back to hold today but could upgrade should a breakout occur. HOLD

Rani Therapeutics (RANI) has been on a wild ride lately. Management reported up to $45 million in debt funding from Avenue Venture Opportunities Fund last week, released Q2 results and announced top-line Phase 1 results of RT-102 (seemed good) then launched a secondary offering, which tanked the stock. They then pulled the secondary and shares rallied. Stepping back and looking at the chart, the net result is RANI is still trading near its flatlined 50-day moving average line. I moved to hold on Friday because of all the volatility and will stick with that rating for now. Big picture, the company is marching forward as planned, but let’s just hang on and let the stock do its thing until more trial results come in. HOLD

Repligen (RGEN) was the subject of acquisition speculation recently with the rumored acquirer to be Catalent (CTLT). I don’t think that’s likely and while anything can happen my assumption is Repligen will remain independent for the foreseeable future. Second-quarter revenue grew by 27.4% while full-year revenue guidance went up $20 million at the low end to a range of $790 - $810 million. With such a big move in the stock (RGEN +20% since the day before the report), I moved to hold last week. HOLD

Sprout Social (SPT) reported that Q2 revenue grew 37.4%. Full-year guidance of $253.9 - $254 million is slightly above consensus of $252.7 million and implies growth of over 35%. The stock hasn’t done much after the report so I’m still maintaining at hold. Please note that SPT was our only stock also included in the Cabot Early Opportunities advisory and I elected to sell it from that portfolio. That’s not because I don’t like the stock. It’s mainly because I cover five stocks per month in that service so it has higher turnover so that the portfolio doesn’t swell to an unmanageable size. HOLD HALF

TransMedics Group (TMDX) Q2 revenue rose 150% to $20.5 million. This was a good quarter and adds to the positive momentum the company showed in Q1. Management was cautious on the conference call due to risks around inventory depletion (it’s trying to triple manufacturing capacity) and air transport fulfillment challenges. But the company still raised full-year guidance by roughly twice the Q2 beat to a range of $67 - $75 million (up from $59 - $65 million). The company also launched an equity offering a few days after the report to raise roughly $130 million at 40 a share. The stock has pulled back a little but still trades above the offer price (near 42.7 today). Keeping at Buy Half for now as we look for a pullback before buying larger positions. BUY HALF

Xometry (XMTR) grew Q2 revenue by 89% to $95.6 million. Management updated full-year revenue guidance to a range of $395-$400 million (+81% to +83%). Contrary to many companies Xometry is doing well in Europe. More broadly, the company sees strength in auto, electronics and semi. Looking to upgrade to BUY but want to see a little more price stability first. HOLD

Please email me at tyler@cabotwealth.com with any questions or comments about any of our stocks, or anything else on your mind.