January 27, 2022

Are We There Yet?
Anybody that’s done a drive with kids has faced this question more times than they’d like to recall. We’re facing the same question now with respect to the market’s retreat as we look for some stability.

So, are we there yet?

Best guess is a very, very tentative “yes,” at least for now. But ask me again in a few weeks.

This week (so far) we’ve had multiple heavy-volume days where the bulls have put up enough defense to keep the market from imploding. While it looks far from great the S&P 600 SmallCap index has been able to hold near the low end of its 11-month trading range.

We’ve also seen the S&P 500 hold near (roughly) the October 2021 lows.

However, we have seen the Nasdaq fall below its October 2021 low (14,180). That feels significant. On the flip side there was the extremely impressive rebound in Microsoft (MSFT) after reporting Tuesday (stock was initially -5% or so after hours before going slightly positive later in the evening).

Big picture, Microsoft is something of a bellwether for cloud/software stocks and given the extreme weakness in many of these names a strong showing here felt critical. That said, MSFT is down around 15% from the highs and just above its 200-day line so it hasn’t been immune to the selling.

Another concern …

The market performance during Powell’s press conference yesterday was just depressing. I’m sure I wasn’t the only one yelling, “Land the plane already!” By the time he was done the gains from early in the day were gone even though what he said was about what we all expected.

But another positive, specific to small-cap stocks …

I think the case for small caps, broadly speaking, is relatively strong. As you’ll note in that chart I posted above, the asset class has done nothing for almost a year. Given small-cap stocks are more prone to the impacts of Covid/Omicron (less diversified businesses) we could see some relief rallies when the Omicron spike dissolves.

Furthermore, data from Bank of America shows small caps are cheap versus history, and trade at a 27% discount to large caps. That’s below the Covid crash and Great Financial Crisis lows. And it makes small caps the cheapest since 2000.

Many of the small-cap stocks that have been the hardest hit will also be the ones with the most upside … when things turn around.

The one factor that has overwhelmingly led to upside performance coming out of corrections – especially with smaller companies – is revenue growth and revenue beats. That’s what we’re going to be focused on in the upcoming Q4 reports.

Bottom line. If you’re into reading tea leaves, there appear to be signs that things are stabilizing. But even if they are – and it’s too early to reach any conclusions – the real money isn’t made trying to trade around a potential market bottom but rather on the longer-duration uptrends.

Right now, without any positive uptrend to speak of in growthy, or even growth + value small-cap stocks, it’s mostly a waiting game. What strength has been out there has tended to be with the value stocks (mostly energy, financial, material). We may dip a toe there, depending.

Recent Changes
No Changes

Updates
Arena Pharmaceuticals (ARNA) slipped back toward the 90 level this week on no news. We’re continuing to hold half our position given the takeout price of 100 is more than 10% above ARNA’s current level. The discount represents risk that the deal might fall apart. While anything can happen, that risk is likely quite low. SOLD HALF, HOLD HALF

Avalara (AVLR) is down very modestly from last week and like a lot of high growth software names has the appearance of probing for a near-term bottom. The upside potential is significant here, which is why we’ve continued to hold our noses and maintain a position in the stock. We have an earnings date of February 10. Investors are likely to be most focused on 2022 guidance, which likely needs to come in above the high end of consensus estimates ($853 million). BUY
Earnings: Thursday, February 10

CS DISCO (LAW) is now more than a week past lockup expiration (Monday 1/17) and has spent roughly three weeks dancing around the 30 level. As mentioned last week, LAW is a potential disruptor in the legal industry (software focused) and has potential revenue upside to analyst estimates in 2022. We don’t yet have an earnings date. BUY

Everbridge (EVBG) has given an earnings date of February 24, a couple weeks later than I was hoping. CEO David Meredith will be done with the company as of the end of this week. We have been awaiting further clarity on the state of the business and it is absolutely astounding that there has been no further communication about senior management transition or progress in Europe. The communication vacuum has left investors assuming that things are really not going well. We will hold our final quarter though the weekend and revisit ahead of next week’s monthly Issue. HOLD FINAL QUARTER

Inspire Medical Systems (INSP) pre-announced Q4 results two weeks ago. This week shares have probed their December lows near 198 and have thus far held. With solid Q4 numbers INSP is now trading on sympathy of what goes on in the rest of the market. Will keep at buy now but if it breaks lower I will re-evaluate. BUY

JOANN (JOAN) has posted poor performance since we jumped in, but over the last two months the stock has been largely immune to much of the volatility in the market. In fact, it looks very similar to the performance of the small-cap index (maybe a little stronger even over the last week). With a 4% yield and a lot of bad news priced in I think patient investors will be well served to hold on and those looking to increase exposure to small-cap value stocks should consider adding to JOAN here. As mentioned, over the last two weeks a recent JP Morgan note outlined five reasons to buy the stock: (1) reopening/normalcy should be a benefit, (2) strong competitive position in a niche industry, (3) store refreshes provide additional upside, (4) “Blue Ocean” initiatives on the horizon (think JV with Singer as example), and (5) most attractive valuation in Hardlines. BUY

Kornit Digital (KRNT) has had a tough go lately and we sold the rest of our position last week (around the current level). This was a very tough decision since I think the selling should be about done here but we couldn’t risk another step down in the share price. KRNT remains on my daily watch list as I believe the fundamentals of the business are sound. SOLD

Rani Therapeutics (RANI) is back to its old tricks, swinging around wildly. Yesterday shares were up 20%, today they’ve given it back. The most likely explanation is market dislocations related to lockup expiration (yesterday). Buy, but don’t chase on the crazy days. BUY

Revolve (RVLV) has been bouncing around above the 40 support level as investors try to grapple with the broader market volatility and all the noise that may (or may not) drive consumer spending over the course of 2022. As I mentioned last week if we look back to the Q3 report we see sales in October were keeping pace with the 58% growth posted in Q3, and the Forward brand was cranking. Should consumer spending slow in 2022 there could be some softness here, but at the same time expectations for 24% revenue growth in 2022 and 10% adjusted EPS growth (to $1.24) appear to leave some room for outperformance. BUY

Repligen (RGEN) recently said it’s maintaining guidance for $200 million in Covid-related revenue in 2022. The team also cited increased demand for both existing and in-development vaccines. Yesterday larger peer Danaher (DHR) reported Q4 results that were largely in line with their pre-announcement (19.5% revenue growth) and issued 2022 revenue guidance that was roughly in line. Notably, Danaher alluded to a second-half slowdown in Covid-related diagnostics, but not vaccine/therapeutics. This seems to gel with what we expect from Repligen. As the only SMID cap bioprocessing company of any scale out there, and with a solid track record of innovation, Repligen is a scarce asset. Continuing to hold as the stock looks to find firm footing. HOLD

SiTime (SITM) is behaving similarly to the semiconductor ETF (SOXX), albeit the moves are larger. Management will report next Wednesday, however SITM may move tomorrow based on Apple’s (AAPL) earnings. Remember, over the last two years, SITM has gotten 35% to 40% of revenue from Apple (I believe that number is trending down, we’ll know more when full-year results are out). The company has done very well lately due to supply-chain disruptions in quartz timing solutions. Not only is SiTime’s silicon a better performing solution, the company has much more stable supply capacity. It should be well positioned for the next couple of years given exposure to data, networking, communications, auto, aerospace and mobile/IoT markets. That said, there are a lot of factors quarter to quarter. Maintaining at buy into the earnings report. Analysts are expecting revenue to grow 76% to $71 million and adjusted EPS to be up 153% to $1.09. BUY
Earnings: Wednesday, February 2

Shutterstock (SSTK) is increasing its quarterly dividend by 14% to $0.24 (need to be a shareholder by March 3). Current yield is just over 1%. Q4 earnings are due out a week from Wednesday. We’re looking for revenue to be up 12% to $202 million and adjusted EPS of $0.48. For 2022 we’re looking for at least 9% revenue growth (to $840 million) and adjusted EPS of $3.52 (up 10%). The stock is unchanged over the last 10 sessions. BUY
Earnings: Wednesday, February 10

Sprout Social (SPT) is looking for support around the 60 level, where it’s been trading for the last week. We took a partial profit (1/4 position) recently to lock in a 90% gain, just in case. We have an earnings date of February 22. Sprout is one of the crop of high-growth software stocks that “should” fly higher when investors return to these names. We’re looking for Q4 revenue growth of 37% ($51.3 million) and adjusted EPS of -$0.07. In 2022 we’re expecting revenue growth of 26% ($240 million) and adjusted EPS of -$0.15 (flat year over year). There should be upside to these numbers. Sprout has beaten revenue expectations in all of the last eight quarters (average beat of 3%) as well as its own quarterly guidance (average beat of 2.7%). No guarantees the trend holds but the company has been hiring and appears to be in a strong position. SOLD A QUARTER, HOLD REST
Earnings: Wednesday, February 10

Thunderbird Entertainment (THBRF, TBRD.CA) has drifted lower over the last two weeks on no new news. With the big streamers still looking for content – especially for children – and Thunderbird’s initiative to build out its gaming and consumer products division, the company appears well positioned for 2022. BUY

Xometry (XMTR) hasn’t had any trend to speak of since we entered the position at the beginning of the month. Given the state of the market, especially for software and marketplace stocks, that’s not too surprising. This was our “aggressive but not crazy aggressive” way to dip a toe back into the software space, not necessarily to capture gains in the next month or two but for a much bigger gain over the coming years. Xometry has a potentially disruptive platform that brings buyers and sellers of industrial supplies/services together. Revenue is seen up 76% next year after rising 49% in 2021. BUY

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