Cabot Top Ten Trader Issue: November 18, 2024

Messy Pullback, but Most Leadership Looks Fine

We’ll be honest: Last week’s pullback in the major indexes was pretty disappointing, with many indexes retracing back to, or slightly below, their breakout levels from the prior week, while some leaders began to act sloppy and with some older leading areas (chip stocks) looking very iffy. It’s definitely something to watch, but when we took a look around at all the evidence this weekend nothing much had changed on an intermediate-term basis: Most leading stocks are acting fine (though getting a bit choppy with some selling on strength), the trends are still pointed up for the major indexes and, while it’s been a bit more rotational of late, there are still plenty of fresher titles that are advancing. We’ll be watching everything going forward (including the still-steep uptrend in Treasury rates), but at this point, we remain optimistic, though we do think it’s important to manage your portfolio (partial profits, etc.) and hunt for decent entry points with so many names extended to the upside. We’ll leave our Market Monitor at a level 8.

This week’s list is chock-full of growth-y names, many of them familiar ones. Our Top Pick is Shopify (SHOP), the big, liquid, well-sponsored e-commerce emerging blue chip that just catapulted out of a big base on huge volume; you can enter here but near-term wobbles are possible.

Stock 1

Applied Optoelectronics (AAOI)

Why the Strength
Applied Optoelectronics makes fiber optic networking hardware, such as transmitters, transceivers, lasers, optical modules and amplifiers, all of which go into making large-scale fiber networks work effectively and with greater data volumes. The Texas-based business is showing itself to be another winner of the AI explosion, as its customers appear eager to buy recently introduced high-volume products at 400G and 800G speeds. Early indications are that demand will be strong for both sets of gear, with early orders firm and indications that much larger ones are coming – among its customers is Microsoft, which provided R&D funding to Applied last year to speed along development of the new high-volume equipment. Based on indications from the market, management expects sales from the 400G and 800G equipment to hit $300 million over the next few years as it builds out its manufacturing capabilities up to full capacity. AI-related demand predictions put a bullish context around third-quarter results, which actually saw an unexpectedly large loss of $0.21 per share—but the loss came from Applied pouring money into R&D to accelerate the timeline on next-generation products to meet expected demand. Top-line results for the period were good at $65.2 million revenue, the high end of guidance, as customer types and product demand shifted – telecom customers were weaker, while cable providers strengthened; older product lines eased while available high-data products, like the 400G line, were in demand. But the stock is strong because of what’s to come: Sales are expected to grow 65% in Q4 and triple digits in 2025 as earnings rip into the black. This is a small-cap outfit, so there’s risk, but if things go as expected the upside could be big.

Technical Analysis
AAOI started reversing a seven-month implosion after the market’s August low—and instead of building a bottom, it headed up right away, starting off with a six-week win streak and continuing higher from there with a couple of sharp retreats along the way. The second of those dips started in mid-October and saw shares slip from 20 to 15, but it found support near its 50-day line and then catapulted to new highs two weeks ago. We think dips toward 25 would be a decent near-term entry, though be sure to use a loose stop given AAOI’s volatility.

Weekly Chart

Daily Chart

Stock 2

Astera Labs (ALAB)

Why the Strength
California-based Astera is a fabless semiconductor company specializing in high-speed data transfer and computer connectivity offerings. The company sells its connectivity chips and semiconductor solutions mainly for artificial intelligence uses and cloud data centers, specifically focusing on AI infrastructure, where high-speed data transfer is critical and where much of the demand in the semiconductor space has come from lately. The firm has been in hypergrowth mode, and that continued in the third-quarter earnings report that was a cause for celebration on Wall Street: Astera reported consensus-beating sales of $113 million that jumped over 200% from a year ago (and rose 47% from Q2!), plus earnings of 23 cents that beat estimates by six cents and were up from a tiny loss a year ago. The company said it’s entering a “new growth phase” thanks to the AI boom, with massive demand expected from its just-introduced Scorpio Smart Fabric Switch portfolio, including the industry’s first PCIe 6 switch, which allows hyperscalers to mix current and next-generation devices in the same platform—in turn making upgrades easier. (The Scorpio portfolio provides Astera with a highly lucrative addressable market that’s expected to increase to $12 billion by 2028.) In the earnings call, Astera emphasized that Scorpio and its other product portfolios are cementing its position as a critical part of AI connectivity infrastructure while “unlocking additional multi-year growth trajectories” for the company. Astera expects the revenue momentum to continue going forward and guided for midpoint sales of $128 million in Q4 (up 13% sequentially, likely conservative), driven in part by the firm’s already-established Aries PCle and Taurus Ethernet product lines. Additionally, management said it’s “very bullish” on the market for Astera’s entire product portfolio across third-party GPU-based systems, and it expects to benefit from increased dollar content per accelerator in next-generation AI infrastructure deployments. The valuation is certainly up there, but Wall Street sees rapid sales and earnings growth for a long time to come.

Technical Analysis
ALAB came public in late March at 51 and rallied to as high as 95 within a few days before the typical post-IPO droop set in. Shares eventually fell to around 40 in early August, where a multi-week low was established. It found its legs again in September, gapped up to 70 the next month and broke out to new highs on exceptionally big volume after the recent earnings. The pullback in the last few days has seen volume dry up, so all looks normal so far. We’re OK nibbling here with a loose loss limit.

Weekly Chart

Daily Chart

Stock 3

Atlassian (TEAM)

Why the Strength
Atlassian focuses on business software that allows teams to work together far more effectively, dramatically boosting the efficiency and coordination of project planning, management and workflows. The company is already well-established in corporate IT departments, with 300,000 clients globally paying a subscription for Atlassian’s suite of services – more than 500 of which pay more than $1 million annually. Atlassian has had a lot of tailwinds from corporations moving into the cloud, and that’s being followed by demand for AI services integrated into the platform. Atlassian has introduced its own AI product, Atlassian Intelligence, which clients can deploy on top of their own data in the cloud to gain insights and action items on things like product development and data security incident detection and offers a natural language search engine; it’s sold as a premium offering that encourages customers to upgrade their subscription tier. Just made widely available is Rovo, part of the Atlassian AI platform that’s adept at gathering data that organizations have planted in the maze of different applications most now use. Clients appear to be embracing the AI platform, with its usage up 10-fold in 2024 and management saying it’s the key reason one of the world’s largest investment managers (they didn’t disclose what firm) is migrating to Atlassian, a huge win for the business. The cloud and AI combination led to a great third quarter for Atlassian, with $1.19 billion in sales and earnings per share of $0.77, both better than consensus expectations and driven by strength in cloud, which is still a big growth area for the company. Migration to cloud services has been growing at a double-digit pace and is expected to continue for the foreseeable future. Wall Street sees both sales and earnings growth accelerating in 2025.

Technical Analysis
TEAM had a decent off-the-bottom run from late 2022 until early 2024, but then proceeded to retrace most of that move during the tough decline that followed into the market’s August low. The recovery was slow to start but picked up steam into October, and after some very tight trading, shares went bananas after earnings to start November—and, importantly, followed through nicely on the upside after that. You could start a position on a bit more of a pullback from here.

Weekly Chart

Daily Chart

Stock 4

Dutch Bros (BROS)

Why the Strength
Dutch Bros. is a beverage chain that’s known for its quick service and ever-changing menus (seasonal and energy drinks to go along with the normal shakes, teas, coffees and more; most sales are cold beverages). However, as investors, we compare the story more to Shake Shack—both have great cookie-cutter stories, but both have struggled on the cost side of the equation while same-store sales were just so-so. Shake Shack has cleared up some of those issues, and for Dutch Bros., it looks like something similar is happening: In Q3, not only did overall sales rise 28%, but same-store sales lifted 2.7% overall and 4.0% among company-operated stores (which make up two-thirds of locations and the vast majority of new locations), bolstered in large part by higher transaction growth (not just from higher prices in other words; transaction growth of 2.4% was the second fastest in two years). And the store opening plan remains on its rapid track, with 38 new locations in Q3 and 150 or so for the full year—the store count was up 21% in Q3, with 15% to 20% growth likely for at least the next couple of years as the firm works its way toward its goal of 4,000 locations (up from 912 at the end of September) down the road. Moreover, the store economics here are slowly improving: While margins are still touch and go (EBITDA lifted 20% in Q3, which was slower than sales growth), company-operated stores are on a good track, with a 20%-plus restaurant-level margin within three quarters of opening—and with things like mobile ordering still ramping up here (just launched earlier this year, with 90% of stores now up and running; those who order up their frequency by 5% or so; mobile orders still make up just 7% of the total), there’s no reason transaction growth and margins won’t have upside from here. The potential here is big if the top brass can pull the right levers.

Technical Analysis
BROS has been effectively stuck in the mud for seemingly ever, first getting crushed during the bear market and then spending a couple of years bottoming out, with the occasional foray higher (like that seen in the spring of this year) being rejected (in that case, after August’s quarterly report). But after another three months of stabilization, BROS took off on its recent earnings report, reaching new multi-year price and relative performance highs, though round-number resistance near 50 has held so far. We’ll aim to enter on a bit of weakness.

Weekly Chart

Daily Chart

Stock 5

Fortinet (FTNT)

Why the Strength
California-based Fortinet (covered in the October 7 issue) is one of the world’s top cybersecurity outfits, specializing in products that combine artificial intelligence and machine learning to stay ahead of evolving network threats. On the domestic front, Fortinet is the fourth-ranked cybersecurity company by revenue, behind #3 CrowdStrike and #2 Palo Alto Networks. However, a new partnership with CrowdStrike has put Fortinet in a position to challenge Palo Alto’s dominance on both the firewall and endpoint protection fronts. (The integration of the firm’s FortiGate Next-Generation Firewall (NGFW) with CrowdStrike’s Falcon Insight XDR will allow organizations to leverage AI-powered threat protection and zero-trust access for cybersecurity across all digital infrastructure.) Unified Secure Access Service Edge (SASE) building growth of 14%, secure operation building growth of 32% and secure networking that returned to positive growth all contributed to total revenue of $1.5 billion in Fortinet’s Q3—a 13% improvement from a year ago—along with earnings of 63 cents a share that beat estimates by 11 cents and boomed more than 50%. Other metrics showed similar strength, including total billings of $1.6 billion that rose 6% (driven by retail and manufacturing customers), deferred revenue of $6 billion that increased 14% and free cash flow of $572 million that jumped 19% and was easily above earnings. Elsewhere in the portfolio, software license revenue continued to grow by double digits, driven by SecOp Solutions and representing a mid- to high-teens percentage of total product revenue. Further, Fortinet just completed the acquisitions of cloud security firm Lacework and data security startup Next DLP, both of which are expected to bolster the firm’s SASE platform while materially contributing to billings and revenue growth going forward. Management guided for Q4 billings and revenue growth of 5% and 12%, respectively, while Wall Street expects earnings growth of around 20% the next couple of quarters.

Technical Analysis
After more than a year of being stuck in the proverbial meat grinder, FTNT changed character with a bullish earnings reaction in early August, as shares gapped to the high 70s in the weeks that followed and spent most of September and October in a tightening pattern while the rising 50-day line caught up. The kiss of that support line occurred right around Halloween, and the latest quarterly report brought the breakout. The weakness since then looks normal, so we’re OK entering around here with a stop in the low 80s.

Weekly Chart

Daily Chart

Stock 6

HealthEquity (HQY)

Why the Strength
Following his recent U.S. presidential election win, Donald Trump announced plans to make changes to the nation’s healthcare policy, including regulatory reductions and a potential undoing of parts of the Affordable Care Act. If implemented, these actions could lead to an expanded role for consumer-driven healthcare solutions like health savings accounts (HSAs, which are usually paired with cheaper high-deductible health plans), which explains the latest strength behind HealthEquity. With more than 16 million total accounts and over nine million HSAs, the Utah-based company is America’s leading non-bank HSA trustee, with a cloud-based platform that allows customers to lower monthly premiums and long-term payments, while further serving as a custodian of tax-free HSAs regardless of which financial institution the funds are deposited with. Also contributing to the recent show of strength was HealthEquity’s fiscal Q2 (ended July) report, which featured an eye-opening 23% year-on-year revenue increase, to $300 million. Earnings of 86 cents a share beat estimates by 16 cents, while adjusted EBITDA of $128 million increased 46%. The number of HSAs and HSA assets increased by 15% and 27%, respectively, driven by record first-half sales growth and the transition of the firm’s acquisition of Conduent’s BenefitWallet portfolio to the HealthEquity platform. (HealthEquity said BenefitWallet has greatly enhanced the opportunity for cross-selling benefits into next year, along with locking in strong custodial yields on those assets for years to come.) Moreover, the company said the top- and bottom-line momentum, plus margin expansion, will allow it to accelerate its platform investments and prompted it to raise guidance while also announcing a $300 million share repurchase authorization. Interest rate cuts will probably hurt interest income (on the float) here, but Wall Street sees a continued ramp in HSA demand with the new administration’s rules providing some tailwinds—analysts see calendar 2025 earnings up 20%, which should prove conservative. The next report is due December 9.

Technical Analysis
HQY has been mostly stuck in a range the past couple of years, with the 75 level (reached way back in 2022 as higher interest rates promised much higher interest income) essentially capping the stock, with forays above there in February and June of this year being rejected. But like so many names, HQY changed character after the August market low, with just two down weeks since then, including the big move to multi-year highs after the election. Shares look great, though we prefer to target near-term dips to enter.

Weekly Chart

Daily Chart

Stock 7

Jefferies (JEF)

Why the Strength
After a significant downturn in the last two years, M&A dealmaking has made a comeback in the first nine months of 2024—in Q3, global M&A activity increased by an impressive 29% from a year ago in terms of deal value, while deal volume grew by 13%. This is welcome news for investment banking and capital markets leader Jefferies, for which another major Wall Street bank recently assigned a “Buy” rating based on its advantage in financial sponsor-related M&A as well as a structural increase in its return profile. And with the incoming Trump administration’s expected pro-business climate likely to encourage even more deal-making activity, analysts are bullish on next year’s outlook for acquisitions (a big reason for the stock’s latest show of strength). Increased global M&A activity was a key reason for Jefferies’ strong showing so far this year, especially in Q3 (reported in September), with investment banking revenue booming to $949 million, up 47%, and within that business, advisory revenue of $592 million soared 76%, making it the best quarter on record for this segment—all of which contributed to total revenue of nearly $1.7 billion lifting 42%, with earnings of 72 cents increasing 227%. Other segments did just fine, too, including Capital Markets revenue of $671 million that was 28% higher due to stronger performance in equity volumes and more favorable trading opportunities, while Fixed Income revenue increased 13% from stronger results across the company’s credit trading businesses. Additionally, Jefferies closed on the sale of Italian wireless broadband provider OpNet in Q3, which furthered the firm’s goal of reducing its merchant banking business in order to focus on investment banking. (Management said it wants to build the “very best pure play global investment banking and capital markets firm.”) Looking ahead, the company said its investment banking pipeline is “strong” with momentum across all its business lines, and it sees falling rates and pent-up demand for driving advisory deal flow next year. Analysts see the bottom line surging in the 2025 with more likely in 2026.

Technical Analysis
JEF didn’t go anywhere from January 2023 to April 2024, but it began perking up from there and earnings in late June kicked the uptrend into high gear. Since then, the trend has been definitively up, with the occasional test of the 10-week line, the latest of which was seen a couple of weeks ago as shares pulled in near the election. The action since then has been outstanding, with an initial gap to new highs, further strength and very little giveback yet. Even so, given JEF’s character, it’s best to target getting in on weakness.

Weekly Chart

Daily Chart

Stock 8

Lumentum (LITE)

Why the Strength
Lumentum (covered in the September 30 issue) is a leading player in the laser-based photonic product market, as well as making other technology for optical networking and commercial customers. While its lasers are used in a broad array of applications ranging from precision manufacturing to biotechnology, data centers and telecom networks, photonics—which involves using lasers for data transmission, computing and sensing—is the biggest part of the growth story at this time. Like many companies with exposure to the artificial intelligence buildout, Lumentum has been focusing much of its recent efforts on growing its cloud and AI business; the company’s latest batch of products, including its series of high-speed datacom laser chips, which enable the growth of hyperscale data centers and 5G wireless applications, have benefited from record orders. In fiscal Q1 (ended September), Lumentum set a new record for datacom laser chip orders, including “substantial” 200G EML orders, reflecting “strong demand” from multiple customers (as well as securing a new hyperscale transceiver customer that placed its first volume order). Revenue of $337 million increased 6% from a year ago, reversing a multi-quarter stretch of shrinkage, and earnings of 18 cents beat estimates by six cents, which prompted the recent strength. The results prompted a major investment bank to up its target price for the stock owing to its recent string of optical transceiver customer wins (which it expects to start shipping in the first half of calendar 2025 and ramping through the year), as well as rising demand for externally modulated lasers (another reason for the strength). Lumentum further secured two new (unnamed) enterprise customers for its high-speed transceiver products, which the firm expects will significantly boost future revenue. Management guided for double-digit sequential revenue growth in fiscal Q2 based on expanding cloud demand and improving trends in the broader networking market. Further out, the top brass said the firm’s “robust” pipeline of cloud customers, combined with improving trends in the traditional networking market, reinforces its confidence in achieving its target of growing revenue to $500 million per quarter by the end of fiscal 2025. Analysts see the bottom line more than doubling from low levels both this fiscal year and next.

Technical Analysis
After peaking at 110 in early 2021, LITE entered a giant bear market that took it briefly under 40 in late 2022. But the stock started rounding out a bottom heading into this year while making multiple attempts at overcoming resistance at 60. A failed breakout attempt in July was followed by a big shakeout back to 40 in early August during the market’s brief implosion, but LITE turned the corner from there—the August quarterly report brought in a lot of buying, multi-year highs were reached in September, and after a dip to the 10-week line, it bolted to new highs after earnings. We took a quick profit a few weeks ago, but we like the recent gap and subsequent dip—we’re OK starting a position on this retreat.

Weekly Chart

Daily Chart

Stock 9

Norwegian Cruise Lines (NCLH)

Why the Strength
Norwegian Cruise Lines ($11.5 billion market cap) is smaller than Royal Caribbean ($62 billion) and Carnival ($28 billion), but it’s thriving thanks to the same trends of tight capacity, rising charter prices and a future outlook that continues to brighten despite doubts as to how long the boom can continue. Norwegian operates three different brands (its namesake makes up 85% of beds, with Oceania and Regent making up the rest), and they’re firing on all cylinders, with the latest quarterly report on Halloween showing 11% sales, 30% earnings and 24% EBITDA growth, with margins picking up (EBITDA margins are expected to come in at a whopping 35% this year, up 4.6 percentage points from 2023) and with bookings at the “upper range of an optimal booked position,” with Q3 bookings mostly for 2025 at this point. (Advanced ticket sales totaled $3.3 billion at the end of Q3, up 6% from last year’s already-record figures.) However, another big reason for the strength here is that the firm has embarked on an aggressive expansion campaign: From last year’s capacity of 22.7 million, the firm is targeting 6% growth annually through 2028 (including a 5% bump next year) and 4% through 2036 (longer-term plan); all told another 13 ships are likely to hit the water in the next few years, so if the industry remains in good shape, Norwegian should thrive. To be fair, the firm is relatively highly leveraged, partially because of that expansion phase—its debt is still 5.6x EBITDA, though that’s down 1.75x in the past nine months—but the focus by investors is on the growth potential. After a huge earnings pop this year, analysts see another 27% gain in 2025, but given that Norwegian has hiked estimates three times already this year, those are probably headed higher.

Technical Analysis
NCLH doesn’t get as much attention as some of the larger firms in the cruise industry, but its fundamental results have been just as good and now the stock is starting to discount it. After a huge base-building effort that started in July of last year, shares bottomed out with the market this August and turned up nicely in September, breaking out on good volume in October and getting an added boost after the election. The recent dip has been very reasonable—an entry here or on further dips would make sense.

Weekly Chart

Daily Chart

Stock 10

Shopify (SHOP) ★ Top Pick ★

Why the Strength
Shopify was a young upstart a few years ago, but today it’s one of the leading commerce platforms (mostly online but offline services, too; more on that below) out there for all sorts of businesses, though its core remains small and mid-sized operations, with a couple of million total merchants on the platform (many operating more than one storefront) that benefit from the firm’s well-rounded offering—from building an online store, shipping automation, marketing help with online and social media (including new AI tools), connecting catalogs to big players like Amazon and Target, managing finances and payments, accessing capital and much more, Shopify has become the offering of choice for entrepreneurs as well as many mid- and large-sized operations. Business did slow as the world turned right side up after the virus, but an expansion of partnerships, a move into AI-bolstered products (Shopify Magic generates product descriptions, images, FAQs, guides email response times and more) and an emphasis on newer areas (business-to-business sales, international, offline) has re-accelerated growth, which is the big reason the stock looks great today. In Q3, revenue growth of 26% was the fastest in a few quarters, while earnings shot ahead 167% and gross merchandise volume lifted 24%, but perhaps more encouraging were the countless sub-metrics, with the newer areas (merchandise volume up more than 30% internationally, up 27% offline, up 145% business-to-business and up 31% with Shopify Pay) looking great, while many big names continue to sign up (Reebok, Haynes, Joann Stores, Vera Bradley) and margins boomed. To be fair, nobody is expecting a return to triple-digit growth, but it looks like mid-20% top-line growth should continue, and earnings estimates are likely too low.

Technical Analysis
One of our old trading maxims is simply to never underestimate a very liquid, very well-sponsored stock when it gaps up huge on earnings—and that’s what SHOP did last week. The stock was actually one of the better-performing former leaders during the 2023 and early 2024 rally, but the correction starting in February was a doozy, pulling shares down as much as 47% into the August low. The recovery from there was excellent, though, with great progress higher and incredibly low selling volume when shares did exhale—and that was followed by last week’s moonshot on earnings (up 21% on 9.5x average volume). We’re OK starting a position here or on a bit more weakness with a loss limit in the mid-90s.

Weekly Chart

Daily Chart

Previously Recommended Stocks

The next Cabot Top Ten Trader issue will be published on November 25, 2024.

Copyright © 2024. All rights reserved. Copying or electronic transmission of this information without permission is a violation of copyright law. For the protection of our subscribers, copyright violations will result in immediate termination of all subscriptions without refund. Disclosures: Cabot Wealth Network exists to serve you, our readers. We derive 100% of our revenue, or close to it, from selling subscriptions to our publications. Neither Cabot Wealth Network nor our employees are compensated in any way by the companies whose stocks we recommend or providers of associated financial services. Employees of Cabot Wealth Network may own some of the stocks recommended by our advisory services. Disclaimer: Sources of information are believed to be reliable but they are not guaranteed to be complete or error-free. Recommendations, opinions or suggestions are given with the understanding that subscribers acting on information assume all risks involved. Buy/Sell Recommendations: are made in regular issues, updates, or alerts by email and on the private subscriber website. Subscribers agree to adhere to all terms and conditions which can be found on CabotWealth.com and are subject to change. Violations will result in termination of all subscriptions without refund in addition to any civil and criminal penalties available under the law.