In this Month’s Issue of Cabot Early Opportunities I discuss one simple way to measure how much a given stock will move relative to the market. I also feature five stocks, from quite small to larger than we normally go. All have something different going for them. We are tilted toward software names this month, though I round things out with another solar name and an emerging biotech opportunity.
Cabot Early Opportunities 106
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How Volatile Is My Stock?
One of the characteristics of early-stage stocks that takes some getting used to is their tendency to move around a lot more than the broad market. I suspect you’ve already noticed this with many of the stocks featured in Cabot Early Opportunities.
This makes sense intuitively because these stocks tend to have higher return potential than the S&P 500, so they’ll move further, faster. Investors must accept more volatility to compensate for the greater upside potential.
But it can still be a little nerve-racking to watch your stocks swing around.
The good news is there is a simple way to gauge how much you can expect most stocks (but not all; more on this in a minute) to move around before you buy. Just look at a stock’s beta.
Beta measures how closely a stock is correlated with the market. A beta of 1.0 means it tends to move the same amount as the broad market (the S&P 500) while a beta over 1.0 means it tends to move more. A beta less than 1.0 means the stock tends to be less volatile than the market.
Beta gives you some indication of what to expect. But it can also give you some sense of how much more, or less, a stock tends to move than the broad market.
Specifically, a stock’s degree of relative movement is measured by the difference between its beta and 1.0. For instance, a beta of 1.2 implies a stock has moved 20% more (either up or down) than the broad market over the last year (assuming that’s the period over which the beta was calculated).
For many stocks it is easy to find the beta through your broker, or an online financial website. But in some cases, such as with newly public stocks with shorter trading histories, you won’t find a beta listed. That’s because many data providers require 12 months of trading history.
That’s annoying, especially because the only way to calculate the beta in those cases is to download closing prices for both the stock and the index you’re comparing it to (over the desired time period), and then complete the calculations.
Most of us don’t have the time or patience to do that, so here’s what I suggest: expect that a newly public stock is going to be a heck of a lot more volatile than the broad market! That’s just the reality. It doesn’t necessarily mean the stock is good or bad. It’s more like there’s just a breaking-in period.
In most other cases you can find a beta. For instance, I just pulled a beta of 1.72 for Digital Turbine (APPS), 1.57 for Smartsheet (SMAR), 1.64 for Deciphera Pharmaceuticals (DCPH) and 1.40 for Five9 (FIVN). Clearly, all of these stocks have moved a lot more than the S&P 500 over the last year.
But I do try to find stocks that are less volatile than the broad market yet can still outperform. Some examples: Freshpet (FRPT) has a beta of 0.92, Survey Monkey (SVMK) has a beta of 0.87 and ModelN (MODN) has a beta of 0.99.
To be clear, I’m not saying beta is everything, or that you should or shouldn’t buy a stock based on it. I’m simply saying that beta is worth checking out, along with a stock’s fundamentals and chart, as you consider whether it is right for you. Finally, keep in mind that beta is a historical measure and that it will change over time depending on how the stock acts relative to the broad market.
What to Do Now
Be conservative on the buy side and trim positions that you’ve purchased recently but don’t have the conviction to hold through any market turbulence. This is standard operating procedure during (or after) a recent surge in a longer-term bull market.
We’ve seen the market rip higher in 2020, even in the face of many events that had the potential to trip it up. So far, it’s been resilient and that’s helped a lot of stocks move higher. But it won’t last forever!
I’m not predicting a pullback or a crash or anything like that. I’m just trying to pull in any investors that think we can only go higher because that’s what we’ve been doing. Remember that the market moves in cycles. Stepping back to a 10,000-foot view, while I’m bullish on the market in 2020, we should be cautious in the short-term.
As always, when buying (and selling), I tend to favor incremental moves rather than all-or-nothing moves. That means averaging in, and out.
Today’s issue features five stocks from quite small to larger than we normally go. All have something different going for them, but we are tilted toward software names this month.
Specifically, we’re stepping into a big name, Slack (WORK), that has a lot of potential but has done poorly (until just recently) since going public. We also have a recent IPO in Sprout Social (SPT), and a security stock, Varonis (VRNS), that’s our Top Pick and is on the backside of a transition to the SaaS business model. We round out the Issue with a solar company, Sunnova (NOVA), and an emerging biotech stock, Y-mAbs Therapeutics (YMAB).
STOCKS
Slack (WORK)
There have been many attempts by software companies over the years to come up with a replacement for email that allows teams of workers to collaborate better. Slack (WORK), which has a market cap of $15.2 billion, was the first to come up with a solution that comes close.
The company’s collaboration software uses “channels” to keep conversations separate, allowing everything related to a project, topic or team to be organized and searchable. Teams can work with members outside of their organization too, and people can come and go from conversations as they please, even using threads to keep side conversations from derailing the main topic or project at hand. It’s incredibly easy to share pictures and videos too.
The best evidence of how successful Slack has been in creating a viable alternative to email is how ubiquitous it’s become since the company was founded in 2009. It’s hard to find a company that hasn’t at least dabbled in it. Part of that is because pricing plans start free for small teams and go up from there, with the largest customers paying over $1 million a year.
The company currently has over 12 million daily active users across 150 countries. As of the end of October 2019 ,Slack had 105,000 paying customers (up 30%), including 821 that are paying more than $100,000 a year (up 67%). Customers paying over $100K accounted for 45% of revenue in the most recent quarter.
Slack also has 53 customers paying more than $1 million a year, 70% of which are Microsoft Office365 customers. Analysts see that as compelling evidence that Slack truly is different from email (and Microsoft Teams, which is free for Office365 users). The trends imply that even though revenue was up 110% in 2018 and 82% in 2019 Slack has a ton of room to grow in what’s estimated as a $30 billion collaboration software market.
Despite the growth and potential, there are bears out there that see other products, such as Teams, creating a major growth obstacle. But it’s hard to predict a company’s downfall when it’s still doing very well. Analysts see Q4 revenue up 43% when results come out on March 12, and full-year revenue up 55%, to $622 million. Annual growth should be comfortably above 30% through 2022 too, though first profits aren’t likely until after that.
The Stock
WORK came public at 26 via direct listing in June 2019 and immediately shot up by 49%. That was the top. From there WORK slid all the way back down to 20 by late October, then bounced around between 19.5 and 24 through early February. WORK shot nearly 15% higher on February 10 and has been strong since, suggesting bulls may be coming back to the table.
Sprout Social (SPT)
There are nearly 3.5 billion people and roughly 90 million businesses around the world communicating over social media. Businesses are using social media for just about everything under the sun, not just in marketing departments, but in in sales, product development, customer service and even thought leadership & strategy.
Deciphering, filtering and managing all the incoming social media content across different channels represents a huge amount of work for businesses. But they need to do it in order to glean effective insights from the treasure trove of data. This is where Sprout Social (SPT) comes in. The company has developed a social media management platform that helps businesses reach their audience, engage their community and measure their performance.
This industry is in its early days, so analysts aren’t entirely sure how big the global market is. Some think it could be up to $30 billion a year (roughly $15 million in the U.S.). A more conservative estimate that strips out smaller businesses with less than five employees pegs the market closer to $10 billion. Even in that case, Sprout Social, with estimated revenue of $100 million in 2019, has only captured 1%. That means a lot of room left to grow.
To pursue the opportunity, Sprout Social has created a powerful and exceptionally easy-to-use software platform that most people can use with just a couple hours of training. It works across major social channels, including Twitter, Facebook, Instagram, Pinterest, LinkedIn, Google and YouTube. The company has around 23,000 customers.
Most customers (90%) start with a free version (which reduces friction in the early days and translates to low-marketing expense) then upgrade to more sophisticated premium modules as they gain familiarity with Sprout. These modules, which were rolled out in 2018 and 2019, include Listening, Premium Analytics and Reputation.
The company, which just came public on December 13, 2019 and has a market cap of $995 million, will report its first quarter (Q4 2019) as a public company on February 26. Analysts expect Q4 revenue to grow by 22% to $27.3 million, and 2019 revenue to be up 27% to $100 million. But with the new modules, a small revenue base, and so little time as a public company, there’s a good chance analyst estimates will be off by at least a little. Sprout Social isn’t expected to be profitable for several years.
The Stock
SPT came public on December 13 at 17 and dropped 5% on the first day. It retreated to 16 by the end of the year then climbed in January, eventually peaking at 21.72 on February 4. The stock fell back into the high teens a couple weeks ago, then advanced to 21 last week. This stock is going to continue to be volatile given how recent the IPO was, and because lockup expiration has not yet passed.
Sunnova (NOVA)
On January 29 the Energy Information Administration (EIA) published its Annual Energy Outlook 2020 report. Among the many bullish themes for alternative energy stocks were several specific to solar, which is seen growing from 13% of the renewable energy mix today to 46% by 2050. The EIA also sees a big jump in customer-owned rooftop solar, which it sees growing from less than 1% of total electricity generation today to over 3.5% by 2050.
If those trends sound encouraging to you then Sunnova (NOVA) should pique your interest as well. The $1.4 billion market cap company specializes in residential solar and battery storage systems. It is directly beneficiary of the trends the EIA sees accelerating over the next three decades.
Sunnova was founded in 2012 in Houston, Texas and came public in July 2019. Its services are offered in 20 states, though new locations are being added every year. In addition to offering solar panels and battery storage (available only in some locations), Sunnova can even install a new roof (currently in California and New Jersey only). The company is differentiated by its regional dealer and installer network, which allows for custom-tailored projects and permits the selling of long-term service plans.
Internally, the trends are bullish. In Q3 2019 (reported October 31) management reported that it had doubled the total number of dealers over the last 12 months, to 136. It also reported almost 73,000 customers, an increase of 48% over the comparable quarter in 2018, and that 15% of customers were including SunSafe battery storage in their projects, up from 11% in the previous quarter.
Revenue in Q3 was up 20% to $36.6 million while adjusted EPS loss was -$0.34. The company ended the quarter with $1.74 billion of gross contract value (using the standard industry discount rate of 6%), an increase of 26% over Q3 2018. Those contracts will provide stability for over two decades; in Q3 loan principal and interest (Loan P&I) payments totaled $7.5 million.
Looking forward, analysts see Q4 2019 revenue up 23%. In 2020, management has guided for customer growth of roughly 32% and Loan P&I payments of roughly $30 million. That should help push total revenue up by 20%, to $159 million. As a purchaser and installer of long-lived equipment Sunnova does finance part of its installations and equipment with debt. To that end it recently raised $150 million through debt and convertible senior notes, implying the company will end 2019 with around $1.37 billion in long-term debt.
The Stock
NOVA went public on July 25, 2019 at 12. The IPO landed with a thud. Shares mostly traded below the IPO price through 2019, then began to rise after management raised debt and said the business was accelerating in late December. Following lockup expiration on January 21, NOVA broke out to fresh highs. It’s been running higher since and currently trades near all-time highs. Given the recent run it is particularly important to average into NOVA. I suggest starting with no more than a half-sized position.
Varonis Systems (VRNS)
Varonis Systems (VRNS) was founded in 2004, went public in 2014 and currently has a market cap of $2.8 billion. It is a stock with two stories. The first is about the company, which has developed a unique data security software platform that helps companies visualize, analyze, optimize and protect human generated, unstructured data, including email, documents, spreadsheets, etc.
The software pulls metadata from enterprise IT infrastructure and maps out relationships among employees, data objects, content and usage. It is then able to flag abnormal behavior and take steps to protect data from bad actors. Varonis is a beneficiary of the EU General Data Protection Regulation (GDPR), which became law in May 2018 and is changing the landscape of regulated data protection across the world.
The second story is about the transition from a perpetual to a subscription license (SaaS) business model, which Varonis announced in late 2018. This means Varonis no longer sells perpetual licenses with big upfront costs, and instead sells lower-cost subscriptions that are billed monthly or annually. Varonis switched because it was selling two dozen different software licenses, which made life difficult for everyone both inside and outside of the company.
The SaaS business model streamlines sales, operations and R&D processes, while making it easier for customers to purchase larger software packages. But it does mean a transition period during which revenue from existing customers takes a hit. That is why revenue was down 6%, to $254 million, in 2019.
But the big-picture story is much more attractive now. In Q4 2019 (reported February 10) management said that, while revenue was down 17% and the company lost $0.09 per share, customers are purchasing more modules than ever, in part because of the subscription model. Annual recurring revenue (ARR) was up 62% and customers now average four to five licenses, versus two to three historically.
Management now sees 90% of revenue coming from subscriptions in 2020, meaning the transition is nearing completion. That translates into guidance for 13% to 15% revenue growth this year (to $286 million to $292 million), though analysts see closer to 17% growth.
Looking out to 2021 and 2022, when the transition is complete, Varonis should be growing closer to 31% and 25%, respectively. The company will still lose money this year (adjusted EPS loss of -$0.89 is expected) but should be able to turn an adjusted EPS profit of $0.17 in 2021 and $1.26 in 2022.
This is one of those stories that is likely misunderstood by many Main Street investors who don’t look past the drop in revenue in 2019. Don’t be fooled! It’s a good stock and a good story that should deliver in 2020.
The Stock
VRNS went public in February 2014 at 22 and doubled on its first day, then shares retreated and were mired in the mud for several quarters. They turned north in mid-2016 and by June 2018 VRNS were trading just north of 80. Another correction sent the stock just below 50 early in 2019. There was no clear trend last year, when VRNS oscillated mostly between 57 and 75. The breakout came in October 2019 after Q3 earnings came out, and shares advanced steadily into the Q4 report in February, after which they have remained near all-time highs.
Y-mAbs Therapeutics (YMAB)
Y-mAbs Therapeutics is a clinical-stage biopharmaceutical company that’s developing novel, antibody-based therapeutic products to treat cancer. The company currently has a late-stage pipeline focused on addressing high unmet needs in pediatric cancers. The company was founded in 2015, went public in September 2018, and has a market cap of $1.3 billion.
The two lead drug candidates are naxitamab and omburtamab, which target tumors that express GD2 and B7-H3, respectively. Naxitamab is in a Phase 2 pivotal trial for relapsed/refractory high-risk neuroblastoma. It has been granted Orphan Drug Designation, FDA Breakthrough Therapy Designation and Rare Pediatric Disease Designation. Omburtamab is in a Phase 2 pivotal trial for central nervous system metastases from neuroblastoma.
There are no approved therapies for these indications beyond chemotherapy, radiation and/or surgery, which are often ineffective and leave few second-line options. With accelerated approval pathways for both drug candidates things are advancing quickly; potential U.S. approval could come in 2020 (PDUFA for both are expected in October).
So far, the data looks good. In earlier trials naxitamab showed objective response rates above 70% (well above the 30% threshold required by the FDA) and omburtamab showed a median survival of roughly 51 months, a vast improvement over the five- to 10-month median survival rate for untreated patients.
These lead candidates could target expanded indications down the road too. Omburtamab is being developed for the treatment of Diffuse Intrinsic Pontine Glioma (DIPG) and Desmoplastic Small Round Cell Tumors (DSRCT), while naxitamab’s potential is being explored in front-line high-risk neuroblastoma and relapsed osteosarcoma. Y-mAbs has other early-stage assets as well, including a humanized bispecific GD2 antibody and a GD2-GD3 vaccine.
There’s little doubt Y-mAbs is going after relatively small markets, at least initially. Estimated peak sales for naxitamab and omburtamab is roughly $700 million. However, approvals in the most advanced trials would raise the probability of expanded indications, not to mention the chances of success in the early-stage pipeline.
Assuming all goes to plan we could see revenue begin to trickle in this year then ramp up to $120 million or so by the end of 2023. Profitability is further out, possibly in 2025. Equity offerings (for $140 million to $250 million) to fund development are all but guaranteed in 2020 and 2021. Management just raised $144 million in November 2019, which translated to a roughly $98 million cash balance as of the end of Q3 2019.
As with any early-stage stock, and especially with clinical-stage biotech stocks where the future hangs on approvals and there are so many unknowns, please average in!
The Stock
YMAB went public at 16 in September 2018 and shot up 50% on the first day. Aside from one nasty pullback to 15 in December of that year, YMAB then traded mostly between 20 and 30 for its first 12 months. But late last year, the stock began to establish a pattern of higher highs and higher lows, albeit while still trading in a wide range. The three most recent highs were followed by pullbacks of 24%, 15% and 13%. With shares roughly 10% off the most recent high of 36.29, and potential positive catalysts this year, this looks like a good time to establish a position.
Previously Recommended Stocks
Below you’ll find previously recommended Cabot Early Opportunities stocks. Stocks rated BUY are suitable for purchasing now. In all cases, and especially recent IPOs, I suggest averaging into every stock to spread out your cost basis.
Those rated HOLD are stocks that still look good and are recommended to be kept in a long-term oriented portfolio. Or they’ve pulled back a little and are under consideration for being dropped.
Stocks rated DROPPED didn’t pan out, or the uptrend has run its course for the time being. They should be sold if you own them. DROPPED stocks are listed in one monthly Issue, then they fall off the DROPPED list and into oblivion.
Please use this list to keep up with my latest thinking, and don’t hesitate to call or email with any questions.
Since the January Issue, via Special Bulletins, I moved 10x Genomics (TXG), Digital Turbine (APPS), Frontdoor (FTDR), Lemaitre Vascular (LMAT) and Lightspeed POS (LSPD.TO) to hold. No additional stocks are being moved to hold today.
We also sold Cryoport (CYRX) for a roughly 26% gain on January 29 and that position is shown in the DROPPED list. No stocks are being DROPPED today.
The next Cabot Early Opportunities issue will be published on March 18, 2020.
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