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Growth Investor
Helping Investors Build Wealth Since 1970

Cabot Growth Investor 1396

The market’s evidence remains mostly bullish, so we do, too, but it’s a selective advance—most indexes are doing just OK, but growth-oriented stocks and sectors have put on a great show. In the near-term, there are signs of exuberance, and while that doesn’t mean you should sell your strong stocks, it is a sign to keep your feet on the ground.

In the Model Portfolio, most of our stocks are performing well, but we’re standing pat for the moment, holding about 20% in cash as we look for solid entry points in fresh leading stocks.

In tonight’s issue, we review the market, all of our stocks and even write about one growth sector that’s showing extreme power of late—we already own two of the leaders in the group, but many look great. We also touch on the sentiment backdrop, while highlighting a few potential new buys if things settle down a bit.

Cabot Growth Investor 1396

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Growth Stock Bonanza

Not much has changed over the past two weeks when it comes to the overall market. The intermediate- and longer-term trends are still pointed up, with growth-oriented indexes like the Nasdaq and S&P 600 SmallCap leading the way. On the other hand, many major indexes are mostly stuck in the mud, and the same goes for a bunch of stodgy sectors.

What has changed, though, is what’s going on under the surface: Growth stocks have gone vertical! In fact, this has probably been the strongest environment for growth stocks since 2013, with many sectors showing extreme power (check out page 6 for our view on retail stocks) and, encouragingly, a bunch of these names represent new leadership—it’s not just Netflix, Amazon and Nvidia leading the charge, in other words.

Thus, it’s been a great ride during the past month, but we’re not here to slap each other on the back. The question is what happens from here—is it best to dive into some of the market’s high flyers? Hold on? Pare back?

With our trend-following indicators positive and the buyers in control of most growth stocks, we’re obviously going to stay mostly bullish; we’re trend followers, after all. Plus, examining a ton of charts, we see that the vast majority of leaders have broken out of multi-month consolidations within the past four to five weeks; barring a total market collapse, it’s unusual for even shorter-term moves to roll over and die in that brief a time.

That said, there’s no question that the massive run-up in growth stocks of late has included some frothy action; a handful of recent IPOs, for instance, have more than doubled in the past month! And, more broadly speaking, some tried-and-true sentiment measures (like the put-call ratio; see page 7 for more) are telling us investors are complacent—something that often leads to some rocky trading.

That’s no reason to get defensive or start selling your best stocks, but it is a good idea to make sure you don’t lose your head. For our part, we’re still heavily invested in the Model Portfolio, but we’re also holding onto a 20% cash position as we look for low-risk entry points in some new leaders.

[highlight_box]WHAT TO DO NOW: Remain bullish, but pick your spots. In the Model Portfolio, where we’ve had a solid first half of the year (up 14% in 2018 coming into this week), we continue to hold nine stocks and a cash position of 20%, though we could be doing some new buying soon.[/highlight_box]

Model Portfolio Update

The past three weeks were fantastic for growth stocks, but with the advances came some jubilant sentiment, which, combined with the divergences in the market (most indexes are still range bound), had us holding onto our remaining cash.

That said, with our trend-following indicators still positive and most stocks in uptrends, our lack of buying recently is more about the difficulty of finding advantageous buy points than a general market call. So if we see good entry points emerge in the wake of this week’s downdraft, we could do some buying.

As for our current stocks, most are in good shape, but we’re watchful for signs of stalling out. Splunk and Proofpoint, while still fine, bear watching on that front. Overall, though, we think we own some early-stage leaders, so we’re content to give most names room to consolidate after good-sized recent rallies.

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Current Recommendations

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BUY—Alibaba (BABA 206)—BABA has been flopping around since our recommendation two weeks ago. First the stock got dinged after Altaba’s share exchange offering (which is open until July 11). Then, after bouncing back, this week BABA sagged following Google’s investment in Chinese e-commerce peer JD.com and as the U.S-China trade war heated up (the thought being that a larger trade scuffle would damage China’s economy, and hence hurt Alibaba’s growth). If the market cascades from here, all bets are off, but we don’t see BABA’s recent action as abnormal; so far it’s just gyrating on top of its prior multi-month range. Fundamentally, we concede that a knock-down-drag-out trade war wouldn’t be good, but of course, Alibaba’s growth trajectory is about a lot more than a point or two fluctuation in China’s GDP growth. Plus, not all the news is bad; reports indicate that China is likely to meaningfully increase tax deductions and boost consumers’ monthly allowance in a bid to spur consumer spending. Back to the stock, a drop into the low 190s would tell us BABA’s breakout has failed, causing us to cut our loss. But right here, we remain optimistic the stock’s next big move is up. We’ll stay on Buy.

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BUY—Five Below (FIVE 97)—FIVE has been consolidating in solid fashion since its monstrous earnings gap two weeks ago, hanging around the 100 level (give or take a few points). While the stock could easily correct and consolidate a while longer, this past earnings report likely represented a coming out party of sorts for the company, with institutional investors now thinking the firm’s growth has a long runway and is very dependable. Indeed, while Q2 will provide some tough year-over-year comparisons because of last year’s fidget spinner craze, same-store sales growth should pick up from there, and the fact that the company is opening up so many stores in existing markets (31 of the 33 it opened in Q1 were in markets that already had at least one location) is leading many to see Five Below’s long-term target of 2,500 stores as conservative. Analysts see earnings up 36% this year (boosted in part by corporate tax cuts) and another 20%-plus for years after that. More broadly, we’re encouraged to see many specialty retail stocks show explosive power on earnings recently (see page 6), a positive sign for the sector. Long story short, if you don’t own any, we’re OK buying some around here or on further weakness.

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BUY—Grubhub (GRUB 113)—GRUB joined the party last week, pushing to new highs near 120 before the market’s early-week dip yanked it lower. As we’ve written numerous times, the stock’s big October–March advance (more than doubling during that time) could mean GRUB needs more time to chop around (maybe the 200-day line, now above 81, needs to catch up a bit more), but we think the next big move is likely up, especially given its reasonable consolidation in recent months. The company has been quiet on the news front since announcing its partnership with Jack in the Box in early May; an update on the progress of that or the huge Yum! Brands partnership could keep buyers active. A drop back into the mid 100s might be a sign this breakout has failed, but given the evidence in front of us, we think new buyers can take a position here. As for the Model Portfolio, we have just a small position right now, but we could add a few more shares if the stock and market hold up and show further strength. For now, though, if you own some, just sit tight.

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BUY—Nutanix (NTNX 60)—NTNX burst to new highs last week, though like most growth stocks, it’s been reeled in a bit as the market has wobbled. The company presented at couple of conferences last Tuesday, and while there wasn’t much new to report, Nutanix’s report did a nice job showing how its various products (including some new ones) address many data center and cloud challenges; how its solutions are used by the top players in a slew of industries; and how its addressable market is many times the firm’s current size. Also encouraging—70% of bookings come from current customers, which goes hand in hand with the fact that new customers generally quadruple their initial purchase size within 18 months. We think Nutanix is the leader in the next big data center and IT technology (hyperconverged infrastructure), and if management continues to make the right moves, the company should grow many-fold in the years ahead. Sit tight.

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HOLD—Okta (OKTA 54)—OKTA is still trying to shake off the aftereffects of its wild earnings day reversal, which, because it came after a great run since February, had the look of a near-term top. Still, except in the most extreme cases, one bad day is often just one bad day, and the stock is still holding near its 25-day line, so it’s not like the bears are in control. All in all, we’re content to hold the stock down into the mid 40s (a bit below its rising 50-day line) before concluding shares are cooked. Fundamentally, we think all systems are go, as estimates for Okta’s revenues have been hiked since the report (36% growth this year and 31% next), and it’s likely that both of those will prove conservative. We’ll just play it by the book during the next couple of weeks—a drop below the 50-day line will probably have us moving on, while a push back into the upper 50s would be positive sign that the uptrend is resuming.

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BUY—PayPal (PYPL 86)—PayPal has been toying with its January high during the past few trading days, though it hasn’t decisively broken out yet. Even so, we’re still of the mind that the stock’s longer-term uptrend is resuming—hence our Buy rating. One factor that gets ignored when it comes to PayPal and potential competition is the firm’s huge stable of partnerships that continue to expand—in Q1, the firm inked deals with JP Morgan (certain members get more cash back when using PayPal with their credit cards), Bank of America (link credit cards to PayPal), Visa (merchants don’t have to ask for credit card info on follow-up transactions), Samsung Pay (integrated with PayPal), Grubhub and Seamless (both of which are now integrated with Venmo), creating an ever-greater moat in the payments industry. Another thing to consider: While PayPal’s take rate (how much of a cut it gets from each transaction) has been sliding, it’s not all from competition—in Q1, the take rate fell 19 basis points, but eight of that was currency fluctuations and another seven was the growth in its peer-to-peer platforms (like Venmo) that are just starting to be monetized. Bigger picture, we think PYPL has the combination of steady and reliable growth that big investors crave. We’re OK buying some here.

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HOLD—Proofpoint (PFPT 125)—PFPT remains in a tight basing phase, which is fine for now—as we’ve seen many times, growth stocks will often go dead and test people’s patience for weeks and months before resuming their major uptrend. FIVE was a classic example of this “dead money” scenario, doing nothing for five months before soaring on earnings; we’re not predicting such a huge move for Proofpoint, but we think it’s best to hold on as long as the stock hasn’t broken down and the fundamental story and growth are sound. All that said, there’s no question shares have been lagging most growth stocks, so we are going to nudge up our mental stop to the 113 to 114 range, below intermediate-term support. Above there, we advise holding on, while a move north of 129 would be highly bullish.

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BUY—Shake Shack (SHAK 69)—SHAK is one of many strong retail-related stocks that have shown exceptional power in recent months—in SHAK’s case, starting with its earnings reaction in early May and continuing through this week. The firm presented at the Jeffries Consumer Conference yesterday and confirmed that it’s on track for the current 2018 goals (revenues up 25% for the year, with the restaurant count rising from 159 to more than 210 by year-end), mentioned its longer-term international expansion through licensees (it sees a lot of openings all over Asia during the next three years) and touched on some menu expansions it’s experimenting with (the BBQ Cheddar & Bacon Cheeseburger looked particularly tasty). The stock is acting great, lifting to new highs this week even as most growth stocks have sagged. It’s a bit stretched to the upside (the 25-day line is down near 62), so try to buy on dips of a couple of points.

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BUY—Splunk (SPLK 116)—SPLK spiked to 118 in early May, soon after the market got going, but since then, the stock has had trouble continuing its advance, with resistance up to 120 and, last Friday, a good-sized distribution day after an analyst dropped his rating to Sell. It’s not ideal, but SPLK continues to find support every time it pulls in, with shares remaining just a few points from new closing highs. A break of 110 or so (just below the 50-day line) will probably have us booking partial profits, but we’re staying on Buy right here, not just because of the chart but because we think the overall uptrend of this well-sponsored stock (887 funds owned shares at the end of March, including many top-rated funds, up from 746 a year ago) has further to run.

Watch List

Dropbox (DBX 37): DBX is a new stock, but is one of the most-used cloud collaboration platforms in the world. The stock just broke out from an IPO base; see page 5 for more.

Ligand Pharmaceuticals (LGND 199): LGND is a bit thinly traded but we like the story, the growth potential and the stock’s recent pause following a powerful breakout thee weeks ago.

Spotify (SPOT 176): SPOT is another recent IPO we’re watching closely; it’s the leader in online music streaming. The stock hit new highs last week but has since backed off a bit.

Twilio (TWLO 60): We continue to love this story, but don’t see a great entry point yet. A knockout-type move into the lower 50s could do the trick.

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.

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Dropbox (DBX 37) — Dropbox’s business is simple: It lets businesses easily store, share and edit information. For as little as $12.50 per month per user, a business can get two terabytes of space and a host of management and security tools. With a freemium business model, the company boasts a roster of over 500 million Dropbox users (11.5 million are paying) and 300,000 teams using Dropbox Business, which is what powers the company’s steady revenue growth (28% in each of the two latest quarters) and free cash flow of $51.9 million in Q1. After its late-April IPO at 22, DBX traded sideways in an 11-week flat patch with support at 30. But when the rally came, the stock blasted higher in three days of high-volume trading, vaulting above 40. It’s still young, but if the stock calms down it could present an enticing entry point.

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Floor & Décor (FND 52) — Floor & Décor runs a string of 83 warehouse-style stores that stock a ton of flooring materials (far larger selection than its peers) and all the accessories. These warehouses average about 73,000 square feet, which makes them tough competitors in the flooring wars. The company has booked five straight years of over 30% revenue growth and more than nine years of comparable same store sales growth of over 15%. FND came public in April 2017 and had a sharp initial run, but since then it’s tried to break out twice (once in December of last year, and again in April of this year), but both attempts failed. Now it’s setting up again, and we think the third time could be the charm. There are probably some worries about higher interest rates affecting the housing market, but FND is much more than a cyclical play. A move to new highs would be bullish.

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SVB Financial (SIVB 318) — Since its founding in Silicon Valley 35 years ago, SVB Financial has been providing financing for startups and fast-growing companies in tech and other industries. In fact, SVB had a hand in 50% of the U.S. venture-capital-backed companies that came public in 2017. Rising interest rates, the corporate tax cuts and uptrends in many target sectors helped SVB grow its total assets by 15% in 2017 and the company’s revenue grew by over 30% in the Q4 2017 and Q1 2018, with earnings up 53% and 90%, respectively. SIVB gapped up big on April 27, but has meandered sideways in a tight range since then, making for a nice set up. The price is high, but you can just buy fewer shares.

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Tesla (TSLA 362) — Everybody has an opinion about Tesla, as Elon Musk has fervent supporters and detractors. And that’s probably a negative; we prefer stocks that aren’t so widely followed. But if you strip away all the babble, the stock’s future still comes down to production and orders, and on that front, investors are getting encouraged. Despite worries, production has been picking up and Musk is aiming for a rate of 3,000 Model 3s per week going forward—indeed, analysts see revenues surging 67% this year and 41% in 2019. TSLA has a huge shakeout in April, but immediately snapped back on giant volume. And now, after a bottoming phase, the buyers are getting active. Following a few choppy years, it’s worth watching to see if a lower-risk buy point emerges in TSLA.

Earnings Gaps Galore in Retail

If you’ve been reading us for a while, you know that one of our favorite technical patterns, one that produces high-probability, high-potential trades, comes when a stock etches a multi-month consolidation and then gaps out of that launching pad on heavy volume. The best moves tend to have volume of at least five times average on the gap, though it can vary based on the liquidity of the stock.

Such powerful breakouts aren’t too uncommon during a bull market; we usually spot a handful of them every earnings season, in fact. But what’s unusual now is that we’re seeing a ton of them in one sector—specialty retail—and nearly all of these companies sport excellent sales and earnings growth, with big earnings potential going forward.

In the Model Portfolio, both of our retail-related stocks look like leaders. Five Below (FIVE) is one of our big winners, thanks in large part to its monstrous earnings gap (six times average volume), which came on the heels of a five-month rest period. And Shake Shack (SHAK), a newer addition, soared in early May on nearly nine times its average volume, which was a big reason we bought in.

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Those are our two favorites, but they’re by no means the only stocks to consider in retail. RH Inc. (RH), formerly known as Restoration Hardware, is more of a special situation—the business isn’t growing fast, but the share count has been cut by a third and costs are being wrung out of the business, which is leading to giant earnings and free cash flow (which could total more than $10 per share this year!). The stock etched a six-month, 32%-deep base before exploding higher on 14 times average volume!

Also last week, we saw Canada Goose (GOOS) surge on earnings. The company has the makings of another high-end retail winner, with a top-notch brand that is still scratching the surface of its potential, especially as the company moves from solely winter outfits to springwear and knitwear. Sales (up 153%!) and earnings crushed expectations, and management reiterated a bullish three-year outlook (at least 20% sales and 25% earnings growth annually). You can see the reaction—GOOS went bananas last Friday, rising 33% on 20 times average volume, continuing its base breakout from mid-May.

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Clearly, all of these stocks could rest and pull back for a while, especially if the market hits a pothole. But we’re intrigued by the action, not only because of the recent action (big launching pads and massive gaps higher), but because many of these stocks appear to be in the early-to-middle innings of their upmoves, with their original breakouts in the past few weeks or months.

The same can be said for the retail sector as a whole, which mostly sat out the dance in 2017 and has been correcting and consolidating with the overall market for much of this year. It certainly looks like the group and many of its fastest-growing stocks have the wind at their backs.
Some Signs of Giddiness

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In the Nasdaq, where small caps and growth stocks have gone vertical in recent weeks, we’re beginning to see a few extremes in sentiment. One example is the 15-day equity put-call ratio, which has slid to its most complacent level since January (near the market top). Before that, you have to go back to 2014 to find readings this low. And if you look only at the smallest options trades (10 contracts or less), you see the most enthusiasm since 2009! That’s a big reason why we’ve held onto a 20% cash position during the past couple of weeks.

Of course, as we always write, sentiment is a very inexact timing tool. Even if every sentiment measure were flashing red, that would be no reason to turn bearish—trends often go to extremes, so there’s no telling when a powerful uptrend (or downtrend) will eventually end.

Plus, not every sentiment measure is flashing red. Money flows into all equity funds and ETFs during the past month have actually been negative, and the 10-day average of assets in the Rydex leveraged bull funds (shown here), while elevated, isn’t close to its December/January peak. So it’s hard to say the average Joe is piling into stocks.

All told, we wouldn’t pare back because of the recent sentiment readings. But they are a reminder to keep your feet on the ground—remember to honor your stops, look for good entry points and confine yourself to the market’s leading stocks.

Cabot Market Timing Indicators

The bull market remains in fine shape, though it all depends what you own—leading growth stocks are doing great, while much of the rest of the market is just OK. These divergences (and elevated sentiment) bear watching, but with most of the evidence bullish, we remain heavily invested.

Cabot Trend Lines: Bullish

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It’s the same old, same old with our Cabot Trend Lines, with the key long-term timing indicator remaining bullish. Last week, the S&P 500 and Nasdaq closed 3.4% and 8.5% above their respective 35-week moving averages, a clear sign the market’s major trend is still up. Some correction and consolidation could easily occur going forward, but barring a meltdown, it wouldn’t affect the overall bullish trend.


Cabot Tides: Bullish

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Our Cabot Tides also remain positive, with four of the five indexes we track above their lower (50-day) moving averages even after this week’s retreat. (The NYSE Composite is the hold out.) The strongest index of the bunch is still the S&P 600 SmallCap, which has been in a persistent uptrend since the beginning of May. With both the intermediate- and longer-term trends pointed up, you should stay mostly bullish.

Two-Second Indicator: Unhealthy

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The Two-Second Indicator was showing some improvement last week, with four straight days of fewer than 40 new lows. But the recent weakness in the Dow and NYSE Composite has caused the readings to balloon again, indicating that the broad market isn’t in great health. That’s not a death knell, but it’s better when most stocks and sectors are rowing in the same direction.

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Send questions or comments to mike@cabotwealth.com.
Cabot Growth Investor • 176 North Street, Post Office Box 2049, Salem, MA 01970 • www.cabotwealth.com

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 JULY 3, 2018

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