In early September, we have seen a violent, significant and largely unprecedented shift in the investment landscape from momentum stocks to value stocks. Month-to-date, the iShares Momentum Factor ETF (BATS:MTUM) is down more than 1%, while the iShares Value Factor ETF (BATS:VLUE) is up more than 7%.
What’s happening under the hood? Long story short, investors were hyper-concerned about a recession in August. In response to rising recession fears, investors ditched economically sensitive value stocks that require a good economy to head higher, and piled into momentum growth stocks that don’t require a good economy to head higher (because they have such strong secular tailwinds).
In September, though, recession fears have backed off. The Federal Reserve has sounded as dovish as they’ve ever sounded. China and the U.S. have resumed trade talks. Long bond yields have moved higher. The curve has mostly un-inverted. In response to these easing recession fears, investors are unwinding their momentum trade. That is, they are booking profits on their momentum stocks, and buying the dip in value stocks, since these stocks should now move higher that the economic outlook is improving.
In other words, the September momentum-to-value shift is actually a vote of confidence in the economy from the equity markets.
The last time a momentum-to-value shift like this happened? Mid-2016, when the global economy was in the process of shaking off slowing growth headwinds.
What happens next? All stocks go higher — momentum stocks and value stocks. Broadly, the global economy isn’t going into a recession. On the contrary, conditions are improving. As conditions do improve, both value and momentum stocks will move higher over the next few quarters.
The implication right now? Selectively buy the dip in high quality momentum stocks. Which ones are on my shopping list? Let’s take a look.
YTD Gain Before Selloff: Almost 200%
% Off High: 15%
First up, we have e-commerce solutions provider Shopify (NYSE:SHOP), which — thanks to a near 200% gain from January to August 2019 — has been one of the most unstoppable stocks this year. But, as we all know, there is no such thing as an unstoppable stock. Indeed, SHOP stock has been stopped recently. Over the past few weeks, the stock has shed 15% as investors have booked profits on what has been an 800% rally over the past three years.
The “buy the dip” thesis on SHOP stock revolves around three things.
First, the fundamentals underlying Shopify stock remain rock solid — the company just reported (yet another) 50%-plus volume growth quarter with robust margin expansion, and the underlying decentralization and direct retail trends supporting the growth narrative remain vigorous. The only thing that has changed is the stock is now cheaper.
Second, this momentum trade unwind won’t last forever. It’s tough to see investors selling Shopify stock and buying Rite Aid (NYSE:RAD) stock for the foreseeable future. They won’t. This momentum-to-value shift is short lived, and is simply a reversion to the norm (momentum’s out-performance relative to value got over-extended in the summer). Once we do get back to the norm, investors will pile back into SHOP stock because this stock is supported by one of the most robust growth narratives in the market.
Third, excluding the late 2018 selloff, corrections in SHOP stock usually bottom out once they hit a 20% peak-to-trough decline. We are almost there today, so it looks like the worst of this sell-off is over.
YTD Gain Before Selloff: About 120%
% Off High: 24%
Next up, we have cloud security and access management company Okta (NASDAQ:OKTA). Through late July, OKTA stock was up a whopping 120% year-to-date. Ever since, though, the stock has come crashing down, and now trades in bear market territory, or more than 20% off recent highs.
Much like the selloff in SHOP stock, the August/September selloff in OKTA stock is a buying opportunity. The rationale? The fundamentals remain great and the optics are improving.
Big picture, Okta is a hyper-growth cloud player in the secular growth identity access management market, which is essentially an identity-centric approach to data security and management. This market is very big (around $10 billion in 2018), is growing very quickly thanks to widespread cloud adoption and the mainstream emergence of IoT devices (13% compounded annual growth rate projected into 2025), and Okta is rapidly gaining share in that market (roughly 1% share in 2015, to 4% share in 2018). Assuming Okta can continue to expand share in this market thanks to its exclusive focus on cloud IAM (comps in this space have many different verticals, of which IAM is just one), then Okta projects as a big revenue grower for a lot longer.
At the same time, gross margins are really high, and approaching 80%, while the opex rate is rapidly falling with revenue scale. This dynamic will persist for the foreseeable future, meaning Okta projects as big time profit grower for a lot longer, and that reality provides a favorable fundamental backdrop for OKTA stock.
Meanwhile, as mentioned earlier, the optics surrounding big growth momentum stocks should improve over the next few months. As those optics improve, they will converge on favorable fundamentals, and ultimately spark a nice rebound rally in OKTA stock.
YTD Gain Before Selloff: Over 120%
% Off High: 23%
Third on this list of momentum stocks to buy on the dip is programmatic advertising leader The Trade Desk (NASDAQ:TTD). Once up over 120% year-to-date, TTD stock has come crashing down over the past few years, and presently trades in bear market territory.
The next move in this stock will likely be higher for three big reasons. First, the fundamentals remain supportive of sustained long-term growth. Second, the optics surrounding TTD stock will improve going forward. Third, the stock is closing in on major technical support.
On the first point, The Trade Desk is the leader in the secular growth programmatic advertising market, which entails automating and optimizing the ad transaction process by using data and algorithms. As the global economy becomes increasingly automated and data-driven, so will the global advertising world, meaning that at scale, The Trade Desk’s programmatic ad platform will be a very important and relevant piece in the global ad machine.
Right now, less than a percent of global digital ad spend flows through The Trade Desk’s ecosystem. Thus, the runway for growth here is quite robust in the big picture.
On the second point, as mentioned earlier, the momentum-to-value shift won’t last forever. Once it ends — and it should end soon — momentum stocks will come back into favor, providing an upward lift for TTD stock.
On the third point, TTD stock is rapidly closing in on its 200-day moving average, which has — historically speaking — provided a significant level of support for the stock during selloffs. If TTD successfully tests and holds this support level, the next move here will almost assuredly be higher.
YTD Gain Before Selloff: Over 90% (from its IPO price)
% Off High: 20%
Another momentum stock that looks compelling on recent weakness is social media and digital ad platform Pinterest (NYSE:PINS). Pinterest went public in April 2019 at a price of $19 per share. By mid-August 2019, PINS stock had nearly doubled from its IPO price. Since, the stock has tumbled alongside other momentum names and presently trades 20% off those August highs.
The bull thesis on PINS stock goes something like this. Pinterest has always been a great company. They operate a unique and differentiated social media platform that is used for visual discovery and inspiration, and which importantly: 1) has very little use-case overlap with other social media platforms, and 2) is a perfect place for ads, since consumers are going to Pinterest looking for something. Consequently, as this company just starts to ramp up its ad business, the next few years should comprise very big growth since advertisers will love the unique attention they get through the Pinterest platform.
Despite all this greatness, PINS stock simply became too richly valued in August. It’s now sold off — to much more reasonably valued levels. As such, the fundamentals check out here, and imply that this selloff is a buying opportunity.
So do the optics, which — as mentioned before — should improve surrounding all momentum stocks over the next few months as this momentum-to-value shift stops. Net net, then, favorable fundamentals and optics should drive PINS stock higher from today’s lows.
YTD Gain Before Selloff: Over 30%
% Off High: 18%
Another cloud momentum stock that looks good on this dip is big data company Splunk (NASDAQ:SPLK). SPLK stock has been less hot this year than its momentum peers — at its peak, it was up just 30% year-to-date. But, this relative under-performance in 2019 has not shielded the stock from recent momentum stock weakness. At current levels, SPLK stock trades nearly 20% off recent highs.
Time to buy? I think so. Splunk is at the heart of arguably the biggest growth narrative in the market today — data-driven decision making. Broadly, everyone and their best friend are starting to understand that data is the future of everything, since it allows individuals and companies to make better, smarter and faster decisions. Consequently, enterprises everywhere are doing all they can to get their hands on data. But, what good is data if you can’t understand it, and glean actionable insights from it?
Insert Splunk. This is exactly what Splunk does. They help enterprises of all shapes and sizes turn their raw machine data into actionable insights. Consequently, as companies continue to pivot into data-driven decision making processes over the next several years, they will adopt and more heavily lean into Splunk’s services.
The long-term implication? Splunk’s revenue and profit growth trajectory will remain robust for a lot longer. As it does remain robust, SPLK stock will continue to move higher, meaning that recent weakness in the stock is nothing more than a long-term buying opportunity.
YTD Gain Before Selloff: About 60%
% Off High: 26%
One momentum stock that has been hit particularly hard over the past few weeks is digital education company Chegg (NASDAQ:CHGG). At one point, CHGG stock was up an impressive 60% year-to-date. That was back in late July and early August. Ever since, CHGG stock has come crashing down and presently trades more than 25% off those recent highs.
This big selloff is a compelling opportunity for three simple reasons.
First, nothing company-specific prompted this selloff. The last news we heard from Chegg was a double beat-and-raise Q2 print which shot the stock to all-time highs in late July. Ever since, we haven’t heard anything big — good or bad — from the company. Thus, CHGG stock has shed more than 25% on no news.
Second, the core fundamentals underlying CHGG stock remain very healthy. The company has created a connected learning platform that is rapidly becoming a necessary learning tool for high school and college students across America. Current growth rates are huge, with 25%-plus revenue growth last quarter and 30% subscriber growth. Margins are powering higher — gross margins were up nearly 500 basis points last quarter thanks to the software pivot. The opportunity remains large — only 3 million subs for Chegg, in a 36 million U.S. high school and college student market. Thus, broad strokes, the fundamentals underlying Chegg stock remain very good.
Third, the valuation is now attractive. In late July, this stock had a near 60-times forward earnings multiple. Today, that multiple stands narrowly above 30, which is below the application software sector average forward earnings multiple.
Net net, CHGG stock looks ready to bounce back. This selloff was largely unwarranted, the fundamentals remain good, and the valuation leaves room for multiple expansion powered upside.
YTD Gain Before Selloff: Over 35%
% Off High: 11%
Last, but not least, on this list of momentum stocks to buy on the dip is cloud giant Adobe (NASDAQ:ADBE). Adobe stock, which at one point was up more than 35% year-to-date, presently trades about 11% off recent highs. That matches the biggest drop ADBE stock has posted in 2019, and the second-biggest drop over the past three years.
In other words, with ADBE stock, you have a winning company in the midst of its second-biggest selloff in three years. That’s a compelling set-up to buy the dip.
Adobe is a very good company. This company dominates the visual cloud segment, with very little competition. That’s a great segment to dominate today. All content is becoming visual — think streaming TV services, or visual-first social media apps. We live in a world where consumers love to consume visual content, meaning we live in a world where enterprises, advertisers and creative professionals have to create visual content. When those entities create visual content, they do so with Adobe — and they’ve been creating more and more visual content than ever before, meaning adoption of Adobe’s services is growing rapidly.
Just look at Adobe’s numbers for proof of this. Revenue growth has been in the double-digit range for a long time, and will remain there for a lot longer, because secular visual consumption trends are far from being over. At the same time, Adobe can get away with price hikes and huge gross margins, because there’s hardly any competition in the space. Thus, this is a big margin, big growth company that will ultimately stay on a big profit growth trajectory for a lot longer.
What will that result in? A winning trajectory for ADBE stock in the long run. Thus, near-term weakness in ADBE stock is nothing more than a long-term buying opportunity.
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