Cabot’s “Almost Perfect Stock”

What's Cabot Growth Investor hinting at as the "the perfect stock in these times of social distancing, working from home, telemedicine, and remote learning?"

By Travis Johnson, Stock Gumshoe, October 21, 2020

Today I thought I’d take a quick look at the “you must add it to your holdings now” pitch from Cabot Growth Investor ($497/yr) — the ad is worded quite similarly to past ads saying that they expect a “double in the next 12 months” from these folks, some of which have worked out well (including Teladoc (TDOC), which was a big teaser push from them in the months before the pandemic hit the US, a solid growth stock tied to some very fortunate timing, and before that, Five Below (FIVE) in 2017, which also presaged a strong run).

So will this next one be a big winner? Let’s see if we can ID it for you, then you can make your own judgement… without the pressure of $497 weighing on one side of your mental scales. Here’s how Mike Cintolo gets us revved up about this secret stock:

“We all know there are no perfect stocks—especially now with the Covid-19 crisis turning Wall Street and our lives upside down.

“But if there was one that was almost perfect, this is it.”

And since one of the thing most of the Cabot newsletters look for is strong past performance, it’s no surprise that this stock has already done well in 2020… some clues:

“128% gains year to date — all thanks to 47% revenue growth.”

OK, so it’s some kind of “pandemic winner” we’re dealing with here, no doubt — probably a technology stock benefitting from work/play from home trends. What else?

“… the only flaw I can see in this stock is that few investors know about it. Yet, it is making money hand over fist behind the scenes and it has been for years.”

OK, so it’s not a brand-new startup, and it’s “making money” — maybe that means it’s profitable? Let’s see what else Cintolo drops in the way of hints…

“It’s the perfect stock in these times of social distancing, working from home, telemedicine, and remote learning. That’s because it provides the technology and software to to keep your company’s internet infrastructure up and running.”

OK, so there you go — some kind of web infrastructure or networking technology stock. This is what the ad says they do:

“… ensuring the reliability of company websites, APIs, and applications… and protecting internal resources such as behind-the-firewall applications, teams, and devices.”

What else?

“Shares are up more than 111% from the company’s $15 IPO price”


“With companies shifting operations online, this can only spell even greater profits as demand for its 5G edge-computing services continues to grow.”

And Mike Cintolo’s projection:

“If you can get in at today’s low prices, you could easily see your money jump another 40% after they announce next quarter’s earnings and then double again over the next two years.

“Hold longer term—five to 10 years—and you could easily see a $10,000 investment grow well into $100,000.”

The ad includes a chart of the institutional holders of the stock, but that doesn’t turn out to be terribly helpful — mostly because they apparently used the wrong image, what they included were the top institutional holders of Teladoc from late 2019, not the current holdings in whatever this new “secret” company might be. We’ll be charitable and assume it’s an editing error, not an effort to throw your friendly neighborhood Gumshoe off the scent.

So who might this be, dear friends? Well, thankfully Cabit includes a chart in the pitch, so we can use that for our confirmation — and after tossing the rest of the clues into the Thinkolator’s hopper and setting it to “pulse” for a few minutes, the answer that came out was easily confirmed… this is our old friend Cloudflare (NET).

The chart they use when pitching those 128% gains ends in August, sadly, so it fails to account for the fact that the stock had another strong run after that — perhaps that means Cabot Growth Investor recommended this stock in late August or September and they’re just turning that slightly dated newsletter recommendation into an ad pitch, that kind of thing is fairly common… but either way, yes, this is the edge computing and cybersecurity stock Cloudflare. And yes, I’ve covered it a few times — and after digging into it when I was working on solving a RiskHedge teaser back in May, I started buying it myself.

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How do we match those clues? Well, Cloudflare has posted 47% revenue growth for each of the past two quarters, and as of August, which is when the chart that they shows in the ad ends, the stock was up 128% on the year (and up 111% from the IPO, which was priced at $15 a share and came just a little over a year ago, in September of 2019). They are not yet making a profit, but analysts think they’re pretty close.

And I mentioned that Cloudflare had surged higher still after August — what’s up with that?

Well, it seems mostly to have been driven by the launch of what they’re calling “Cloudflare One” on October 12 — they say this
“new platform uses a Zero Trust security model to provide an easy and reliable way for companies of all sizes to protect the devices, data, and applications they rely on.” So that seems timely, no?

Cloudflare is a company I was probably pre-wired to buy once I looked into it, because they actually saved from a DDoS attack that followed a critical article I wrote about a penny stock promoter almost ten years ago — at the time, Cloudflare’s product was only about a year old, and their emergency support seemed like a really expensive solution for our little company… but it was worth it, it worked, and I certainly thought fondly of them as I wrote the check. They do a lot more than just caching and DDoS mitigation these days, but that was one of their specialties in those early days, and they did it well. The company has some overlap with companies like Fastly (FSLY) in edge computing, and Zscaler (ZS) or Crowdstrike (CRWD) in cybersecurity and attack mitigation, just to name a couple other hot growth “stories” … and they trade at a pretty similar valuation to those three right now, in the ~40X sales neighborhood.

Here’s how they describe themselves today:

“Cloudflare, Inc. is on a mission to help build a better Internet. We have built a global cloud platform that delivers a broad range of network services to businesses of all sizes around the world—making them more secure, enhancing the performance of their business-critical applications, and eliminating the cost and complexity of managing and integrating individual network hardware. Today, approximately 16% of the Fortune 1,000 are paying Cloudflare customers.”

Analysts have had only a week or so to react to that “Cloudflare One” announcement, and I haven’t seen any meaningful upgrades — probably because they’ll be reporting their next quarter in a couple weeks (November 5), and analysts will want to wait until some guidance is issued before they leap to any conclusions about the impact this might have on growth. The stock did come down slightly last week because of the Fastly news, or maybe just because of profit-taking after the big 50%+ surge the previous week — Fastly pre-announced that their third quarter would miss their forecasts because of weaker-than-expected revenue from TikTok and a couple other significant customers, so FSLY fell by 30% or so, and NET has now dropped to roughly 10% below their all-time-highs (of a week ago).

I still like and own both of these companies, though I bought a larger Fastly position when I was first looking at them early this year — mostly because they were a bit smaller and cheaper and growing faster than Cloudflare (that’s still arguably true, though the difference is smaller now). The way I read it, Fastly is arguably more nimble and focused on flexibility and appealing to developers and fueling startups, with slightly better revenue growth… Cloudflare is larger and more expensive, with a more diversified product offering and somewhat more stable customer base — and when it comes to the big buyers who really drive revenue, Cloudflare has about twice as many “enterprise customers” as Fastly (those who spend more than $100,000/yr).

So it’s a great company, it has thus far been a great investment… and it’s expensive. Right now, Cloudflare analysts expect them to almost double revenues again between now and 2022, meaning that they’re in the middle of a three-year period of about 35% average annual revenue growth, and they trade at about 24X the revenues that analysts expect in 2022. That kind of valuation is fairly common for rapidly growing “cloud” and software stocks right now, but it was almost unheard of before this year (except for a few ugly months in the year 2000, when dot-com mania was ruling the land)… maybe it will turn out to be justified, the growth is exceptional and these businesses have the potential for extraordinary scalability, so there is room for some optimism (if Cloudflare gets to its targeted operating margins of 20% in a few years, and keep up the growth rate to hit a billion in sales by, say, 2024, it’s possible that they’re now trading at “only” ~80X 2024 earnings).

Personally, with these kinds of companies I find I have to nibble slowly even if I really like the long-term prospects, since I can’t stomach a big commitment to a stock at 40X revenues. The company is growing fast, and that means they can certainly “grow into” this valuation, a revenue growth rate of ~50% covers a lot of “paid too much” sins and it’s always possible that analysts are being too conservative in their estimates, so if you are convinced of Cloudflare’s long-term strength I won’t talk you out of buying shares. I might even add to my position a bit if this little downdraft continues as we head into earnings… but there are often big and volatile swings in sentiment-driven momentum stocks, so if you love the story but don’t want to chase it too aggressively, the odds are pretty good that a few bad days will hit at some point and give you a chance to pay a little less for shares. Whether you will want to buy falling momentum stocks on a day when other people are panicked, of course, is an open question. Momentum stocks go up because they’re going up, so when that tide turns it can turn ugly quickly as they go down because they’re going down — and you have only to look at Fastly’s chart last week to see if that kind of volatility is something your stomach can handle.

That’s what I think, and what I’m doing with my money… for your money, of course, you have to make the call — ready to get on board the Cloudflare train, or maybe want to wait a couple weeks to see what the next quarter is like first? Split the difference? Think it’s a roaring value, or an overpriced example of the current market insanity? Let us know with a comment below.

Disclosure: Of the stocks mentioned above, I own shares of Fastly, Cloudflare, Amazon and Teladoc. I will not trade in any covered stock for at least three days after publication, per Stock Gumshoe’s trading rules.

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