These rebounding momentum stocks have ample firepower to keep breaking out
In early September, we saw an unprecedented shift in the investment landscape from momentum stocks to value stocks. This came amid a recovery in economic fundamentals and a sharp rise in interest rates.
By mid-September, the the iShares Momentum Factor ETF (BATS:MTUM) was down more than 1%, while the iShares Value Factor ETF (BATS:VLUE) was up more than 7%. This big divergence prompted me to write a piece on InvestorPlace outlining seven momentum stocks to buy on the dip.
The logic was simple. These sharp momentum-to-value shifts don’t happen often. But, when they do, it’s when the things are getting better. See late 2016. It is investors voting with their money that the coast is clear to buy stocks that require a good economy to head higher. As such, these shifts are normally temporary, and a harbinger of a broader market rally. When they end, both value and momentum stocks power higher alongside a rising economy.
Thus, I reasoned that the September weakness in momentum stocks presented a solid buying opportunity into 2020, when all stocks would power higher supported by easing trade tensions, re-accelerated global capital investment and economic activity, revamped corporate profit growth, healthy labor markets and supportive central bank policy.
Fast forward two months. Since then, both the Momentum Factor ETF and Value Factor ETF are up more than 3%, five of the seven momentum stocks I recommended are up more than 8%, and three of them are up more than 20%.
I think this momentum stock rebound will continue. As such, let’s take a deeper look at five of my favorite momentum stocks that have shown impressive strength since mid-September.
Momentum Stocks to Buy on the Rebound: The Trade Desk (TTD)
% Gain Since Sept. 16: 20%
At one point in time, programmatic advertising leader The Trade Desk (NASDAQ:TTD) was one of the biggest losers in the mid-2019 momentum-to-value shift. Shares had shed almost a quarter of their value by mid-September. But, since then, shares have soared 20%.
This big rebound in TTD stock will persist for a few reasons.
First, the long-term fundamentals are favorable here. Programmatic advertising is “smart” advertising, which leverages algorithms, data and machine learning to transform ad transactions and ad spend allocations from a guess-and-check process, to an automated and optimized process. The whole ad industry is pivoting into programmatic advertising, yet only a small portion of global ad dollars are transacted programmatically today. The Trade Desk is at the center of this pivot. Thus, as more ad dollars flow into the programmatic channel over the next few years, TTD’s revenues and profits will continue to roar higher.
Second, the valuation remains reasonable. By my numbers, The Trade Desk will net $12 in earnings per share by fiscal 2025, behind 20%-plus annual revenue growth, steady profit margin expansion and 25%-plus profit growth. Based on an exit multiple of 35-times forward earnings (which is average for application software stocks) and a 10% discount rate, that equates to a 2019 price target for TTD stock of $260 — above today’s $250 price tag.
Third, the optical backdrop will remain supportive. Yields appear to be done surging, so the valuation headwinds which hit TTD stock in September also appear to be over. At the same time, easing trade tensions should support a rebound in enterprise capital spending, and as that picks up, companies should spend more on their programmatic advertising pivots.
Ultimately, TTD stock should stay in rebound mode.
% Gain Since Sept. 16: 8%
Shares of creative solutions giant Adobe (NASDAQ:ADBE) weren’t hit that hard by the mid-2019 momentum-to-value shift. But, ADBE stock has still rattled off an impressive 8% gain since mid-September as momentum stocks have come back in favor. Shares presently trade just a few bucks shy of all-time highs.
The fundamentals here imply that ADBE stock should hit new all-time highs soon.
The economic and market backdrops are healthy. Trade tensions are easing. Easing trade tensions will support a rebound in capital spending, which will fuel a rebound in the global economy. As the global economy rebounds, stocks will broadly power higher. This rising tide will lift most boats, including ADBE stock.
Adobe’s internals are equally healthy. This is a company which dominates the secular growth creative solutions market with essentially no real competition. Growth is big because enterprises and professionals are investing more into creative solutions as the world becomes more visually based. Margins are huge, because Adobe commands tremendous pricing power. Profit growth is consequently big, too. All of this should continue for the foreseeable future, and at an accelerated rate in 2020, thanks to a rebound in enterprise spending trends.
Also of note, the valuation on ADBE stock remains tangible. By my projections, Adobe will remain a double-digit revenue growth company for several years thanks to creative market tailwinds, while margins will naturally improve with scale. Those growth projections create visible runway for earnings per share to hit $20 by fiscal 2025. Based on a systems software sector-average 25-times forward earnings multiple and a 10% discount rate, that equates to a 2019 price target for ADBE stock of $310.
All in all, then, the data here suggests that ADBE stock will remain in rally mode.
% Gain Since Sept. 16: 24%
Another momentum stock which was hit hard during the momentum-to-value shift was identity cloud company Okta (NASDAQ:OKTA). Much like TTD stock, OKTA stock lost about a quarter of its value during this shift. Since mid-September, though, OKTA stock has rattled off a 24% gain.
OKTA stock should continue to rebound for three big reasons.
First, Okta is a big growth company with strong long-term fundamentals. At its core, this company is reinventing the way companies protect their data. Instead of building a castle of security surrounding an entire enterprise ecosystem (as most traditional cybersecurity solutions do), Okta is outfitting each member in an enterprise ecosystem with personalized “armor,” under the idea that if each individual is protected, so is the entire ecosystem.
Okta calls this new method the Identity Cloud. This Identity Cloud is surging in popularity, because it improves enterprise flexibility, mobility and convenience, without compromising on security integrity. Still, Okta is a relatively small company (less than $500 million in revenue) in a huge cybersecurity market ($170 billion and growing), so there is ample room for Okta to stay on a big growth trajectory for a lot longer.
Second, the valuation on OKTA stock isn’t stretched. My modeling suggests that Okta has a visible opportunity to net $11 in EPS by fiscal 2030 (assuming 20%-plus revenue growth, sustained big gross margins, and significant positive operating leverage). Based on an application software sector-average 35-times forward multiple and a 10% discount rate, that equates to a 2019 price target of nearly $150.
Third, the optics are improving. Specifically, capital spending trends are rebounding, and Okta’s revenues come from the capital spending well.
Big picture — OKTA stock can and will keep moving higher.
% Gain Since Sept. 16: 11%
On seemingly no catalyst whatsoever, shares of digital education giant Chegg (NASDAQ:CHGG) tumbled from nearly $50 in late July 2019, to below $30 by early November 2019. Then, Chegg reported strong third-quarter numbers, which implied that the selloff was grossly overdone. CHGG stock has since rebounded to $40.
This rebound should continue until CHGG stock runs back to its $50 all-time highs.
Chegg is a big growth company. This company has created a connected learning platform which is increasingly becoming a necessary and vital part of the learning experience for high school and college students. That’s because Chegg has built the first education platform that caters to modern student’s needs. They want digital services, they want on-demand services, they want streamlined services and they want all-the-time services. Chegg provides all four, all in one place.
As such, it isn’t too far off to think that Chegg will one day be used by most high school and college students across America. There are 36 million students who fit that description. Chegg has only nabbed 3.1 million of them. Thus, with a meager 10% penetration rate in a highly fragmented market that is ripe for disruption, Chegg is primed for big growth over the next few years.
This big growth simply isn’t priced into CHGG stock today. By my numbers, Chegg has a realistic opportunity to hit $2.50 in EPS by fiscal 2025. Based on a big-growth 30-times forward earnings multiple and a 10% discount rate, that equates to a 2019 price target for CHGG stock of $45.
That’s well above where shares trade today. So long as shares remain fundamentally undervalued and the momentum/growth stock backdrop remains favorable, CHGG stock should grind higher.
% Gain Since Sept. 16: 28%
Big data analytics company Splunk (NASDAQ:SPLK) was hit hard in mid-2019 on cash flow, growth, and margin concerns. But, Splunk reported third quarter numbers in November that put those concerns to ease. SPLK stock has since sprinted to all time highs.
Although the valuation on SPLK stock seems somewhat stretched here, most signs indicate that this rally will continue.
First, Splunk is in the game of turning data into actionable insights. Current trends imply that demand for this service is surging. Not only did Splunk just report strong Q3 numbers that included 30% year-over-year growth, but Alphabet (NASDAQ:GOOG, NASDAQ:GOOGL) also recently acquired Fitbit (NYSE:FIT) in a data acquisition play, tennis players have recently started using big data to prep for matches and the real estate industry is getting in on the big data trend.
Second, recovering business sentiment — thanks to easing trade tensions — should provide a lift to Splunk’s revenue trends, since the higher business sentiment goes, the more those businesses spend on things like data, and the more money makes its way into the Splunk ecosystem.
Third, Splunk is in the early stages of realizing the financial benefits of its recently launched Data-to-Everything platform. Building that platform has been a multi-year, multi-billion dollar commitment. That investment phase is over. Now comes the growth part. This transition should provide a lift to SPLK stock.
I’m slightly concerned about valuation on SPLK stock up here. But, momentum stocks have a tendency to ignore valuation risks when they have full momentum. That’s exactly what Splunk has right now. So, for the foreseeable future, shares should keep making new highs.
Author: Luke Lango
Source: Investor Place: 5 Momentum Stocks to Buy on the Rebound