When it comes to stocks, it’s all about expectations. In theory, the present value of a stock is equal to the company’s earnings power, discounted back at an appropriate rate. In practice, this basically means that the more optimistic investors are about the future growth of a company, the higher that stock will go, and vice versa.
One feature of the expectations game in stocks is that expectations end up being correlated with potential return. The bigger expectations are for a company, the more those positive expectations get priced into the stock, so when good news happens, everyone was ready for it, and the stock consequently fails to rally in a big way.
But, when the expectations are low on a company, good news isn’t priced in. Thus, when good news converges on a depressed stock, that’s when you get the big 20%-plus, 30%-plus, and bigger rallies.
In other words, the expectations game in stocks means that underdog stocks — or dark horse stocks, as I like to call them — are often the biggest winners in the market.
Which dark horse stocks are running higher in 2019? Let’s take a closer look.
YTD Return: 150%
Heading into 2019, Wall Street was very pessimistic on shares of Snap (NYSE:SNAP). The social media platform had seen its user base shrink in the back half of 2018, which coincided with a rapid slowdown in revenue growth. At the same time, the company was still reporting wide losses, and competition from bigger digital ad players was only getting more fierce.
But, in 2019, the tide has started to turn for this dark horse stock. User growth has come back into the picture. Revenue growth has stabilized. Margins have improved. Competition has become less fierce. Losses have narrowed. In other words, every late 2018 headwind, has turned into an early 2019 tailwind, and SNAP stock has consequently more than doubled this year.
Can the rally continue? I’m hesitant to say yes here. Snap stock has come very far, very fast, and the valuation is now very big. User growth, although positive, is still tepid. Revenue growth isn’t all that impressive. Margins are still a concern. Competition hasn’t gone away entirely. Broadly, although things are improving here, they still aren’t great, and that will ultimately keep Snap stock from heading much higher.
YTD Return: 230%
In late 2018, Wall Street seemed to forget the secular growth story which supported streaming platform Roku (NASDAQ:ROKU). Investors became overly concerned about competition derailing this company’s growth trajectory, and a slowdown in the global economy similarly derailing the OTT video trend. ROKU stock was consequently hammered.
Those concerns were overstated. The economy hasn’t slowed much, and the OTT video trend has only gained momentum in 2019. Further, competition still hasn’t caught up to Roku, and the company has continued to dominate the streaming device market this year. As it has, investors have jumped back on the Roku bandwagon, and in a hurry. The stock has more than tripled in 2019.
Can the rally continue? I think so. Sure, Roku stock needs to take a short term breather because, after all, stocks don’t go up in straight lines forever — even dark horse stocks that suddenly pull ahead. But, after that breather, the rally should continue. This company is increasingly turning into the cable box of the OTT video world, and that will translate into billions of dollars in advertising and subscription sharing revenue at scale. Those revenues are high margin, so we are talking potentially hundreds of millions of dollars in profit here. ROKU stock just isn’t priced for that, so it will continue to move higher.
Stitch Fix (SFIX)
Source: Stitch Fix
YTD Return: 55%
Wall Street was quick to fall in love with online personal styling service Stitch Fix (NASDAQ:SFIX). But just as quickly as investors fell in love with the stock, they fell out of love with it. In just over a year after its IPO, SFIX stock went from $15, to $50, back to $15, as investors backed away from the stock in late 2018 as growth dramatically slowed.
But the growth slowdown was temporary, due to one-time changes and purposefully lower marketing spend. Those one-offs have been phased out, and marketing spend has re-accelerated. Consequently, growth in 2019 has re-accelerated, too. As it has, SFIX stock has come roaring back. Shares are up more than 50% in 2019.
Can the rally continue? I’d say yes. Stitch Fix is changing the game in retail to a curated, on-demand model. We’ve seen these shifts before. Netflix (NASDAQ:NFLX) changed the content game by curating content and making it on-demand. Chegg (NASDAQ:CHGG) changed the education game by curating textbooks and making learning an on-demand experience. The retail pivot will play out in a similar manner. Curated, on-demand shopping will gain share and traction. As it does, Stitch Fix’s growth trajectory will remain favorable, and SFIX stock will stay in rally mode.
Advanced Micro Devices (AMD)
YTD Return: 70%
The best performing stock in the S&P 500 last year was Advanced Micro Devices (NASDAQ:AMD), and the out-performance was all because the relatively small CPU and GPU maker was stealing market share from the far bigger Intel (NASDAQ:INTC) and Nvidia (NASDAQ:NVDA). Investors were concerned that this market share expansion would not persist in 2019, so AMD stock traded lower into the end of 2018.
But, AMD stock has risen another 70% in 2019 because the company’s market share expansion narrative remains as vigorous as ever. The company continues to beat competitors to market with next-gen chips. At the same time, competitors are struggling with supply shortages. This combination has led to AMD continuing to win share, which has led to AMD stock running higher.
Can this dark horse stock keep running? Yes, but at a more moderate pace. The current outlook is for AMD to keep stealing share from Intel and Nvidia for the foreseeable future. This will power healthy revenue, margin, and profit growth. But, a lot of that growth is already priced in, as AMD stock is significantly more expensive than both Intel stock and Nvidia stock. As such, while the trends here will remain favorable going forward, the uptrend in AMD stock will likely slow.
YTD Return: 70%
Hyper-growth furniture e-retail giant Wayfair (NYSE:W) has never had a problem with top-line growth. Top-line growth rates have always been very big here. Instead, the problem has consistently been with margins, which have remained stubbornly low for a long time despite increased scale. Those depressed margins got more depressed in late 2018, and as they fell, so did Wayfair stock.
But, Wayfair stock has staged a huge turnaround in 2019 as top-line growth rates have remained impressive, and margins have started to show signs of improvement. Year-to-date, Wayfair stock is up 70%.
How much higher can Wayfair stock go? In the near term, not much higher. The long-term growth narrative here is promising, however. Furniture e-retail is under-penetrated relative to other e-retail segments, and Wayfair is the leader in this under-penetrated yet rapidly growing market. Margins will scale over time, and the company will one day produce sizable profits. But, the valuation already reflects all this growth, and then some. As such, the stock needs to take a breather here around $150.
YTD Return: 50%
It might be weird to find any marijuana name on a list of dark horse stocks. Pot stocks were all the craze in mid-2018. But as the economy slowed and the legal Canadian cannabis market got off to a rough start thanks to supply shortages, pot stocks dropped big in late 2018. Canadian cannabis producer Cronos (NASDAQ:CRON) was no exception. CRON stock fell from $14 in mid-2018, to $7 in late 2018.
But the stock has staged a huge turnaround in 2019 thanks to three things: the global economy has stabilized, the Canadian cannabis market has found its footing, and Cronos scored a huge near $2 billion investment from tobacco giant Altria (NYSE:MO). In response to all that good news, CRON stock has risen 50% in 2019.
Will renewed strength in CRON stock persist? Probably not. Cronos is the smallest of the well known Canadian cannabis producers in terms of volume of cannabis sold last quarter. But, the company has one of the largest market caps in the group, because of the Altria investment. In other words, investors expect the Altria investment to supercharge growth and allow Cronos to expand. Now, Cronos needs to deliver on those expectations. If they don’t, the stock could crater. If they do, well, it’s already priced in. As such, the risk-reward here doesn’t look great at the current moment.
YTD Return: 55%
Last, but not least, on this list of dark horse stocks that have run higher in 2019 is law enforcement technology solutions provider Axon (NASDAQ:AAXN). This company has pivoted from selling tasers to selling a suit of cloud-hosted technology solutions to law enforcement communities around the world. As it has, the company’s growth trajectory has improved meaningfully, and AAXN stock has shot higher. But, that growth trajectory hit some turbulence in late 2018 as growth slowed. Investors weren’t impressed. AAXN stock dropped from $75 to $40 in late 2018.
Growth has picked back up in 2019. AAXN stock has consequently rebounded in a big way, rallying more than 50% over the past five months.
How much higher can Axon stock go? The rally may be over. For now. In the big picture, the growth narrative here is really good. The law enforcement world desperately needs a tech makeover. Axon is giving it a tech makeover. There’s hardly any competition, because Axon has either acquired or squashed everyone else in this space. Also, the cloud-hosted solutions pivot means higher margins at scale, so not only is this a big revenue growth story, but it’s also a big profit growth story, too.
Having said all that, the stock is already priced for all that growth, and further upside is hard to justified, even under optimistic long term growth assumptions.
As of this writing, Luke Lango was long ROKU, SFIX, NFLX, CHGG, and INTC.
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