KEY POINTS FROM THIS WEEK’S ISSUE:

• Raging fires in So-Cal has us cutting Trade Desk shares loose
• Here’s why we’re avoiding body camera stocks
• Speaking of Apple…
• Some mobile gaming stocks go under the microscope

It’s been a wild ride in the market this past week, as investors shift their view from “will tax reform pass” to “with tax reform likely, which sectors will benefit?” Candidly we find this to be the wrong question to ask, not just because we believe sector investing is dead (it is!) but because we see a better question being which thematically well-positioned companies are poised to benefit from lower tax rates in 2018?

We’re rolling up our sleeves, proceeding with that analysis and we’ll have some answers in the coming days. In the meantime, we’ve got another full weekly issue of Tematica Investing to share with you. Here goes…

Raging fires in So-Cal has us cutting Trade Desk shares loose

Shares of digital advertising platform company Trade Desk have been under renewed pressure this week, in part due to weakness in the Nasdaq Composite Index, but also to the fires raging in southern California. As a reminder, Trade Desk is headquartered in Ventura, California and despite the prospects for half of all global advertising to be spent online by 2020, odds are Trade Desk will experience either some disruption or distraction in the current quarter that could lead to the company missing quarterly expectations. We’ve seen how share prices react to such misses, and we’d rather get out ahead of any potenital miss to expectations and minimize the impact to Select List.

As such, we are cutting Trade Desk shares loose at market today, which will generate a blended loss of more than 17% across the two tranches on the Tematica Investing Select List. We’ll look to revisit the shares once the full extent of the damage has been priced into the shares.

• We are issuing a Sell on Trade Desk (TTD) shares.

Here’s why we’re avoiding body camera stocks

One of the key investment themes that we talk quite a bit about here at Tematica is the Connected Society investment theme and the impact it is having on industries and companies. It’s not to take anything away from our other themes, it’s just the Connected Society has been a disruptive force across a growing number of industries. We’re seeing its impact stretch across how we shop, bank, communicate and consume content ranging from video and audio to news and even stock information.

We’re also seeing the impact outside of consumer-facing opportunities in part with the Internet of Things, but also with our Safety & Security investing theme. As a quick reminder, this theme spans defense, homeland security, personal security, and cybersecurity, but also law enforcement. When it comes to law enforcement we have seen a number of new items ranging from rubber bullets to bean bag guns come to market, but with the Connected Society, we are seeing a shift from reactive to proactive monitoring via body cameras. It’s a razor to razor blade business model, with the body cameras serving as the razor and the data management the ongoing spend, a model that is similar to buying new blades every month.

Interestingly enough, I received a subscriber email that was asking about a company that falls into this category – Digital Ally (DGLY). Trading at just under $3 per share the past month, DGLY shares are well off their 52-week high of $6 per share, and yet have a consensus price target of $5. That along with the underlying fundamentals of the body camera market were more than enough to get me to look at the shares.

Not to be all Debbie Downer, but in reviewing the company’s financials, I have a few cautionairy observations to share:

• The company’s business model has been and looks to be currently upside down. In that I mean it’s operating expenses vastly outweigh its revenue stream. Over the last 12 months, Digital Ally’s revenues totaled a whopping $15.2 million, while its operating expenses over the same period hit $26.6 million
• It should come as little surprise the company is bleeding on its bottom line and hemorrhaging cash, which it doesn’t have much of. Exiting the September quarter Digital Ally had $0.3 million in cash and short-term equivalents. In the same quarter, its net loss was $3.5 million.

As the saying goes, the numbers don’t lie and simply put, DGLY shares are not a pretty picture. This lack of balance sheet strength in the face of ongoing losses was one of the flag’s I identified with Blue Apron (APRN) shares and I see it here with Digital Ally as well. And for those keeping score, Blue Apron shares are down 27% since my initial bearish comments on October 24^th.

Aside from the financial statements, there are other concerns that also have me steering away from DGLY shares — namely back and forth patent infringement cases with competitors WatchGuard and Axon Enterprise (AXON), the company formerly known as Taser. These cases are always messy, with companies throwing resources at legal fees and that’s going to hurt a company with Digital Ally’s balance sheet. Based on what is seen here, it’s quite possible that Digital Ally could be one of those companies that vanishes unless it were to undergo what would likely be a painful and dilutive secondary offering that injects capital onto the balance sheet.

Is it possible that Digital Ally could be a takeout candidate? Perhaps, but as one Chief Financial Officer once shared with me when I asked him why not buy out a struggling company to improve his company’s competitive position – “why buy it now when in a few months I can probably buy it for cents on the dollar?” It was a great point, and besides what acquirer would want to step into the current lawsuit mess?

Better to move along and examine other potential candidates than take a flyer on a stock that is cheap for a reason. And for those wondering, that same set of lawsuits, as well as another factor, has me on the sidelines with Axon Enterprise shares as well. That other factor I mentioned is the current pilot program being run by the Jersey City Police Department that is testing a new smartphone app called CopCast that would allow police officers to turn an everyday smartphone into a body camera. While this is the first test in country, the JCPD has already expanded its pilot program to 250 officers from an initial ten. We’ll continue to monitor both this program, as well as those body camera company lawsuits. On the one hand, the outcome of that monitoring program could be a positive for the Apple (AAPL) shares on the Tematica Investing Select List, on the other it could mean revising DGLY and AXON shares. Time will tell.

Speaking of Apple…

Over the last week as part of the move lower in the Nasdaq, shares of smartphone company Apple (AAPL) moved lower by 2% — a hair better than the 2.2% decline in the Nasdaq. We here at Tematica remain upbeat on this recent addition to the Tematica Investing Select List with our confidence in Apple buoyed by two recent findings. First, a new report from Barclays’ surveyed 1,000 people and found that 62% will upgrade their smartphone in the next year, while 72% plan on doing so in the next 18 months. Of those upgrading, 54% are planning on choosing an iPhone with 35% choosing the iPhone X. It’s worth noting this iPhone X percentage is significantly higher than the August Barclays’ survey that found just 18% of would be Apple buyers would be willing to spend $1,000+ on the iPhone X.

The second report comes from IHS Markit, which forecasts that Apple will sell 88.8 million iPhones in the current quarter – its biggest quarter ever. As robust as that might be, the item that caught our analytical eye was the notion that Apple needs to ship just 31 million iPhone X units for its overall iPhone average selling price to crack $700 – another new record for the company. IHS’s forecast hinges on the collapsed shipping times for the iPhone X, which have fallen from 5-6 week initially, to roughly one week as Apple ramped production.

We expect additional forecasts to follow, but with the iPhone X making a number of “best of” lists, it appears this latest iPhone could once again be the holiday gift to get.

• Our price target on Apple (AAPL) shares remains $200.

Some mobile gaming stocks go under the microscope

One of the key themes that caught investor attention over the last few quarters is the accelerating shift to digital consumption, especially mobile consumption that is part of our Connected Society investing theme. We saw this over the recent Thanksgiving-to-Cyber-Monday holiday shopping period, as digital sales over the five-day period hit a new record of $19.6 billion. Based on reports from Adobe (ADBE), Shopify (SHOP) and others, it appears that mobile sales rose to equal 40%-45% of all digital shopping sales this year.

We would also point out this shift to digital shopping is not occurring just inside the U.S. This year, Alibaba’s Singles Day hit $25.3 billion in sales, with over 90% of Alibaba’s sales made on mobile devices compared to 82% in 2016 and 69% in 2015.

I believe we can all agree that there is a pronounced shift underway favoring mobile consumption.

A few weeks’ back, we shared some thoughts on e-sports, which tie into how gaming is becoming a new kind of content that people consume not only by themselves or in small groups, but also in communal experiences. And in size… such size that corporate advertisers are sitting up and taking notice when such events are selling out Madison Square Garden for instance. It’s safe to say that eSports and video games fall well within the scope of our Content is King investing theme, on top of the Connected Society theme given the demands the games place on connectivity over the internet as well as viewing and playing over mobile devices.

Put these two tailwinds together, and it means looking at mobile gaming, and as luck would have it another subscriber asked about shares of Glu Mobile (GLUU) and Zynga (ZNGA). In the case of Glu — aside from the fact that they count companies like Activision and Hasbro (HAS) as strategic partners, and which game titles they have (if the dog doesn’t like the dog food, what’s the point in owning the company) — the key investor concern entails wrapping our head around 2018 expectations compared to 2017. We are essentially at that time of year when we make the transition to relying more on 2018 metrics and valuations, and it makes sense as we are inclined to own new positions into at least the first half of 2018.

In the case of Glu, the answer to the question set we’ll be asking is how does the company intend to meet (or beat) consensus expectations that have it delivering EPS of $0.09 in 2018, up from a -$0.08 loss this year? It’s a hefty swing, especially when 2018 revenue is expected to grow a tad more than 5% year over year.

The question for Zynga (ZNGA) is a bit different. It is expected to deliver EPS of $0.13 next year, up from $0.10 this year, which is 30% EPS growth, but why the sharp drop compared to year over year EPS growth this year, especially when 2018 revenue is slated to rise by more than 9%?

If you ask a carpenter how they look to minimize mistakes, the answer you usually get is “measure twice and cut once.” Essentially, that’s what we’ll be doing as we get to the bottom of those questions as well as others over the coming days.

As we do that, I’m going to offer a disclaimer of sorts. While we’ve smartly added companies like USA Technologies (USAT) and AXT Inc. (AXTI) to the Tematica Choice List, we generally stick with larger capitalization stocks, which tend to be more liquid and have better established business models, a track record of earnings and cash flow, better capitalized balance sheets and in some cases dividends.

All things being equal, those kinds of companies are less risky and less volatile than micro-cap stocks like Digital Ally or small-cap ones such as Glu Mobile, which often lack institutional investors and whose shareholders tend to be littered with speculators, not investors. In some cases, those stocks are nothing but glorified option plays, and we leave that kind of trading to our Tematica Options+ service, which focuses on trading options and other aggressive trading tactics, while here at Tematica Investing we are long-term and patient investors.

That’s not to say we won’t take advantage of a mismatch between a company’s stock price and the opportunity to be had, rather we’re going to examine each thematic contender on its own individual merits from a thematic and financial perspective. That being said, as we examine GLUU and ZNGA shares, I’ll be doing the same with Activision Blizzard (ATVI), Electronic Arts (EA) and Take-Two Interactive (TTWO) as well.

Before we close out this week’s issue, I’d like to hammer home that the answers to the questions we asked above and ones like them are what we consider to be the basic building block of analyzing and understanding a company and now its business is performing. For those subscribers that are looking for a more detailed set of primer questions, we – that’s Tematica Chief Macro Strategist Lenore Hawkins and myself – included them in Chapter 10 of our book, Cocktail Investing – Distilling Everyday Noise into Clear Investing Signals. And yes, that book inspired our weekly podcast and it would make a great holiday present to a burgeoning investor.