Tom Yeung here with your Sunday Digest.
When I started my career years ago in corporate finance, I quickly realized that December was always a time of big spending for us.
Departments at my employer rushed to buy what they needed because our comptroller had an old-fashioned “use it or lose it” mentality. Department heads who used their entire budgets would get that figure renewed the following year, while spendthrift ones risked getting their future allocations cut.
Only after moving to Wall Street did I realize that every major company does this. Chief financial officers often have little clue what happens at the sub-department level, so they’re willing to let supervisors spend like drunken sailors in December… provided they come in at budget (i.e., who has time to ask if shipping really need 300 staplers).
That often causes a year-end bonanza for enterprise-focused companies like Cloudflare Inc. (NET), a cybersecurity firm that sells DDoS (distributed denial-of-service) protection to 80% of corporate and government websites that use such services. IT managers with excess year-end cash start spending it on “nice to have” software, giving firms like Cloudflare a nice bump when fourth-quarter results are announced in early February.
You’ll notice in the chart below that Cloudflare’s stock price typically jumps during first-quarter earnings cycles. I’ve circled these moments in orange.
The effect is even more pronounced in companies that cater to literal seasonal effects.
Natural gas prices typically surge during winter months as American households turn up their thermostats. Since 2000, Henry Hub, a natural gas index, has risen 12% between July and January, creating windfall profits for the firms that pump, store, and deliver natural gas.
And it’s hard to talk about seasonal effects without mentioning the American consumer. Many retail firms cater to back-to-school spending each summer or year-end holiday shopping, creating “unexpected” profits that seem to recur yearly. Some, like Amazon.com Inc. (AMZN), have made it an annual habit to surprise Wall Street with “better-than-expected” Black Friday e-commerce results.
That’s why we’ve been so excited to reveal TradeSmith’s latest trading strategy, a tool that TradeSmith CEO Keith Kaplan calls its biggest breakthrough since they created TradeStops 20 years ago. By analyzing over seven decades of data, the team has identified precise moments when seasonal effects are strongest. They’re calling this innovation Trade Cycles, and you can learn more about the system by clicking here.
Even more importantly, TradeSmith’s seasonality detector is complemented by its other quantitative tools. After all, we also know that seasonal effects alone are not enough to make a great investment.
Plenty of cybersecurity companies have gone bankrupt; no IT manager willingly wastes their precious year-end budgets on low-quality software. And dozens of retail stores have shuttered after failing to win over holiday shoppers. Christmas Tree Shops, for instance, ingloriously filed for bankruptcy in May 2023 and closed all of its stores three months later.
By combining tools that identify best-in-class companies with seasonality, TradeSmith has created a powerful way for investors to identify the best moments to buy promising firms. To demonstrate TradeCycles, I’m pleased to share three of these companies with you today…
Taking the Chill Off
Cheniere Energy Inc. (LNG) is America’s largest exporter of liquified natural gas (LNG), a compressed version of the fuel that can be loaded onto ships. The Houston-based firm has access to cheap U.S. gas supplies, and its unusual “take-or-pay” contracts mean it generates the difference between American and international gas prices without taking commodity price risk.
That makes winter an unusually lucrative period for the firm. European Union countries rely more heavily on stored natural gas for the winter, so EU natural gas prices tend to rise faster than in America during colder months. Since July 2024, for instance, Dutch TTF Natural Gas prices have risen 18%, compared to a 5% increase in the U.S. Henry Hub.
This creates a relatively predictable seasonal effect for Cheniere’s stock, which has risen 20.7% in the first two months of the year since 2009. Here is the chart from TradeCycles:
In addition, the incoming Trump administration has promised to encourage more drilling of fossil fuels in the coming years. The U.S. Energy Information Administration, a government research body, estimates LNG exports will increase 15% during the first year of Trump’s presidency. That makes Cheniere’s business even more attractive, and Wall Street analysts have revised their 2025 earnings estimates up 13% since last July, a typically bullish sign.
Finally, Cheniere’s stock is solidly in TradeSmith’s “green zone” for its declining risk and positive uptrend. For those seeking winners from the Trump administration’s energy plan, Cheniere Energy would be a solid place to start.
Beating the Buzzer
Sports betting firms sit at an unusual intersection of seasonal supply and demand. On the “supply” side, sporting seasons like football and basketball peak during the second and fourth quarters, creating substantial midyear and year-end profits for gambling firms.
The “demand” side is equally cyclical. January is typically the strongest month for casinos from Las Vegas to Macau, and much of this is driven by gamblers spending year-end bonuses. The effect is noticeable through roughly March.
That’s created a positive seasonal effect for firms like DraftKings Inc. (DKNG), which sees revenue boosts in the first quarter from heavy spending of cash-rich customers on sporting events like the Super Bowl (NFL) and March Madness (college basketball).
DraftKings has also historically notched strong figures during the Q2 and Q4 sporting seasons. The third quarter is typically the slowest month.
This annual cyclicality creates opportunities for market-timing investors to profit.
Since the company went public in 2020, DraftKings has seen a roughly 13% increase in share prices from January through mid-February, when the firm typically announces fourth-quarter results. (Most NFL games are played in this quarter.) The firm also does exceptionally well in August, when second-quarter results are released. This period includes betting on the NBA playoffs and the NCAA Final Four. The seasonal effects are reversed in Q3.
In addition, TradeSmith’s quantitative indicators finds that DraftKings is a solid “green zone” company for its positive momentum. The Boston-based firm has run an incredible marketing campaign over the past several years, and now holds a virtual duopoly with rival Flutter Entertainment plc (FLUT), FanDuel’s corporate owner, in the industry. Traditional players like MGM Resorts International (MGM) and Caesars Entertainment Inc. (CZR) lag far behind.
Analysts expect even greater gains ahead as DraftKings moves from solidifying its user base to profiting from them. The company charges as much as a 10% “rake” on fantasy sports, and some exotic parlay bets can have 25% margins or more.
Analysts expect DraftKings’ net income to flip positive this fiscal year, and for the firm to earn over $1 billion annual profits by 2027.
Year-End Spending Spree
Finally, seasonal-minded investors should consider Cloudflare Inc. (NET), the cybersecurity firm that started our conversation today.
Cloudflare is the dominant player in protecting websites from DDoS attacks – the malicious attempts to disrupt web traffic by flooding sites with junk requests.
In November 2021, for instance, Microsoft’s Azure cloud computing service was suddenly hit with requests from 10,000 locations in at least 10 countries. The 3.47 terabit-per-second attack, which was thought to be the largest at the time, was mitigated by Cloudflare’s services. The firm countered an even larger 5.6 terabits per second attack last year.
In fact, Cloudflare protects roughly 20% of all websites, or 80% of all websites with DDoS protection. If you’ve ever seen something like the below pop up in your browser, that’s Cloudflare’s software at work.
That allows Cloudflare to “see” much of the internet, improving the odds of stopping an attack. If the firm identifies a malicious group of servers targeting one customer, it can blacklist that node, protecting its other customers from attack. It also makes Cloudflare’s services a “must-have” firm for Fortune 500 companies. Only the largest cloud computing firms like Amazon can afford to build their own DDoS protection services. Everyone else must hire Cloudflare to protect their businesses from disruption.
That’s turned Cloudflare into a “must-own” stock as well, especially during the first quarter. Since 2019, the company has exceeded earnings-per-share estimates by 41% thanks to consistently excellent fourth-quarter sales.
In addition, Cloudflare is successfully cross-selling new services. Its secure access service edge (SASE) product is growing fast, and the company has continued to add capabilities with bolt-on acquisitions.
That’s allowed the San Francisco-based firm to continue growing with ease. Analysts expect Cloudflare’s revenues to rise another 23% this year from an already-large base, and for net income to increase 25% to $942 million.
Though shares have already risen strongly in 2024, the company’s strong fundamental performance suggests even more gains are on the way this year.
The Season for Profits
Seasonality investing might sound too good to be true.
I get it.
If everyone knew a stock would rise on great fourth-quarter results, they should presumably front-run the market by buying shares in January before the numbers are announced. More thoughtful investors would buy shares in December… November… October… and so on. In theory, hedge funds should arbitrage any abnormal seasonal profits out of existence before ordinary investors can touch them.
However, the real world provides a twist.
High-quality cybersecurity firms like Cloudflare do outperform thanks to year-end spending… but struggling ones like Qualys Inc. (QLYS) go the other way when the December surge fails to materialize. Shares of the Silicon Valley firm dropped 10% after missing revenue expectations in February 2024, and then continued to fall another 24% over the next 11 months as the extent of its troubles became clear.
In other words, seasonality effects exaggerate the moves of great investments… and terrible ones.
That’s why I highly encourage you to watch Keith’s latest presentation on Trade Cycles. In his broadcast, he goes into detail about how TradeSmith’s quantitative tools help identify the best stocks to buy, and how optimal seasonality scores then finds the right moment for investors to pounce.
It wasn’t easy to create the system. Keith’s team had to run 2.4 quintillion tests in total, using thousands of custom-built algorithms. But in the end, it worked. Keith’s model portfolio has returned 857% since 2006, outperforming the stock market’s 412% return.
To learn more about how you can access these tools, click here.
And I’ll see you back here next week.
Regards,
Thomas Yeung
Markets Analyst, InvestorPlace