Cabot Dividend Investor Issue: December 11, 2024

A Great Pick for a Promising 2025

Whatever the history books say about the year 2024, one thing is beyond dispute: It will have been a strong year for the market.

The S&P 500 is up about 27% for the year with three weeks left. That’s nearly three times the average historical return. And it’s a healthy 27% too. Yeah, the S&P was up 26% in 2023. But the gains were driven almost entirely by technology. The rest of the market was quite lame. But the rally stretched its legs and broadened out this year.

All eleven S&P 500 sectors have positive returns for the year. Six sectors are up over 20% and four have returned more than 30%. Sectors including consumer, financials, industrials, and utilities, which weren’t even on the radar last year, are delivering fantastic returns. And sector leadership is rotating. In the summer and early fall, interest rate-sensitive sectors in utilities, REITs, and financials led the market. Since the election, the cyclical consumer discretionary, financials, and technology sectors have led.

But that’s in the past. What does 2025 have in store for stocks?

While no one ever knows what will happen (remember the pandemic), there is reason for optimism. We are in a bull market that began in October of 2022. Bull markets don’t usually run out of gas after just two years, especially recent ones. The Fed has begun a rate-cutting cycle that is likely to last for the next two years. Plus, the economy is solid and expected to get stronger. Rate cuts in a strong economy are unusual but the combination should be great for stocks.

Wall Street is bullish. A recent roundup of S&P 2025 targets from 14 major financial companies shows all of them expecting positive returns, and most expecting double-digit returns. It is as positive an outlook as I’ve seen in a while. Of course, that might be a negative.

There are still uncertainties. There always are. The higher level of economic growth that is expected because of the election may take a while to materialize. Stocks are also selling at historically high valuations overall. The easy part of the rally might be over.

But one sector may have a better 2025 prognosis than the overall market: Financial stocks have been on a tear since the summer. The Financial Select Sector SPDR Fund (XLF) is up 33% YTD and 22% since early August. Despite the recent spike, many financial stocks are still cheap after a decade and a half of underperformance. The XLF only permanently eclipsed the 2007, pre-financial crisis high a little over two years ago.

Financial stocks are dependent on yield spreads, economic growth, and relaxed regulations. All those areas are improving or expected to improve as a result of the election.

The Fed has begun a rate-cutting cycle that will likely last for two years. Rates may decline more slowly than previously expected, but the trend is unmistakably lower. Banks also need a good economy with strong loan demand. The better economic prognosis after the election is bullish. Plus, there is likely to be a much friendlier regulatory environment for banks and financial companies in the new Administration.

In this issue, I highlight one of the highest-growth companies in an industry that is on the rise and will surely benefit from the improving dynamic going forward. It is the leading all-digital bank in the country. Unlike many other industry-leading stocks, it is still well below the high because of a recent temporary stumble which has likely only delayed its price spike.

What to Do Now

The portfolio beneficiaries of the post-election spike have been pulling back. The stocks that took a hit after the election have leveled off. It looks like the market has digested the election and is looking for a way forward in 2025.

Midstream energy companies Enterprise Product Partners (EPD), ONEOK (OKE), and The Williams Companies (WMB) were on a tear for most of last month but have pulled back over the past week. It’s been a similar story for homebuilder Toll Brothers (TOL) and natural gas exporters Cheniere Energy (LNG) and Cheniere Energy Partners (CQP). But Business Development Companies Main Street Capital (MAIN) and FS KKR Capital Corp. (FSK) are still hanging in there.

The prognosis for these stocks is still bright. It’s just that they flew like crazy after the election and that situation couldn’t last. I think these stocks will consolidate for a while and then regain some upward traction early next year.

Utility stocks Brookfield Infrastructure Partners (BIP) and NextEra Energy (NEE) as well as REITs AGNC Corp (AGNC) and American Tower (AMT) fell after the election buy have since regained footing. These stocks are still relatively cheap and should be fine going forward as interest rates trend lower. Constellation Energy (CEG) and Digital Realty Trust (DLR) are in similar sectors but really trade on a different schedule because of their own peculiarities.

Technology stocks Broadcom (AVGO) and Qualcomm (QCOM) have been mostly hovering around in limbo for the past few months. But it shouldn’t take too long for the artificial intelligence gods to shine favor on them again.

There is no one sector or area that I favor right now. A diversified mix of the BUY-rated stocks is best until 2025 identifies itself more. There is one existing portfolio stock that seems poised for a great 2025, AbbVie (ABBV). That stock got through the tough year, with falling revenue from the Humira patent expiration, in great shape. Management expects a return to “robust” earnings growth in 2025. ABBV should soar next year with its main trouble behind it.

Recent Activity

November 13
Sold Alexandria Real Estate Equities, Inc. (ARE) - $108.62
FS KKR Capital Corp. (FSK) – Rating change – “HOLD” to “BUY”
Main Street Capital Corporation (MAIN) – Rating change – “HOLD” to “BUY”
NextEra Energy (NEE) – Rating change – “BUY” to “HOLD”
Purchased Cheniere Energy Partners, L.P. (CQP) -$51.94

November 27
Digital Realty Trust, Inc. – Rating change – “BUY” to “HOLD”

December 11
Buy Ally Financial Inc. (ALLY) 

Featured Action

Buy Ally Financial Inc. (ALLY) 

Yield: 3.1%

Ally Financial is the leading all-digital banking company in the U.S. with 3.3 million customers and over $100 billion in loans. The primary revenue source is automotive loans (over 70%), but it is also diversified in auto insurance, commercial lending, mortgage financing, and credit cards.

The company was the financial segment of General Motors (GM) where it developed a 100-year-old, fully developed auto loan business. It was spun off in 2009 during the financial crisis as part of GM’s bankruptcy reorganization. The company has since focused on the online business.

Ally is still a relatively small bank among the big players in the country. But it is becoming very well established in the high-growth, online banking part of the business. It focuses on this area more than established banks and may grow into a much bigger player in the years ahead.

Ally can attract a large deposit base online because it can offer higher rates than traditional banks. It can do this because it is unburdened by the costs associated with physical branches and staffing. The bank has been able to add retail deposit customers for 62 consecutive quarters, including 57,000 in the third quarter.

Ally uses these deposits to make auto and other loans. The bank earns money on the spread between what it pays on deposits and what it charges for auto loans. At the end of the last reported quarter, it had $83.6 billion in retail auto loans and $23.9 billion in commercial auto loans.

Ally has grown the business through online banking. That business is accelerating, and revenues have about doubled since 2017 from $5.8 billion to trailing 12-month revenue of $11.5 billion. Online banking now accounts for 88% of loans compared to 54% in 2016.

Ally has had major success improving its funding structure as the peculiarities of the burgeoning online business become more well-known. The profitability of its deposit base has improved with the more expensive CDs making up a much smaller portion. Continuing improvements in this funding structure mean wider net interest income (NII) margins and better than historical returns going forward.

The bank is also diversifying into other profitable areas like credit cards. These other areas grew revenue 40% in the last quarter from a year ago. It provides some relief when the auto market gets tough and can raise overall margins.

A big reason to buy ALLY now is because it’s cheap, much cheaper than its peers. Despite the recent rally and the market at highs, ALLY sells at just 8.4 times forward earnings and 0.93 times book value, both valuations are well below those of the market averages. But there’s a reason it’s cheap.

Ally is highly leveraged to the auto market where things have been challenging. Consumers are strapped from inflation and loan rates are still high. The dynamic has led to flattening sales and an increasing number of defaults. ALLY plunged over 20% in early September after the company disclosed that loan defaults were worse than expected.

The percentage of defaults increased to 2.24%, well up from last year. In the third quarter, net charge-offs increased 13.4% over last year’s quarter to $517 million, and the amount set aside for loan loss provisions going forward increased 27% to $645 million. Also, net financing revenues decreased 2.9% from the same quarter last year.

But I believe the market overreacted and the selling is overdone. First, Ally has taken strong risk management steps for loans, which they have proven to be good at. Second, the current issues are just temporarily reducing growth but not killing profitability. Ally still grew revenue 6.9% and earnings were up 14.5% in the third quarter versus the year-ago quarter. Third, things are likely to improve next year.

Inflation is under control. Interest rates are coming down. And the economic prognosis is improving. Although the fourth quarter will likely feature lower earnings growth than previously expected, next year looks good. In fact, analysts are expecting Ally to deliver 40% earnings growth for 2025.

Net interest margins (NIMs) are projected to be 3.2% in 2024, down from 3.32% last year. However, the company expects a medium-term average of 4% NIM margin going forward.

And there’s something else. Financial stocks have been booming over the last year. The Financial Select Sector SPDR Fund (XLF), a sector bellwether, is up 46% over the last year (as of 11-22). Even after the selloff, ALLY is up 44% over the same period. Financial stocks also got a huge further boost after the election as investors anticipate less regulation and higher growth.

ALLY has been trending higher since the September selloff, but other financial stocks continued the torrid pace higher and got a big spike after the election. While ALLY is down 10% since August 30^th, Capital One Financial (COF) is up 26% and Discover Financial Services (DFS) has soared 28% over the same period.

As the chart below illustrates, ALLY was blowing away the performance of the XLF and booming right up there with the best of them prior to the September selloff. Since then, several good financial stocks have left ALLY in the dust. Now financial powerhouses like DFS and COF are at nosebleed levels at all-time highs while ALLY is still reasonably priced with a price spike likely ahead of it as things normalize.

The market is high. Many financial stocks are even higher. Chasing stocks into the stratosphere typically doesn’t deliver great returns. Finding a stock that has been temporarily held back and is still cheap is a much better strategy. Finding winners in a high-priced market entails seeking out opportunities like ALLY.

Then there’s the dividend. ALLY pays a quarter dividend of $0.40 and an annual dividend of $1.20, which translates to a highly respectable 3.1% yield at the current price. The payout is well-supported with just a 29% payout ratio, compared to an average of 37% for the financial sector. Ally has also grown the payout by an average of 12% over the last five years. Companies that grow the dividend tend to be great performers over time.

Security type: Common Stock 
Sector: Financial (Credit Services) 
Price:  $38.55
52-week range:  $26.50 - $45.46 
Yield:  3.1% 
Profile: Ally is the leading all-digital banking company in the U.S. and specializes in auto loans.

Positives 

• Online banking is the wave of the future and Ally has a big leg up.
• Financial companies should benefit from stronger economic growth and falling short-term interest rates.
• The stock is cheap after a temporary slip while lessor opportunities are far more expensive.

Risks 

• A recession is very bad for auto purchases and would pummel the price.
• Continuing high rates could put pressure on the consumer, reducing purchases and increasing loan defaults.

Ally Financial Inc. (ALLY)
Next ex-div date: February 1, 2025, est.

Portfolio Recap

AGNC Investment Corporation (AGNC – yield 14.8%) – This high-yielding mortgage REIT has been slowly coming back after it got whacked with disappointing earnings and a pivot in interest rate expectations. Costs were higher and the net spread shrank from the prior quarter. Although interest rates are likely to trend lower over the next year, rates are still high. The deterioration of the interest rate story is more of a short-term issue. The stock is still on track for improving performance over the next year. AGNC has also come off the recent bottom and moved up 6.4% in November, recapturing upward momentum. BUY

AGNC Investment Corp. (AGNC)
Next ex-div date: December 31, 2024, est.

Brookfield Infrastructure Partners (BIP – yield 4.7%) – This interest rate-sensitive utility has been hanging tough over the last months while industry peers have dipped. It does bounce around somewhat with the interest rate narrative but appears well positioned for the longer haul. After a tough couple of years of inflation and rising rates, BIP looks back on track. It’s up 26% since June. This infrastructure powerhouse had been a stellar performer for many years prior to inflation and rising interest rates. But now interest rates have peaked and are highly likely to trend lower. (This security generates a K1 form at tax time). BUY

Brookfield Infrastructure Partners (BIP)
Next ex-div date: February 28, 2025, est.

Cheniere Energy Partners, L.P. (CQP – yield 6.0%) – The price of this liquid natural gas exporting partnership has been on fire since the election, up about 18%. The reason for the price spike is the anticipated improvement in the regulatory environment and the likelihood of more natural gas production and lower domestic prices. The administration is highly encouraging of natural gas exports and Cheniere is the country’s largest exporter. The longer-term situation was always strong as the rest of the world desperately needs U.S. natural gas. Now, the short-term situation is improving. (This security generates a K1 form at tax time). BUY

Cheniere Energy Partners (CQP)
Next ex-div date: February 5, 2025, est.

Enterprise Product Partners (EPD – yield 6.4%) – It looks like the party is over. It was bound to end eventually as these normally slow-moving stocks took off like rockets after the election. EPD soared over 22% in November to the highest price since 2015. But it has come down over 5% from the high since. That’s okay. That upward trajectory was never going to last. But the future is still bright. There should be more oil and gas sloshing around the country in the years ahead. And EPD can move higher. The stock is still well below the all-time high set in 2014. And now earnings are much higher. (This security generates a K1 form at tax time). BUY

Enterprise Product Partners (EPD)
Next ex-div date: January 30, 2025

FS KKR Capital Corp. (FSK – yield 13.0%) – This Business Development Company (BDC), with an enormous yield and a quarterly payout, went ex-dividend last week and the price only went down a little and has been moving higher again. FSK is a strong beneficiary of the Trump victory. The perception of high economic growth going forward is exactly what FSK needed to make a new high. It has a portfolio of smaller companies that tend to be economically sensitive. The prognosis just got better going forward. BUY

FS KKR Capital Corp. (FSK)
Next ex-div date: March 4, 2025

Main Street Capital Corporation (MAIN – yield 7.5%) – As a BDC, this story is very similar to that of FSK. Main’s portfolio of companies not only makes high-interest loans, but it also takes equity stakes. The equity stakes are the primary reason the total returns have been better than just about every other BDC. MAIN broke out to new all-time highs this year and just made a new one. But the improved economic outlook leaves room for further appreciation. As a cyclical play, MAIN has been hot and has moved up 10% since the election. BUY

Main Street Capital Corp. (MAIN)
Next ex-div date: December 20, 2024

ONEOK Inc. (OKE – yield 3.6%) – There had to be a reckoning. OKE shot up very fast and was bound to come back to earth. That’s why it was downgraded to a HOLD. The midstream energy company stock soared about 20% between the election and late November and had returned 73% YTD. But it has pulled back over 10% in the last couple of weeks. I’m still bullish though. The market loves the new acquisitions of Medallion Midstream and Enlink Midstream (ENLC), as the new additions will be accretive immediately. The story remains strong as recent actions will enhance earnings growth going forward into a future that just got better with the election. HOLD

ONEOK Inc. (OKE)
Next ex-div date: February 1, 2025, est.

The Williams Companies, Inc. (WMB – yield 3.3%) – Ditto for WMB. It was on fire but has leveled off over the past couple of weeks. But it’s still up 60% YTD. The 9% pullback from the high earlier this month is just a cool-off from the recent torrid pace in not only WMB but the midstream energy group. But the future is bright. Williams guided to the upper half of 2024 estimates and is still in an uptrend that began in the middle of February. BUY

Williams Companies, Inc. (WMB)
Next ex-div date: December 13, 2024

AbbVie (ABBV – yield 3.7%) – Although ABBV has been down recently, I really like the way the stock is setting up for next year. It came way off the high and is down 13% since the end of October. The downside catalyst was news that its Schizophrenia drug flopped in phase II trials. But that’s life with big pharma. ABBV is still up 15% YTD. That’s not bad considering this was supposed to be a tough year with shrinking revenues from the Humira patent expiration.

New immunology drugs, Skyrizi and Rinvoq, are expected to replace Humira’s peak revenues in a short period of time. In fact, management estimates that the combined revenue of these two drugs will be over $16 billion this year and $27 billion by 2027, far exceeding Humira’s peak sales. Management expects the company to return to “robust” earnings growth next year. ABBV is getting through this tough year with flying colors ahead of greener pastures. HOLD

AbbVie Inc. (ABBV)
Next ex-div date: January 15, 2025

American Tower Corporation (AMT – yield 3.1%) – Unlike DLR, this cell tower REIT trades like a REIT and is a slave to the interest rate narrative, which took a turn for the worse after the election. DLR trades more like a tech stock because of the growing data center properties, but AMT doesn’t, despite its cell tower properties. But it has moved off the recent low from earlier this month. It’s a growth business as cell tower demand will increase in the future. Hopefully, another leg higher has begun. HOLD

American Tower Corporation (AMT)
Next ex-div date: December 27, 2024

Broadcom Inc. (AVGO – yield 1.2%) – The earnings report from artificial intelligence bellwether Nvidia (NVDA) failed to deliver an upside catalyst for AVGO. The earnings were stellar to be sure. And AI growth is alive and still super strong. But the market has come to expect that, and booming AI growth is largely built into these stocks. However, Broadcom reports earnings this week, and that report should have a more direct effect on AVGO. The stock has leveled off since the fall but it’s still not far from the high. And AVGO is still up over 66% YTD. BUY

Broadcom Inc. (AVGO)
Next ex-div date: December 19, 2024, est.

Cheniere Energy, Inc. (LNG – yield 0.9%) – This liquid natural gas (LNG) exporter is a definite beneficiary of the Trump election. It stands to benefit from a friendlier regulatory environment, more natural gas production and cheaper domestic prices, and encouragement of natural gas exports. LNG has been flying high since the election, although it has been pulling back a little over the past week. The longer-term trajectory should be strong as the world will continue to demand U.S. natural gas and Cheniere is the largest exporter. The short-term situation just got better too. BUY

Cheniere Energy. Inc. (LNG)
Next ex-div date: February 8, 2025, est.

Constellation Energy Corporation (CEG – yield 0.6%) – Yet another huge deal with a big tech company and an electric utility was announced last week. Meta Platforms (META) has chosen Entergy (ETR) to provide electric power for a planned $10 billion data center. The power isn’t nuclear. It’s natural gas. But it continues the trend of big tech companies securing power sources for the massive demands of AI. CEG has returned 110% YTD and 29% since being added to the portfolio. The stock has been bouncing around a lot with the ebb and flow of headlines and hasn’t been trending higher of late. But the new administration will likely bring a more friendly regulatory environment, making more deals likely. HOLD

Constellation Energy Corporation (CEG)
Next ex-div date: February 15, 2025, est.

Digital Realty Trust, Inc. (DLR – yield 2.5%) – This data center REIT made a huge jump after the company stated that demand for data center AI space is booming in the last earnings report. DLR was downgraded to a hold a few weeks ago on price alone. The stock has pulled back since, but it’s still up 43% YTD and 67% since being added to the portfolio in July of 2023. DLR doesn’t trade like most REITs with the ebb and flow of the interest rate narrative. It trades more like a tech stock because of the AI growth catalyst. The future still looks bright as data centers are booming. HOLD

Digital Realty Trust, Inc. (DLR)
Next ex-div date: December 13, 2024

Eli Lilly and Company (LLY – yield 0.6%) – The superstar drug company announced a $15 billion stock repurchase program and a 15% dividend hike on Monday. The repurchase program replaces the $5 billion that was just completed. It is also the seventh consecutive year of a 15% dividend hike. Obviously, these things are good for the stock, but it hasn’t budged on the news. There is still some trepidation in the sector regarding the nomination of RFK Jr. for HHS Secretary. But LLY is unlikely to stay down for long. It is on track to grow earnings by around 70% per year in the years ahead. BUY

Eli Lilly and Company (LLY)
Next ex-div date: February 15, 2025, est.

McKesson Corporation (MCK – yield 0.5%) – McKesson recovered all the summer and fall dip in a very short time, although the stock is down about 5% in December. The pharmaceutical distributor took a plunge after second-quarter earnings missed because of supply disruptions. But the third-quarter earnings alleviated that concern, and the stock took off again. It never took a hit with the rest of the healthcare sector over concerns about the RFK nomination because it won’t be affected. MCK looks to be back on track to continue slowly trending ever higher in the year ahead as its customer base grows all by itself because of the aging population. BUY

McKesson Corporation (MCK)
Next ex-div date: March 2, 2025

Qualcomm Inc. (QCOM – yield 2.1%) – This semiconductor giant reported earnings that surpassed expectations with year-over-year revenue growth of 19% and earnings growth of 80%. The strong quarter was fueled by a wave of launches of flagship Chinese smartphones. The new quarter is off to a strong start as well with automotive sales expected to rise 50%. Despite the good news, QCOM has fallen back to near the low point of the recent range. The market wants to see strong U.S. smartphone sales from an AI upgrade cycle. But that doesn’t appear to be happening yet, although analysts think it is a strong possibility next year. BUY

Qualcomm Inc. (QCOM)
Next ex-div date: March 5, 2025

Toll Brothers, Inc. (TOL – yield 0.6%) Earnings – The luxury homebuilder reported strong fiscal fourth-quarter earnings on Monday that beat expectations. Revenues rose 10.3% and earnings grew 12.6% over last year’s quarter. Toll Brothers also reported that unit sales were up a whopping 25% for the full year versus 2023. But the stock is down about 6% since the report. It looks like a “sell the news” type of deal. The stock is up almost 60% YTD on home demand and improving dynamics. The future still looks great as interest rates should trend lower and the economy is expected to get stronger. BUY

Toll Brothers, Inc. (TOL)
Next ex-div date: January 10, 2025, est.

UnitedHealth Group Inc. (UNH – yield 1.5%) – In a bizarre development the CEO was assassinated last Wednesday. A suspect was arrested this week. In terms of business, it is a distraction, but it shouldn’t prevent the company from getting back on track. UNH is down about 10% since the shooting, and industry peers are down as well. The reaction to the shooting reveals that UnitedHealth isn’t very popular. The company and the industry are getting some bad publicity. The negative press combines with concern about the RFK nomination. We’ll see if the stock bounces back from the recent losses. BUY

UnitedHealth Group Inc. (UNH)
Next ex-div date: March 9, 2025

NextEra Energy (NEE – yield 2.8%) – Things were bad for NEE. Then they got very good. Then things turned rotten again. Now, NEE is leveling off and appears to have found a new-term bottom. Of course, the volatility is from the macro environment and not the internal operations of the company. The regulated and clean energy utility is doing great. NextEra expects to deliver 10% average earnings growth over the next several years, and it has a long track record of successfully delivering. The utility also stands to benefit from the increased electricity demand from AI and data centers, which will opt for clean energy whenever possible. HOLD

NextEra Energy Inc. (NEE)
Next ex-div date: February 22, 2025, est.

USB Depository Shares (USB-PS – yield 5.3%) – The environment is still good for fixed income despite the recent change in interest rate expectations. These securities love falling interest rates. And interest rates are at least not likely to trend higher and may even move lower in the quarters ahead. Everything looks good for this high-yielding fixed-income security. It’s been through the worst bond market ever and now interest rates are trending down. BUY

U.S. Bancorp Depository Shares (USB-PS)
Next ex-div date: January 15, 2025

Vanguard Long-Term Corp. Bd. Index Fund (VCLT – yield 4.9%) – Ditto for VCLT. The long-term corporate bond ETF loves falling interest rates. The long-term bond ETF doesn’t have the upside leverage that USB-PS does. But the trend is likely to serve this security well going forward. BUY

Vanguard Long-Term Corp. Bd. Index Fd. (VCLT)
Next ex-div date: January 2, 2025, est.

Dividend Calendar

Ex-Dividend Dates are in RED and italics. Dividend Payments Dates are in GREEN. Confirmed dates are in bold, all other dates are estimated. See the Guide to Cabot Dividend Investor for an explanation of how dates are estimated.

The next Cabot Dividend Investor issue will be published on January 8, 2025.

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