August 29, 2024

The September Swoon Is Real, but Temporary

It is a late-summer/early-fall rite of passage on Wall Street: After Labor Day, the institutional investors and hedge fund types return from their summer vacation homes in the Hamptons and immediately start selling. They sell out of their weakest positions that have been neglected and left to rot during the summer months, in the hopes of beefing up their quarterly returns before October brings a new quarter. The result is that September is, far and away, the worst month for stocks, with an average decline of -1.17% in the S&P 500 dating all the way back to 1928. The next-worst month is February, with a mere -0.14% decline.

Often, the selling continues on until about mid-October. Indeed, the market bottom in the second half of the last four years has come in October. Here’s the total September/October, post-Labor Day damage in the S&P from each of those years, with the date that the market bottomed:

2023: -8.8%, October 27 bottom

2022: -8.7%, October 14 bottom

2021: -3.9%, October 1 bottom

2020: -4.6%, October 30 bottom

That’s an average loss of 6.5% in September and October, with the selling lasting about 45 calendar days. When you’re in the middle of it, 45 days of selling can feel like an eternity for your portfolio.

Now, here’s the good news: In all four of those years, the S&P has rebounded to eclipse where it was trading the Friday before Labor Day by no later than the third week of November! Put another way, stocks have risen between Labor Day and Thanksgiving in each of the last four years. They just took the bumpiest road possible to get there.

That’s important to remember these next couple months. Yes, there’s a good chance stocks will fall again next month, especially now that they’ve recovered nearly all of their losses from the late-July/early-August mini-meltdown (which itself should serve as a nice reminder of how quickly stocks can rebound in a bull market). When you factor in the added uncertainty of a presidential election, I’d almost bank on some sort of pullback in the coming weeks. Just know that they probably won’t stay down for long – in fact, presidential elections tend to be catalysts for bigger-than-normal rallies in November in December once the election is over (Wall Street doesn’t care which party/candidate wins – it just wants an answer).

Knowing all that, let’s try and view the possible (likely?) September swoon as a buying opportunity. When the selling stops – whether it’s on the first day of October or the last day before the election – it will be a chance to buy the stocks you’ve had on your watch list at better prices.

Every year is different – history rhymes, it doesn’t repeat, as they say – so it’s possible, given that the Fed is all but certain to start cutting interest rates on September 19, that this September’s selloff will be shorter-lived than usual. I still plan on recommending a new stock in our September issue next Thursday, rather than waiting for any theoretical selling to subside. But even if it does get off to a rocky start – or some of the other stocks in our portfolio take on water (within reason) – don’t panic. Chances are they won’t stay down long and may even be higher by the time you carve your Thanksgiving turkey.

Note to new subscribers: You can find additional commentary on past earnings reports and other news on recommended companies in prior editions and weekly updates of the Cabot Value Investor on the Cabot website.

Send questions and comments to chris@cabotwealth.com.

Also, please join me and my colleague Brad Simmerman on our weekly investment podcast, Cabot Street Check. You can find it wherever you get your podcasts, or you can watch us on the Cabot Wealth Network YouTube channel.

This Week’s Portfolio Changes
Canadian Solar (CSIQ) Moves from Buy to Sell

Philip Morris (PM) Moves from Hold to Sell (reached 120 price target!)

Last Week’s Portfolio Changes
Philip Morris (PM) Moved from Buy to Hold

Upcoming Earnings Reports
Wednesday, September 4 – Dick’s Sporting Goods (DKS)

Growth & Income Portfolio

Growth & Income Portfolio stocks are generally higher-quality, larger-cap companies that have fallen out of favor. They usually have some combination of attractive earnings growth and an above-average dividend yield. Risk levels tend to be relatively moderate, with reasonable debt levels and modest share valuations.

Canadian Solar Inc. (CSIQ) missed earnings estimates by a wide margin last Thursday, which sent shares plummeting more than 15% that day. They clawed their way back up to the mid-13s, offering hope that the selling was overdone, but have since been knocked back to the mid-12s, just a couple dimes above their low from last week – which was a six-year low. Because earnings were so bad (just 2 cents per share, way off the 20 cents per share analysts had anticipated and a complete cratering from the $2.62 it earned in the second quarter a year ago; revenue was also down more than 30% year over year), CSIQ is no longer dirt cheap, trading twice as high on a forward price-to-earnings basis (just under 13x now, vs. 6x a week ago) than it was before the report, despite shares being 15% cheaper. So, there’s no way to justify keeping Canadian Solar in the portfolio anymore. If the stock had tumbled on an earnings beat or earnings that were close to flat, as many small caps in particular did in the past quarter, I would be less concerned and would hold out hope for this leading solar stock that’s trading 80% below its 2021 highs. But that wasn’t the case. So, rather than hold and hope for another 2020-like rebound in the renewable energy sector, let’s take the “L” on Canadian Solar and make room for another, perhaps less aggressive stock. MOVE FROM BUY TO SELL

Capital One Financial (COF) is a diversified bank that provides banking services to consumers and businesses, as well as auto loans. Though it is probably best known for its credit cards – if you watch any TV, you’re probably familiar with its, “What’s in your wallet?” tagline. It’s the fourth largest credit card company in the U.S., with $272.6 billion in purchase volume in the first half of 2023 alone. And it’s on the cusp of getting even bigger: Capital One is in the process of acquiring fellow credit card giant Discover Financial (DFS) for $35 billion. If approved, the deal could be completed either later this year or early next year and would make Capital One the largest credit card issuer in the U.S. and the sixth-largest U.S. bank by assets.

Even absent the Discover buyout, Capital One is growing just fine on its own. Its revenues have expanded from $28.5 billion in 2020 to $36.8 billion in 2023; this year, they’re expected to swell another 5%, to $38.7 billion, with another 5% uptick estimated in 2025.

And yet the stock is cheap, trading at a mere 10x forward earnings estimates, 94% of book value, and 1.44x sales. The share price peaked at 177 exactly three years ago, in August 2021; it currently trades at 144.

The bank has caught Warren Buffett’s attention. In May 2023, Berkshire Hathaway disclosed that it had taken out a nearly $1 billion stake in Capital One. With earnings per share expected to rise more than 25% by the end of 2025, and with Discover Financial possibly adding an even greater windfall should the deal gain approval, it’s easy to see why the Oracle of Omaha likes it.

There was no company-specific news for Capital One this week, and yet COF shares were up 3.5% anyway – evidence that investors aren’t terribly concerned about the previous week’s revelation that Buffett had sold 2.65 million shares, reducing Berkshire Hathaway’s position by 21%. Perhaps investors see the bright side: that Berkshire still owns $1.4 billion in COF stock, and more importantly, that the potentially game-changing merger with Discover Financial seems well on track to approval, perhaps as early as later this year, according to Capital One executives.

The stock has recovered nicely from a sharp decline in the first week of August but still has 28% upside to our 185 target price. BUY

Dick’s Sporting Goods (DKS) has been growing steadily for years.

From 2016 to 2023, the sporting goods chain’s revenues have improved 64%, from just under $8 billion to just under $13 billion. This year, the top line is on track to top $13 billion for the first time. It should top $13.5 billion next year.

Dick’s, in fact, has grown sales in each of the last seven years – including in 2020 and 2021, when most other retailers saw sales nosedive due to Covid restrictions. But Dick’s all-weather ability to keep growing no matter what’s happening in the world or the economy speaks to its versatility. Since Covid ended, however, Dick’s sales have entered another stratosphere. As youth sports returned in 2021, Dick’s revenues jumped from $9.58 billion to $12.29 billion. They’ve been rising steadily each year since and are expected to do so again this year.

But Dick’s isn’t purely a growth stock—it’s also undervalued. DKS shares currently trade at just 17x forward earnings estimates and at 1.51x sales. To be sure, it’s not the cheapest stock in our portfolio. But it is one of the fastest growing – and pays a solid dividend to boot.

There was no company-specific news for Dick’s ahead of next Wednesday’s (September 4) earnings report. As a result, DKS shares were virtually unchanged after a big run-up the previous couple weeks.

As for the earnings report, analysts are looking for 34% EPS growth to $3.79, while sales are expected to come in at $3.44 billion, up 6.8% from $3.22 billion in the same quarter a year ago. The company has beaten top-line estimates in each of the last three quarters. We’ll see if they can make it four in a row, despite the elevated expectations.

DKS has 7% upside to our 250 price target, but that target could prove to be conservative if EPS indeed expands another 34% or more in the latest quarter. We’ll know a lot more a week from now. BUY

Honda Motor Co. (HMC) – After years of declining sales, Honda was rejuvenated in 2023 thanks to hybrids. The Japanese automaker sold 1.3 million cars last year, up 33% from 2022; a quarter of the cars it sold were hybrids, led by its popular CR-V sport utility vehicle (SUV) and Accord mid-size sedan. The CR-V was the best-selling hybrid in the U.S. last year, with 197,317 units sold. The Accord wasn’t far behind, with 96,323 sold. All told, Honda’s hybrid sales nearly tripled in 2023, to 294,000 units.

So, Honda is making the full pivot to hybrids, with the Civic soon to become the latest addition to its hybrid fleet. Investors have started gravitating more to the companies that sell them. Invariably, those are well-established, big-name car companies made famous by many decades of selling internal combustion engine vehicles; most aren’t ready to fully abandon their roots but want to tap into the surging national (and global) appetite for electric, so they instead are turning to hybrids as a compromise. As a result, these once-stodgy car companies are tapping into new revenue streams, and their share prices are surging accordingly.

Among the hybrid-rejuvenated, brand-name automakers, Honda offers the best value.

Honda shares continue to strengthen in the wake of another strong quarter for the company, reported earlier this month.

In its fiscal first quarter of 2025, the Japanese carmaker reported an 8.7% year-over-year profit increase on a 17% improvement in global sales, assisted by a 9% uptick in U.S. sales – thanks to growing demand for its hybrid vehicle models here. A weak yen also had a hand in the company’s profitable quarter, adding nearly 48 billion yen ($326 million) to Honda’s quarterly operating profit. A spike in motorcycle sales in Brazil, India and North America also helped the company offset weakness in China, where total sales tumbled 23% due to escalating competition, rampant price cuts and a shift toward all-electric vehicles – an area in which Honda is still playing catch-up. Still, the company maintained its full-year operating profit forecast of 1.42 trillion yen.

HMC shares are up from 29 to 32 since the report, adding another 1.5% this past week, though they remain well shy of their March highs above 37. Looking at the big picture, things look bright: Honda just had another good quarter thanks primarily to the catalyst that convinced us to add it to the Value Investor portfolio – soaring hybrid sales, particularly in the U.S.

HMC shares remain laughably cheap for a major global automaker, trading at 6.6x forward earnings estimates and 0.36x sales. The stock has 38% upside to our 45 price target. The 4.1% dividend yield helps tide us over until the share price becomes more in line with the company’s value. BUY

Philip Morris International (PM) has reached our 120 price target!

It’s tempting, given the ferocity of the stock’s run-up of late – up 38% since the middle of April – to let it ride and see how high the stock can go. But, with the valuation starting to get a bit bloated – PM shares now trade just under 20x forward earnings, a two-and-a-half-year high – let’s stay disciplined and sell (or, to use my predecessor Bruce Kaser’s term for selling stocks that reached their target price, “retire”) PM stock at a hefty 26% return in less than a year, not counting the 4.4% dividend yield.

Philip Morris has done its job beautifully and is the second stock we’ve “retired” in the last couple months (we retired Agnico Eagle Mines (AEM) in late July after a 34% return in less than four months). That’s the goal of the Cabot Value Investor portfolio – finding undervalued stocks that reach our price targets in relatively short order.

If you want to hang on to a portion of your PM shares to try and squeeze out a bit more return, I won’t argue with you. But on the heels of such a fast run-up, with the stock no longer “cheap,” and with the worst month for stocks starting next week, I think it makes sense to just sell the whole thing and open up another spot for a future opportunity that will hopefully have the same success Philip Morris did. MOVE FROM HOLD TO SELL

United Airlines (UAL) – People are flying in planes again in Covid’s aftermath, and no major airline is taking advantage of it quite like United.

United Airlines is the fastest-growing major U.S. airline. The third-largest airline carrier in the world by revenues behind Delta (DAL) and American (AAL), United is expected to grow sales by 5.9% in 2024 – more than its two larger competitors – and that’s with revenues already topping a record $50 billion in 2023 – 19.6% higher than in 2022, which was also a record year. For United, business has not only returned to pre-pandemic levels; it’s better.

Meanwhile, the stock is super cheap. It trades at a mere 4.5x forward earnings estimates, with a price-to-sales ratio of just 0.25 and a price-to-book value of 1.32. The stock peaked at 96 a share in November 2018; it currently trades at 41.

A company that’s making more money than ever before (gross profits reached a record $15.2 billion last year, though earnings were still second to 2019 levels on a per-share basis), and yet its stock trades at barely more than half its peak from five and a half years ago. A true growth-at-value-prices opportunity.

There was no company-specific news for United this week, and UAL shares pulled back a little more than 1% after rallying more than 4% in each of the previous two weeks. Still, at 41 a share, the stock is well below its May highs above 55 and trades below its 200-day moving average of 45. So, we will keep our rating at Hold for now.

But there’s no denying the value – few big-cap stocks that are growing sales (+5.7% in Q2) and earnings (+23.1%) like United can be had for cheaper, at the moment. If you want to buy it here, I won’t argue with you. HOLD

Buy Low Opportunities Portfolio

Buy Low Opportunities Portfolio stocks include a wide range of value opportunities. These stocks carry higher risk than our Growth & Income stocks yet also offer more potential upside. This group may include stocks across the quality and market cap spectrum, including those with relatively high levels of debt and a less clear earnings outlook. The stocks may not pay a dividend. In all cases, the shares will trade at meaningful discounts to our estimate of fair value.

Aviva, plc (AVVIY), based in London, is a major European company specializing in life insurance, savings and investment management products. Amanda Blanc, hired as CEO in July 2020, is revitalizing Aviva’s core U.K., Ireland and Canada operations following her divestiture of other global businesses. The company now has excess capital which it is returning to shareholders as likely hefty dividends following a sizeable share repurchase program. While activist investor Cevian Capital has closed out its previous 5.2% stake, highly regarded value investor Dodge & Cox now holds a 5.0% stake, providing a valuable imprimatur and as well as ongoing pressure on the company to maintain shareholder-friendly actions.

Aviva reported very solid earnings results two weeks ago.

The London-based life insurance and investment management provider reported first-half (rather than quarterly) 2024 results, with operating profits of £875 million, up 14% from the first half of 2023 and ahead of analyst estimates. Insurance premiums increased 15%, which helped, as did a 49% boost in its protections business thanks in large part to the company’s acquisition of AIG Life earlier this year.

The strong quarter prompted this note from Jefferies analyst James Pierce: “Aviva continues to demonstrate strong delivery versus its targets, beating consensus expectations across all its headline metrics. In our view, Aviva remains the only U.K. insurer that can reliably deliver long-term special capital returns, accretive M&A (mergers and acquisitions), attractive ordinary dividend growth, and consistent earnings-per-share growth.”

“Consistent” is precisely how I would describe the company and the stock. AVVIY shares are up about 6% since the report and have pushed to new 52-week highs in the mid-13s. It has only 3.7% upside to our 14 price target, and yet it still trades at less than 12x earnings and a mere 0.34x sales. I may need to raise the price target on the heels of such a strong first half. But for now, we’ll keep it at 14.

The growing and high-yielding (6.5% yield) dividend adds to Aviva’s appeal – and our total return thus far. BUY

CNH Industrial (CNH) – This company is a major producer of agriculture (80% of sales) and construction (20% of sales) equipment and is the #2 ag equipment producer in North America (behind Deere). Its shares have slid from their peak and now trade essentially unchanged over the past 20 years. While investors see an average cyclical company at the cusp of a downturn, with a complicated history and share structure, we see a high-quality and financially strong company that is improving its business prospects and is simplifying itself yet whose shares are trading at a highly discounted price.

CNH reported mixed earnings results at the beginning of this month.

Revenue declined “only” 16% year over year to $5.49 billion, beating analyst estimates of $5.32 billion. Earnings per share of 38 cents were in line with analyst expectations but down from 52 cents in the same quarter a year ago. The company also lowered full-year profit guidance, down to a range of $1.30 to $1.40 from a previous range of $1.45 to $1.55. Declining crop prices coupled with higher production costs have hit farms hard around the world of late, thus lowering demand for farming equipment.

CNH shares are down more than 5% since the report, though they have rebounded nicely in recent weeks and have seemingly left the mid-9s bottom from mid-August well in the rearview mirror. CNH shares are quite cheap, trading at 7x earnings estimates and 0.57x sales.

Given the recent weakness in the stock (down from highs above 13 in early April), we will maintain our Hold rating for now. HOLD

Gates Industrial Corp, plc (GTES) – Gates is a specialized producer of industrial drive belts and tubing. While this niche might sound unimpressive, Gates has become a leading global manufacturer by producing premium and innovative products. Its customers depend on heavy-duty vehicles, robots, production and warehouse machines and other equipment to operate without fail, so the belts and hydraulic tubing that power these must be exceptionally reliable. Few buyers would balk at a reasonable price premium on a small-priced part from Gates if it means their million-dollar equipment keeps running. Even in automobiles, which comprise roughly 43% of its revenues, Gates’ belts are nearly industry-standard for their reliability and value. Helping provide revenue stability, over 60% of its sales are for replacements. Gates is well-positioned to prosper in an electric vehicle world, as its average content per EV, which require water pumps and other thermal management components for the battery and inverters, is likely to be considerably higher than its average content per gas-powered vehicle.

The company produces wide EBITDA margins, has a reasonable debt balance and generates considerable free cash flow. The management is high-quality. In 2014, private equity firm Blackstone acquired Gates and significantly improved its product line-up and quality, operating efficiency, culture and financial performance. Gates completed its IPO in 2018. Following several sell-downs, Blackstone has a 27% stake today.

Gates Industrial also reported earnings in early August, and its results were also mixed.

Earnings per share of 36 cents narrowly topped estimates of 35 cents and were flat year over year. Sales, however, fell just shy of estimates ($885.5 million vs. $893 million expected) and were down 5.4% year over year. The relatively “blah” report – neither good nor overly bad – initially triggered some fierce selling in GTES shares (the stock was down 13% in the first week of August), but it appears the worst is behind it, and the stock has recovered most of those losses, touching as high as 18 late last week. It remains our best performer, up more than 65%, and the stock has 13% upside to our 20 price target. It trades at just 13x forward earnings estimates. BUY

NOV, Inc (NOV) – This high-quality, mid-cap company, formerly named National Oilwell Varco, builds drilling rigs and produces a wide range of gear, aftermarket parts and related services for efficiently drilling and completing wells, producing oil and natural gas, constructing wind towers and kitting drillships. About 64% of its revenues are generated outside of the United States. Its emphasis on proprietary technologies makes it a leader in both hardware, software and digital innovations, while strong economies of scale in manufacturing and distribution as well as research and development further boost its competitive edge. The company’s large installed base helps stabilize its revenues through recurring sales of replacement parts and related services.

We see the consensus view as overly pessimistic, given the company’s strong position in an industry with improving conditions, backed by capable company leadership and a conservative balance sheet.

There was no company-specific news for NOV this week, and the share price was unchanged. Crude oil prices were up a bit after dipping below $72 a barrel a week ago, but remain well shy of the $80-plus level from June and July. Fortunately, NOV is still just a few weeks removed from a very strong quarter in which revenue ($2.22 billion) improved 5.9% from the second quarter of 2023; earnings per share ($0.57) improved 46%; and profit margins increased from 7.4% to 10%. Its adjusted EBITDA margin came in at 12.7%, the highest since 2015. Energy equipment accounted for more than half of total revenues ($1.2 billion) and was up 8% year over year.

NOV shares were initially gobbled up after the report, rising to six-month highs near 21, but market forces and tumbling oil prices conspired to knock the stock back down to pre-earnings lows in the high 17s. That’s where they remain.

The stock is 36% below our 24 price target. And shares are quite cheap, trading at 11x earnings estimates and at 0.80x sales. BUY

Note for stock table: For stocks rated Sell, the current price is the sell date price.

Current price is yesterday’s mid-day price.

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