Cabot Value Investor Issue: February 6, 2025

Two Years Removed from a Crisis, U.S. Banks are Thriving

The banks are back!

Less than two years after the overnight collapses of Silicon Valley Bank and Signature Bank – two of the largest U.S. banks to fail since the Great Depression – banks are leading the charge this earnings season. According to data compiled by FactSet, the year-over-year earnings growth rate for financials in the fourth quarter thus far is 50.7%, the best of any sector. Banks have been the biggest contributors to that growth, with a whopping 216% EPS growth on average. That comes with a caveat: GAAP earnings per share for banks were weaker than normal in the fourth quarter a year ago due in large part to significant charges related to FDIC special assessments, resulting in easy comparisons this year. Still, even if you subtract out the special assessment from Q4 2023, year-over-year EPS growth for financials would still be 18.8%.

So, what changed for the banks? For starters, the economy improved. After inflation spiked to four-decade highs above 9% in June 2022, it fell to 3% a year later and has been below 3% since last July. That prompted the Fed to (finally) start slashing interest rates from multi-decade highs last September, and while the pace of their cuts is going to be slower than it appeared at first blush after the Fed came out of the gates hot with a 50-basis-point cut, they still have slashed rates by a full percentage point – from a range of 5.25%-5.5% in September to a 4.25%-4.5% range now – in a matter of months and are likely to trim rates by another 50 basis points this year, according to their own dot plot.

Meanwhile, the U.S. economy has been resilient, with no long-feared recession in sight. Gross domestic product (GDP) growth has been between 2.5% and 2.9% for the past three years, virtually identical to its average from 2013-2019 before Covid arrived in 2020, and not far off its 3.2% average since 1947.

The combination of a strong post-Covid economy, inflation dropping back near normal historical levels, and lower borrowing costs (or at least the promise of lower borrowing costs; mortgage rates in particular have remained stubbornly high) has revived U.S. banks in the last two years. In addition, the Silicon Valley/Signature banking collapse of March 2023 served as perhaps a needed wake-up call for U.S. banks desperately wanting to avoid another full-scale banking collapse just 15 years removed from the 2008-09 subprime mortgage crisis. So, most of them restructured their securities portfolios to ensure they had more cash on hand, investing in higher-yielding assets and selling out of lower-yielding securities with longer-dated maturities, and steered customers to fee-based services like wealth management.

Now, with the (re-)election of an “America First” president in Donald Trump, who has also vowed to do away with the types of strict regulations that under Joe Biden may have curbed potential mega-deals in the banking sector like the proposed $35 billion merger between former Cabot Value Investor holding Capital One Financial (COF) and Discover Financial Services (DFS), it has become a perfect storm for U.S. banks.

And yet, even after a year of outperformance – the S&P 500 Banks Industry Group is up 47% in the last year – many bank stocks remain undervalued, trading at a mere 15.47x forward earnings estimates. Only the energy (11.5) and basic materials (14.87) sectors are cheaper right now. And neither of those sectors are growing like the banks are right now.

So today, we add a premiere U.S. bank to the Cabot Value Investor portfolio. It’s a bank that keeps getting up off the mat and is now growing faster than most of the other big banks.

New Buy

Bank of America (BAC)

At times, Bank of America has been a punchline.

Like in 2007-2008, when in the throes of the Great Recession BAC stock lost 93% of its value. Or in 2022-2023, when shares were sliced in half as the double whammy of a bear market and the aforementioned Silicon Valley/Signature banking collapse sparked a selloff in anything related to banks. But BAC keeps bouncing back. And while the share price has never again reached its 2006 heights near 54, I think there’s a good chance it could get there soon.

The bank has never been more profitable or generated more revenue. Of the eight largest U.S. banks by assets (Bank of America is second only to JPMorgan), only Goldman Sachs (GS) is expected to grow sales faster than Bank of America’s 6.15% this year. And despite growing earnings at an estimated 14.3% this year, BAC stock trades at just 12.8x forward earnings estimates, cheaper than the 15.5x average.

In the fourth quarter, profits more than doubled to 82 cents per share – benefitting from the comparison to last year’s $2.1 billion FDIC assessment weighing down Q4 2023 results … but still double the average EPS growth for banks this quarter. Revenues, meanwhile, improved 15%, topping estimates. Equities revenue improved 6% in the quarter while net interest income improved 3%. Both those numbers also exceeded expectations.

Recommending the second-largest bank in America – one literally called Bank of America – may seem cliché and obvious in a time of accelerating growth for America’s banks. It’s been a favorite of Warren Buffett’s for years – it’s still the third-largest position in the Berkshire Hathaway portfolio even after the holding company sold $9 billion of the stock in the third quarter last year. (Berkshire has been trimming positions across all sectors of late, as it holds a record $325 billion in cash.) So, we’re not breaking any new ground here. But sometimes the obvious choice is the right one. The combination of growth, value (BAC trades at just 1.3x book, cheaper than all but Citigroup among the big banks), and share price momentum – the stock is up 43% in the last year, virtually double the 22% runup in the S&P, and 6.5% year to date – makes for an enticing formula.

Wall Street certainly sees plenty of upside. The average price target on the stock is 52.6, with a high of 59. While I can’t quite go as high as 59 – the stock would be trading at 16x EPS estimates at those levels – I think new all-time highs of 57 (or 22% higher than the current price) is a perfect reasonable short- to intermediate-term goal. I think BAC could get there this year. BUY

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
New Buy: Bank of America (BAC) with a 57 price target

Last Week’s Portfolio Changes
Dick’s Sporting Goods (DKS) Moves from Buy to Hold

Upcoming Earnings Reports
Thursday, February 6 – Peloton Interactive (PTON)

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.

BYD Company Limited (BYDDY) has long been one of China’s top automakers. What really sent its sales into hyperdrive, however, was when it made the switch to all battery electric and hybrid plug-in vehicles in 2022. Revenues instantly tripled, going from $22.7 billion in 2020 (a record, despite the pandemic) to $63 billion in 2022. In 2023, sales improved another 35%, to $85 billion. In 2024, it’s on track for $106.4 billion, or 25% growth, with another 20% growth expected in 2025. The EV maker has emerged as a legitimate rival to Tesla.

But there’s even greater upside. Right now, BYD does roughly 90% of its business in China, accounting for one-third of the country’s total sales of EVs and hybrids this year. The company is trying to change that, recently opening its full-assembly plant outside of China, with a new plant in Thailand starting deliveries. A plant in Uzbekistan puts together partially assembled vehicles. A plant in Brazil is expected to open early next year. And BYD has plans to open more new plants in Cambodia, Hungary, Indonesia, Pakistan and Turkey. Mexico and Vietnam are possible targets as well. Despite no plans to do business in America just yet, BYD is on the verge of becoming a global brand.

And while BYDDY stock has fared well, it hasn’t grown as fast as the company. At 16.1x earnings estimates, BYDDY currently trades at less than 20% of its five-year average forward P/E ratio (89.6). And its price-to-sales (1.10) ratio is about half the normal five-year ratio. As BYD continues to expand globally, look for its valuation to catch up with its industry-leading performance.

BYDDY shares were up 2.7% this past week, going against the grain of other Chinese ADRs (American Depositary Receipts) in the wake of Donald Trump’s new 10% tariffs on China since BYD doesn’t sell cars in America yet, making it the rare Chinese large cap that’s immune to another U.S.-China trade war. Instead, it’s expanding to other corners of the globe, with a new $1 billion production facility set to open in Indonesia by year’s end, and sales in Japan surging less than two years after the company debuted its Atto 3 vehicle there in 2023. BYD, in fact, sold more EVs in Japan last year than Toyota!

BYD already dominates China, where it does 90% of its business. Now it’s striving for a global takeover. I wouldn’t bet against them, and our 90 price target looks rather modest. BUY

The Cheesecake Factory Inc. (CAKE) is ubiquitous. With 345 North American locations, chances are you’ve eaten at one, indulged in their specialty high-calorie but oh-so-tasty cheesecakes and browsed through menus long enough to be a James Joyce novel. But despite being seemingly everywhere already and nearly a half-century old, the company is still growing.

Sales have improved every year since Covid (2020), reaching a record $3.44 billion in 2023. In 2024, revenues are on track for $3.57 billion. But the earnings growth is the real selling point. EPS more than doubled in 2023 (to $2.10 from 87 cents in 2022) and are estimated to swell to $3.31 in 2024, a 57.6% improvement, and to $3.69 this year.

It’s still expanding too, opening 17 new restaurants through the first three quarters of 2024. It expects to open a total of 22 new restaurants by year’s end. Those aren’t just Cheesecake Factories – the company also owns North Italia, a handmade pizza and pasta chain; Flower Child, a health food chain that caters to those with special diets (vegetarians, vegans, gluten-free, etc.); and Blanco, a Mexican chain owned by Fox Restaurant Concepts, which The Cheesecake Factory Corp. acquired in 2019.

Despite some recent strength in the stock, CAKE shares trade at 15.2x 2025 EPS estimates and at 0.78x sales. The bottom-line valuation is still below the five-year average forward P/E ratio of 15.6; the price-to-sales ratio is in line with the five-year average.

With shares trading at roughly 13% below their 2017 and 2021 highs, there’s plenty of room to run.

CAKE shares continue to rise despite no news, tacking on 3% this week. They’re now up a whopping 16.6% year to date!

The company reports earnings on February 19, which is likely the next bit of news. In the third quarter, reported in October, sales improved by 4.2% while diluted EPS expanded by 65%. Same-store sales increased 1.6%. The strong quarter got Wall Street’s attention: six major firms have either upgraded their price target or initiated coverage on CAKE since the report.

CAKE shares have 18% upside to our 65 price target. The 1.9% dividend yield adds to the appeal. 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. In 2024, the top line is on track to top $13 billion for the first time. It should top $13.5 billion in 2025.

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 under 16x forward earnings estimates and at 1.5x 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.

A week after nearly reaching our 250 price target, DKS shares pulled back about 4% this week on no news. Last week, Argus Research became the third major Wall Street firm to raise its price target on DKS in the last month, bumping theirs from 255 to 280. Should we bump ours up too? Trading at nearly 17x forward earnings and with no immediate obvious catalysts (earnings aren’t due until mid-March), I’m inclined to say no. But let’s cross that bridge when we get there. As is, DKS shares still have more than 5% upside to our price target.

Given the limited upside and escalating valuation, we downgraded the stock to Hold last week. Let’s keep it right there. BUY

Toll Brothers (TOL) – Historically, when the Fed cuts interest rates, homebuilder stocks are among the first to benefit. Indeed, in 2019 and early 2020 (before Covid hit), during which the Fed cut rates from 2.5% to 1.5%, homebuilder stocks were up 64%, more than double the 30% bump in the S&P 500. Now, with the Fed finally cutting rates for the first time in four and a half years, the homebuilders are undervalued, trading at 13x forward earnings. Toll Brothers is even cheaper, trading at 9.4x estimates – and growing faster than the average bear. In fiscal 2024, revenue improved 10% year over year while adjusted EPS was up 12.7%, which compared favorably to 2023 results (13.6% EPS growth on a 2.7% downturn in revenues).

Toll Brothers isn’t the biggest homebuilder in the U.S. – its $10.5 billion in revenue last year paled in comparison to the likes of D.R. Horton’s ($35 billion), PulteGroup’s ($16 billion), or Berkshire Hathaway holding Lennar’s ($34 billion). But it’s cheaper and growing faster than all of them.

As Treasury yields have dipped below the magical 4.5% threshold, Toll Brothers shares have rebounded, up 7.7% year to date despite pulling back a little more than 1% this week as rates mostly held firm, though they finally broke below the 4.5% threshold on Wednesday, prompting a nice bump in TOL shares. There’s been no major company-specific news, so right now the falling rates are the primary catalyst. Last week’s Jerome Powell press conference neither helped nor hindered the interest-rate narrative, which qualifies as a win compared to the last couple Fed announcements.

Mortgage rates remain stubbornly high at just under 7% for a 30-year loan. Until those drop in a meaningful way, TOL’s upside may be limited. Even a dip to the low 6% range for the first time since October would likely have a positive impact on homebuilders.

We are now almost back to breakeven on our TOL position. The stock has 23% upside to our 180 price target. BUY

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 7.3% in 2025 – more than its two larger competitors – and that’s with revenues already topping a record $53 billion in 2024 – 6% higher than in 2023, 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 scant 8.5x forward earnings estimates, with a price-to-sales ratio of just 0.63.

A company that’s making more money than ever before (gross profits reached a record $15.2 billion in 2023, 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.

United Airlines (UAL) is coming off another record quarter, reported late last month. Revenue came in at $14.7 billion, ahead of the $14.47 billion analyst estimate, while adjusted earnings per share came in at $3.26, well ahead of the $3.00 estimate. Sales improved 8% year over year while net profits increased 64%. Better yet, United upped its EPS guidance for the current quarter, to a range of 75 cents to $1.26 – way beyond the 54-cent analyst estimate.

Soaring travel demand post-Covid, a booming loyalty program, and higher prices for seats, especially in business class, helped buoy United to its best year ever. Meanwhile, its cheaper economy seats saw a 20% sales bump in Q4.

The latest stellar quarter from United has pushed shares up another 5% initially, though UAL has been mostly stagnant the last couple weeks. Having added UAL to the Cabot Value Investor portfolio last May, we now have a 116% gain on it. We sold half our position in November after the stock blew past our 70 price target. It’s just kept on rising since and has actually outperformed Nvidia (NVDA) in the past year.

Is a comeuppance coming? Perhaps. But UAL has shown zero signs of one, even as the market flailed for six weeks in December and early January. And the stock is still cheap, trading at 8.5x EPS estimates and 0.63x sales. So let’s ride our remaining half position until the stock gives us a reason to part ways with it. HOLD HALF

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.

ADT Inc. (ADT) is literally a household name.

It’s a 150-year-old home security company whose octagon-shaped blue signs with white lettering that say “Secured by ADT” are ever-present in neighborhoods across the country. ADT provides security to millions of American homes and businesses, with products ranging from security cameras, alarms and smoke & CO detectors, to door/window/glass break sensors and more, all of which can alert one of ADT’s industry-best six 24/7 monitoring centers if any one of those security systems is breached.

Business has been fairly stable, with annual revenues hovering in the $5 billion range for four of the last five years (2021 was an exception, with a dip down to $4.2 billion during Covid) and is on track to do it again both this year and next. But where the century-and-a-half-old company has really improved of late is profitability. The last two years marked the first time the company has been in the black in consecutive years, with earnings per share going from 15 cents in 2022 to 51 cents in 2023; in 2024, EPS is expected to improve another 43%, to 73 cents, and then to 83 cents (+14%) in 2025.

All of that EPS growth makes the share price look quite cheap. ADT shares currently trade at just 10.2x earnings estimates and at just 1.37x sales. A solid dividend (3.0%) adds to the appeal of this mid-cap stock.

ADT shares hit the pause button this week after a big (10%) runup in January, all on no news. The stock is still shy of its October highs above 8, but the trend of the last month-plus is encouraging.

There’s been no real news since late October when ADT reported earnings that beat on both the top and bottom lines. Adjusted EPS of 20 cents topped 17-cent estimates, while revenues ($1.24 billion) narrowly edged estimates ($1.22 billion) and marked a 5% year-over-year improvement. EBITDA ($659 million) also came in slightly higher than expectations. Meanwhile, the company maintained its full-year revenue guidance of $4.9 billion and raised EPS guidance to 73 cents at the midpoint – a 3.6% increase. Its recurring monthly revenue reached $359 million, a new record.

The numbers weren’t jaw-dropping, but there was a lot to like in the report, and investors quickly snatched up ADT shares accordingly – they were trading below 7 prior to the report. They eventually sagged back to pre-earnings levels but are now gaining steam again. But the stock remains cheap, trading at less than 10x forward earnings. The shares have 33% upside to our 10 price target. BUY

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 as well as ongoing pressure on the company to maintain shareholder-friendly actions.

Aviva has finalized its agreement to buy Direct Line Insurance Group for 3.7 billion pounds ($4.65 billion), creating the largest motor insurance company in the United Kingdom. The deal is expected to be completed by mid-2025. AVVIY shares were down more than 7% in the weeks after its Direct Line takeover was first reported on November 27 – which is normal share price action for the acquiring company. But they have since recovered all of their losses and are up 7.5% year to date and trading near their highest point since October.

AVVIY shares have 9% upside to our 14 price target. The 6.9% dividend yield adds to our healthy return thus far. BUY

The Cigna Group (CI) is the fifth-largest healthcare company in the U.S., with $247 billion in revenue over the last 12 months. It’s a health benefits and medical care provider with a market cap of $80 billion, 170 million customers in over 30 countries, that pays a dividend (1.9% yield) and grew sales by 27% and adjusted earnings by 9% in 2024 and is expecting another 10% growth this year. And yet, the stock hasn’t budged much in two years and trades at a mere 9.8x earnings estimates and 0.33x sales. It’s the cheapest CI shares have been in more than a year.

Why the underperformance? Earnings have been inconsistent, with EPS declining 18.8% in 2023 and by 31.4% in 2021. But that appears to be changing, with double-digit growth last year and expected again in 2025, led by its Evernorth Health Services branch, which reported 33% revenue growth in the latest quarter. And healthcare stocks as a group were the second-worst performer of the 11 major S&P 500 sectors in 2024, up a mere 0.87%. As Baby Boomers reach their golden years, healthcare is more in demand than ever, so the sector won’t stay down long. And CI has a habit of outperforming when times are good.

Cigna reported rather mixed fourth-quarter earnings last week. First, the good news: revenues improved 28% year over year, and were 4% higher than estimates. For full-year 2024, sales improved 27%, while earnings per share climbed 9%. The bad news? Profits in Q4 declined 2.2% and were short of estimates by 15%. The reason for the EPS shortfall was mostly due to rising medical costs and a declining customer base, which fell 3.2% year over year, though premium rate hikes helped boost revenues. Cigna’s cash and cash equivalents slipped 3.5% to $7.6 billion.

The underwhelming quarter prompted three Wall Street firms to lower their price targets on the stock. However, all three of their price targets are now in the 340 range – roughly 17% higher than the current price. Should we follow suit and reduce our 420 price target? Let’s see how the stock responds first. After an initial 6.5% selloff, CI shares have bounced back to recover about half those losses. All told, the stock isn’t that much lower now than it was a week ago, and shares are still up more than 6% year to date. Meanwhile, the company is upping its dividend by 8%, to $1.51 per share per quarter, starting on March 20.

So, we will maintain our Hold rating on CI for now. I wouldn’t start a new position in it just yet coming off such a mixed quarter, but if you own some, hang in there. It’s possible the post-earnings selling was overdone. HOLD

Peloton (PTON) was all the rage during Covid, as people stuck at home snatched up the stationary bike with a built-in, interactive touch screen like hotcakes, and revenues quadrupled in two years. Then, Covid ended, people stopped buying Pelotons, and PTON shares – up 700% in the last nine months of 700% – fell to nearly zero, at a scant $3 per share. The selling was overdone, considering Pelton’s sales only fell off by about a third. Now, the bleeding has just about stopped, and the company is expecting to grow again in the coming year. Aggressive cost-cutting – the company is lowering costs by $200 million this (2025) fiscal year alone – has narrowed profit losses and allowed Peloton to generate free cash flow again. It’s using that cash to attract and retain customers, investing in software updates such as personalized workout plans and private “teams” for every subscriber. It’s offering new apps such as Strength+ and fitness “games.” And it is exploring new strategic partnerships to broaden its reach and perhaps start attracting new customers again.

Meanwhile, the company just underwent a regime change – always an appealing catalyst for turnaround candidates. Former Ford executive Peter Stern has taken over as CEO, assuming the helm from embattled former CEO Barry McCarthy after two mostly unsuccessful years on the job.

Add it all up, and suddenly there are a lot of potential catalysts for Peloton for the first time since the pandemic. And the stock has become grossly oversold, currently trading at 1x sales, about a quarter of its five-year average and galaxies below the 20x P/S ratio from late 2020 and even the 6.9x sales shares were going for in late 2021.

Peloton reports earnings this morning, before the opening (but after time of publication). Estimates are mixed: sales are seen down 12.15%, while earnings per share is on track for a 19-cent loss – a 64.7% improvement from last year’s 54-cent loss. The company has handily beaten bottom-line estimates in each of the last two quarters. We’ll see if Q4 estimates were similarly conservative.

Ahead of the report, PTON shares were down 4.5% this week, and the stock has been backtracking all year, down 16% thus far. Perhaps another earnings beat can right the ship. PTON stock has 58% upside to our 12 price target. BUY

The next Cabot Value Investor issue will be published on March 6, 2025.

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