December 19, 2024

Programming Note: You will receive your next Cabot Value Investor update as normal next Thursday, December 26, but it will be a shorter, more condensed version due to the Christmas holiday the day before. Happy holidays, everyone!

The “Under-the-Radar” Correction Is Here

The Dow is in a tailspin.

After Wednesday’s Fed-ignited selloff, the 118-year-old index has now fallen for 10 consecutive days – its longest string of down days since 1974. Prior to yesterday, the index hadn’t fallen much during the first nine days of this losing streak, down just 3.47%; but yesterday’s 2.58% decline stretched those losses to an even 6%. So what once was a modest pullback is now hurtling toward a correction.

We’re still in a bull market, and both the S&P 500’s and Nasdaq’s losses have been minimal over the last 10 days - the Nasdaq was actually up 2% over that span entering Wednesday.

Why the disparity?

This is where having only 30 stocks in your index can be a detriment. The Dow is being weighed down by two stocks in particular over the last 10 trading days: UnitedHealth (UNH), which has fallen more than 20% during that time, and new addition Nvidia (NVDA), which has cooled off in the form of a 7% drop. While the Dow does have fellow Magnificent Seven stocks Amazon (AMZN) (+8.3% in the nine days prior to Wednesday), Microsoft (MSFT) (+5.4%), and Apple (AAPL) (+4.5%), it does not have Tesla (TSLA) (+34% in those same nine days) or Google (GOOG) (+12%), both of which have helped prop up the S&P and Nasdaq this month.

Is the Dow a more accurate reflection of what’s actually happening in the market these last couple weeks? Perhaps. Small caps, as measured by the Russell 2000, are down a whopping 8.1% in December. The Equal Weight S&P index is off 6.8%. And value stocks have declined 7.2%. And according to Ryan Detrick of Carson Research Group, there have been 12 straight days (entering Wednesday) of more decliners than advancers in the S&P 500 – the longest such streak since 1990.

So, this is a full-blown “under-the-surface” selloff. Perhaps yesterday was the beginning of it spilling into the S&P and Nasdaq. I wrote in this space last week that I expected as much, especially once the calendar flips to January. The market is due for some sort of pullback, maybe even a correction, having avoided its usual October bottoming phase (that instead came two months earlier, in early August, this year). But even a more widespread pullback will be temporary. And some more numbers from Detrick support that theory.

According to Detrick, since World War II, there have been seven other occasions in which the Dow was down for nine straight days. The index has been higher one year later every time, with an average gain of 19%.

That doesn’t automatically mean it will happen again. But with all the factors I mentioned last week (ongoing Fed rate cuts, even if they’re at a slower pace than anticipated; a strong economy and jobs market; the ongoing AI boom, etc.) putting some wind at the market’s back, I fully expect stocks to be much higher a year from now and this long Dow losing streak to be little more than a historical footnote.

‘Tis the season for optimism, even after a bad day for the market. Happy holidays!

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
Cigna (CI) Moves from Buy to Hold

Last Week’s Portfolio Changes
None

Upcoming Earnings Reports
None

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. Last year, sales improved another 35%, to $85 billion. This year, 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 15.9x 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 (1.07) 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.

BYD’s Xi’an, China factory has produced 1 million cars (and counting) in 2024, making it the most productive electric vehicle factory in China – a third more productive than Tesla’s largest China factory. The news only modestly moved the needle for BYDDY shares – which were flat for the week – Tuesday, but it’s symbolic of BYD’s dominance in China. The company expects to produce 4 million total vehicles in 2024. And with plans to expand into other corners of the globe – including India’s massive market – BYD’s production and delivery tallies should soar in the coming years.

BYD is becoming an equal to Tesla. But Wall Street has yet to treat it as such. Thus, we set a 90 price target on the stock, giving it 29% upside from here. Long term, that seems pretty conservative. It’s probably my favorite stock in this portfolio as we head into 2025. 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 last year. This year, 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 next year.

It’s still expanding too, opening 17 new restaurants year to date. 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 just 13.8x 2025 EPS estimates and at 0.69x sales. The bottom-line valuation is well 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 20% below their 2017 and 2021 highs, there’s plenty of room to run.

There was no company-specific news for The Cheesecake Factory this week. Shares were down about 1.5%, likely in sympathy with the modest pullback in the market. Also, CAKE is two weeks removed from getting a 10% bump right after Black Friday launched the holiday shopping season, so some consolidation isn’t unexpected.

The last bit of company-specific news came in late October when the company reported Q3 earnings, which were solid. Sales improved by 4.2% while diluted EPS expanded by 65%. Same-store sales increased 1.6%. Initially, the impressive quarter did little for the share price. Now it’s playing catch-up.

I’ve set a price target of 65, 31% higher than the current price. The 2.1% 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. 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 15.3x forward earnings estimates and at 1.4x 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 this week, and yet shares continued to climb in the wake of the company’s late-November earnings report, up 1%. It was yet another solid quarter for the sporting apparel giant. Both sales and earnings topped estimates and, perhaps more importantly, the company raised full-year same-store sales guidance to a range of 3.6% to 4.2%, up from the previous range of 2.5% to 3.5%. Earnings per share improved 15% year over year, while sales ticked up only slightly. The company credited a robust back-to-school shopping season for its strength in the third quarter. Also, Dick’s is expanding its new House of Sport concept – 100,000-square-foot arenas that feature rock climbing walls and running tracks. It expects to open 15 new ones next year and is aiming for a range of 75 to 100 nationwide by 2027.

DKS shares are now up 10% since the earnings report. They have 13% upside to our 250 price target. 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 9.3x 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.

Toll Brothers shares continued to fall in the wake of last week’s (December 9) fourth-quarter and full-year 2024 earnings report.

Both the top and bottom lines easily topped estimates. In its fiscal fourth quarter, revenues came in at $3.33 billion, handily beating estimates of $3.17 billion and up 10% year over year. Adjusted earnings per share came in at $4.63, 7.7% higher than estimates and up 12.7% year over year. The company also increased its full-year guidance, forecasting new homes built between 10,650 and 10,750 homes for the year, with an average price of $975,000, a $10,000 increase from previous estimates.

For full-year 2024, the company reported $10.6 billion in revenue, a new record, and an 8.5% improvement over 2023.

Nothing wrong with those numbers. And yet, the stock has been sold off, down 13% since the report. It likely has less to do with earnings and more to do with interest rates, which are on the rise again, up 5% since the report and encroaching on November highs. Perhaps Wednesday’s 25-basis-point rate cut will halt that trend. Amazingly, yields on the 10-year Treasury are up more than 17% in the three months since the Fed started reducing the federal funds rate, which has now been slashed by 100 basis points. Eventually, that will bring down interest and mortgage rates (up more than 8% in those three months). When it happens, Toll Brothers and homebuilders as a group will finally get going.

For that reason, I am maintaining our Buy rating on TOL despite recent weakness. Our price target is still 180, or 36% higher than the current price. 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 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 scant 7.6x forward earnings estimates, with a price-to-sales ratio of just 0.56.

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.

UAL shares have finally entered a rest period, pulling back about 1.5% in the last two weeks. Considering the stock had essentially doubled in the previous six months, breaking above previous highs from 2018, modest consolidation seems perfectly normal. A sharper pullback could prompt us to sell, but for now, it appears UAL remains in Wall Street’s good graces.

Having blown past our 70 price target more than a month ago, we’ve already booked profit on half our position and are holding the remaining half until UAL encounters some real turbulence. In the heart of holiday travel season, I don’t expect that to happen until at least the new year. 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; this year, 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 9.3x earnings estimates and at just 1.25x sales. A solid dividend (3.1%) adds to the appeal of this mid-cap stock.

ADT shares continued their recent slide, falling another 4.5% after a 3% pullback the previous week. There was no news, so the selling is likely at least partly market-driven.

In late October, ADT reported earnings that beat on both the top and bottom lines, prompting a 7% boost in shares since. 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. But the stock remains cheap, trading at 9.3x forward earnings. The shares have 41% 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.

It appears Aviva’s hostile takeover of U.K. motor insurance company Direct Line is going to work. After Direct Line rejected its initial takeover bid of 3.4 billion pounds, Aviva upped its price to 3.6 billion pounds, or $4.6 billion, on which Direct Line has signed a preliminary agreement. The acquisition would give Aviva the lion’s share of the U.K. motor insurance market, creating an entity with a combined market cap of $21.2 billion, up from its current $15.87 billion. That gives AVVIY shares 40% upside from their current price. Given this potential merger, our 14 price target is starting to look conservative, especially after AVVIY shares fell 2% this week to dip back below 12 per share. BUY

The Cigna Group (CI) is the fifth-largest healthcare company in the U.S., with $229 billion in revenue over the last 12 months. It’s a health benefits and medical care provider with a market cap of $82 billion, 170 million customers in over 30 countries, that pays a dividend (1.8% yield) and is on track to grow sales by 25% and earnings by 13.5% this year and another 10.8% next year. And yet, the stock hasn’t budged much in two years and trades at a mere 8.4x 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% last year and 31.4% in 2021. But that appears to be changing, with double-digit growth expected both this year and next, led by its Evernorth Health Services branch, which reported 36% revenue growth in the latest quarter. And healthcare stocks as a group have been the worst performer of the 11 major S&P 500 sectors in 2024, up a mere 5.7%. 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.

Our timing wasn’t the best here. We added Cigna (CI) to the portfolio just before the murder of UnitedHealth Group (UNH) CEO Brian Thompson shined a light on societal anger toward health insurers; before lawmakers began threatening big pharma companies to sell off their pharmacies; and before President-elect Donald Trump singled out pharmacy benefit managers – known short-hand as “middlemen” – as being “horrible,” vowing to “knock them out.”

That’s quite a two-week stretch of bad headlines. And it’s taken a toll on healthcare stocks, which are down more than 5% in December after already entering the month as the worst-performing sector of 2024. As one of the biggest health insurers in the U.S., Cigna has been in the crosshairs more than most healthcare stocks of late, hence the 17% dropoff this month.

None of that rhetoric changes the fact that Cigna is still growing just fine, or that the stock is undervalued (even more so now), or that, as one of the largest healthcare companies in the U.S., it should benefit from the unstoppable trend of an aging population. I’m going to downgrade CI to Hold until the bleeding stops for it and other healthcare stocks. If you already bought on my recommendation two weeks ago, hang in there. If you haven’t, hold off for now. But I think the worst of the selling may be close to over, and soon this imperfect storm will pass. MOVE FROM BUY TO HOLD

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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