November 14, 2024

Embrace the Honeymoon Phase

The honeymoon phase for a second Trump term continues on Wall Street. Stocks are up 3.5% in the week since Trump won the election, with all three of the major indexes advancing to new all-time highs. The reaction is being framed as specific to Donald Trump and his potential influence on stock prices – the so-called “Trump Trade” – but in reality, this is nothing new.

In recent years, there’s always been a honeymoon phase for stocks after a presidential election – regardless of which party or candidate won. And it typically lasts until the newly elected president’s inauguration in late January.

In 2020, when Joe Biden won, the S&P 500 was up 14.3% from election day until his inauguration on January 20.

In 2016, after the first Trump victory, the S&P was up 6.6% in the two and a half months between his election and inauguration.

In 2012, after initially pulling back the first week to 10 days after Barack Obama was elected to a second term (re-elections are never as exciting to the markets as a shiny new, or newish administration, like Trump 2024, in office), stocks rallied the last six weeks of the year and didn’t stop rallying until mid-April of 2013, gaining 11.5% in just over five months following Obama’s election to a second term.

The market is apolitical. It doesn’t care who wins presidential elections. It just is happy the election is over. Beyond that, stocks – led by certain sectors – rise on the promises of what could be under the new administration. It’s not quite “buy the rumor, sell the news” – stocks haven’t exactly backtracked after the new president was sworn in in 2016 and 2020. But the best period to buy stocks after an election in which the incumbent party loses is those two and a half months before the inauguration, as evidenced by the 10.5% average gain during that short period after the last two elections.

In 2020, 40% of the gains in Biden’s first year after being elected came before he was sworn in. In 2016, 31% of the gains in Trump’s first year after election came prior to his inauguration. Stocks typically fare well in a president’s first year in office. But the biggest gains occur right after the election.

Translation? Now is the time to buy stocks! The fast start after Trump’s victory is nothing new. And it’s likely just the beginning, especially if you sprinkle in the added tailwind of the Fed’s new rate-cutting program, with another rate cut likely coming next month.

So far, the rally appears to be even better for the long-unloved and undervalued sectors in which Cabot Value Investor specializes. Value stocks, as measured by the Vanguard Value Index Fund (VTV), have outperformed post-election, up 4.1%. The S&P Equal Weight Index has performed even better, up 5% – nearly a third of its total return for the year.

The post-election rally paid immediate dividends for our portfolio, pushing two stocks into early “retirement” last week, as both Gates Industrial (GTES) (100% gain) and Capital One Financial (COF) (25% gain in three months) blew past our price targets. The strong market also lowered my tolerance for laggards, which is why we also said goodbye to Honda (HMC) last week and are kicking CNH Industrial (CNH) to the curb this week, both of which fell precipitously after earnings misses and just weren’t getting the job done.

Those two sells, plus the two aforementioned stocks that we “retired” after they eclipsed our price targets, leave us with just six stocks after today’s update. That’s too few positions in this strong a market. So I’m not going to wait around until next month to add a new stock to the portfolio. Expect a new addition in next week’s update!

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
CNH Industrial (CNH) – Move from Buy to Sell

Last Week’s Portfolio Changes
New Recommendation – The Cheesecake Factory (CAKE)

Capital One Financial (COF) – Move from Buy to Sell/Retire (reached 185 price target!)

Honda Motor Co. (HMC) – Move from Buy to Sell

Gates Industrial (GTES) – Move from Buy to Sell/Retire (reached our 20 price target!)

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.

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 13.2x 2025 EPS estimates and at 0.66x 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 24% 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 unchanged after rising more than 5% last Wednesday, the day before our November issue came out. So a pause is no surprise, especially in the absence of news. The last bit of 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%.

I’ve set a price target of 65, 30% higher than the current price. The 2.2% dividend yield (hopefully you bought before yesterday’s ex-dividend date!) helps matters. The holiday shopping season could be a boon for the share 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 13.6x forward earnings estimates and at 1.24x 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.

Dick’s bounced back after a couple weeks of sluggishness, up more than 3% this week on no news. The bounce off August lows in the low 190s is encouraging. With no reason for the recent weakness, a turnaround seemed inevitable, especially now that the market rally has resumed in the wake of the election and latest Fed rate cut. Earnings are due out November 26, so perhaps that will be just the thing to rejuvenate the share price. As it stands, DKS has 25% 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 10.6x estimates – and growing faster than the average bear. In fiscal 2024, analysts anticipate 19% EPS growth on 7.5% revenue growth, both of which would easily top 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 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.

There was no company-specific news for Toll Brothers this week. TOL shares were up about 1.5%, however, as the Fed’s latest rate cut bodes well for mortgage rates – and, by proxy, homebuilders – in the intermediate term, even if interest rates remain stubbornly high (4.4% on the 10-year Treasury, a four-month high) in the short term. Still, we have a nice gain on TOL thus far, so let’s stay the course and play the long game on lower interest rates eventually jump-starting the housing industry. The stock has 18% 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 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 6x forward earnings estimates, with a price-to-sales ratio of just 0.46. The stock peaked at 96 a share in November 2018; it currently trades at 91.

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 continue their late-2024 tear, up another 6% this week and a whopping 140% since the early-August bottom. General strength in the airline industry has helped, with record passenger numbers expected this year. But United has specifically done an excellent job of cutting back on “unprofitable capacity,” according to chief commercial officer Andrew Nocella on the company’s recent earnings call. Shedding that dead weight, plus low oil prices, has precipitated improved margins and reduced debt – enough so that United’s board authorized a $1.5 billion share buyback, its first repurchase plan since the company suspended its last one due to Covid, in 2020.

The huge runup after the earnings report in mid-October pushed shares above our initial price target of 70, and we decided to sell half our position to book profits and hold the rest. With the stock still way undervalued (7.4x EPS, 0.53x sales) and plenty of wind in its sails, we will keep our Hold a Half rating until there are signs of trouble or momentum fizzling. HOLD A 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 10x earnings estimates and at just 1.30x sales. A solid dividend (3.1%) adds to the appeal of this mid-cap stock.

There was no news for ADT this week, though the stock was up 2.5%, perhaps in sympathy with the market.

Late last month, 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. But the stock remains cheap, trading at 10x forward earnings. The shares have 30% upside to our 10 price target. And now they have momentum. 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 and as well as ongoing pressure on the company to maintain shareholder-friendly actions.

There was no major company-specific news for Aviva this week. Shares were down another 1.5% and are now trading at their lowest level since early April, having broken below early-August support in the 11.9 range. The pullback the last couple weeks is likely in part a reverberation from Trump’s victory, and his “America First” agenda; Aviva is not an American company.

Still, Aviva remains one of the most reliable stocks in our portfolio and is coming off a strong first half of the year in which it reported 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. And the stock is getting overly cheap, trading at 9.8x earnings estimates and at a mere 0.31x sales, with a microscopic 0.04 enterprise value/revenue ratio. The 7.5% dividend yield adds to our total return.

There’s no reason to think AVVIY shares won’t bounce back from what is likely a market overreaction. It is, after all, an investment management firm (and life insurance company) at a time when money is pouring back into the market.

The stock has 19% upside to our 14 price target. BUY

CNH Industrial (CNH) imploded on earnings last Friday, and it’s time we say goodbye to this underperformer. The farm and construction equipment maker fell short of modest third-quarter profit estimates, slashed full-year guidance, and expects annual sales in its signature agriculture unit to be down 22-23%, down from the 15-20% haircut previously expected. Yikes. The bad quarter prompted Baird to lower its price target on CNH from 14 to 13, and shares are down 9% to a two-month low – and well below their 200-day moving average. CNH’s longevity in this portfolio was essentially riding on this earnings report, given the declining sales and earnings. And it failed miserably. After nearly a full year in the Value Investor portfolio, CNH is now sitting at a 5% loss. Let’s sell before it mushrooms into a bigger loss. MOVE FROM BUY TO SELL

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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