October 10, 2024

Pre-Election Stagnation; Post-Election Jubilation?

Stocks have barely budged for three months.

The S&P 500 is a mere 1.5% above its mid-July highs, while the Nasdaq is actually down 2.5% since its July 10 peak. The Dow has made the most headway, up 2.1% since its July 17 apex. This type of multi-month lethargy is nothing new for an election year.

In 2020, the S&P 500 was down 4.5% in the last two months before the election. In 2016, the index tumbled 2.7% from mid-August through the November 8 election day. In 2012, the peak came in mid-September, and for the next two months the S&P declined by more than 7.5%, with the bottom coming about 10 days after the election. That’s three elections, three different winners, three multi-month pullbacks by an average of nearly 5% in the months leading up to the election. And all three times, stocks quickly rebounded shortly after the election was settled, rising to new highs by the first week of January at the latest.

Each year is different. But in general, history tells us that the market tends to exhale – and exalt – once the dark clouds of an uncertain presidential election part. The market doesn’t care who wins. It just wants a winner. Barring a 2000 Bush/Gore, “hanging chad” situation, in which the winner of a close, recounted election wasn’t known for more than a month after the election, we’ll know who the next president will be a month from now. And chances are, the market will rejoice and advance to new all-time highs in short order.

So while the current malaise has been tedious (although value stocks have made a bit more headway, up 3.3% since the end of July), chances are it won’t last much longer. October is almost never a fun month for investors, and that’s often (50% of the time at least) due to the specter of an uncertain election looming in early November. This year, we have the added macro-headwinds of escalating war in the Middle East and a brutal hurricane season to navigate. But eventually, the clouds will part and investors will happily dive back into a bull market that now has the added fuel of lower interest rates, declining inflation and a still-healthy U.S. economy.

The market likes answers. And the biggest one will come on November 5.

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This Week’s Portfolio Changes
None

Last Week’s Portfolio Changes
ADT Inc. (ADT) – New Buy with a Price Target of 10

Upcoming Earnings Reports
Tuesday, October 15 – United Airlines (UAL)

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.

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 10.7x forward earnings estimates, 98% of book value, and 1.52x sales. The share price peaked at 177 a little over three years ago, in August 2021; it currently trades at 149.

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’s been no company-specific news for Capital One of late. Shares, however, were up more than 2% this week, recovering some of the dip from the previous week.

The company is still awaiting its big catalyst – approval of the Discover deal – which executives are optimistic will occur by either later this year or early next year. If approved, it would give Capital One its own payment network, making it less reliant on Visa and Mastercard and adding $2.7 billion in synergies by 2027, according to management.

Third-quarter earnings are likely the nearer-term potential catalyst, and they will be reported on October 24.

In the meantime, COF has 24% upside to our 185 price target while we wait. 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 15x forward earnings estimates and at 1.28x 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’s been no news for Dick’s of late. The stock stopped the recent bleeding, up about 1% this past week, though shares are still well shy of their late-August highs near 240. There’s been no real reason for the dropoff, and the company is coming off a strong second quarter in which adjusted earnings per share improved 55% year over year and net sales rose 7.8%, both higher than analyst estimates. Those results initially gave DKS shares a big boost, but one that has completely evaporated since.

With no reason for the decline, there’s no reason to believe DKS shares won’t bounce right back. The stock has 22% upside to our 250 price target. 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 had to recall 1.7 million vehicles in the U.S. due to an issue that made steering difficult, raising the risk of a crash. Recalls are never good for automakers, and Honda shares are getting punished accordingly, down more than 2% in Wednesday trading. We won’t really know the financial impacts until early next year, when the company reports Q4 earnings.

Until then, it’s doubtful the stench of the recall will linger too long for investors. Recalls, while not ideal, happen all the time. And with HMC shares down, but still trading above their September lows, this could be a good “buy the bad news” situation for those who have not yet bought Honda.

The stock remains almost unfathomably cheap for a major global company, with shares trading at less than 7x earnings, 55% of book value and 0.36x sales. The stock has been a disappointment for us thus far, but as with United Airlines (see below), I think it’s only a matter of time before bargain hunters catch on and start snatching up this undervalued stock.

I think our patience will be rewarded – eventually. And HMC shares still have 44% upside to our 45 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 10.4x estimates – and growing faster than the average bear. In fiscal 2024, analysts anticipate 18.4% EPS growth on 7.1% 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, and the stock mostly held its ground for a second straight week after advancing 22% in the last two months. Most of TOL’s gains occurred before the Fed’s mid-September rate cut, so it’s likely that they were mostly baked in, at least in the short term.

TOL shares have 19% upside to our 180 price target. Up more than 9% in the first month since we added it to the portfolio, it’s possible that price target is conservative. 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 5x forward earnings estimates, with a price-to-sales ratio of just 0.36 and a price-to-book value of 1.88. The stock peaked at 96 a share in November 2018; it currently trades at 59.

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.

The feverish UAL rally continues! The stock was up another 7% this past week on no major news, ahead of the earnings report next Tuesday, October 15. Expectations are modest: 2.4% sales growth with a -14.5% decline in earnings per share. The company has topped earnings estimates in each of the last four quarters so perhaps that forecast is again conservative.

United flew a record 44 million-plus passengers in the second quarter and set a daily record of 565,000 passengers. Meanwhile, the United app is the most downloaded airline app, with 89% of customers engaging digitally on their travel days. And the low oil prices have been helping keep costs down for United and other airlines.

Add it all up, and then sprinkle in the dirt-cheap value, and you can see why investors have been piling in of late, with shares now trading at new 52-week highs around 60 and up 58% in the last two months! Whether UAL can sustain that momentum will likely depend on the results of next week’s earnings report. It’s very possible, if not likely, that another strong beat is already baked into the share price.

The stock has 16% upside to our 70 price target. And now we have a solid, double-digit gain on it. BUY

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) – 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 33%, to 68 cents, and then to 83 cents (+22%) in 2025.

All of that EPS growth makes the share price look quite cheap. ADT shares currently trade at 9.6x earnings estimates and at just 1.26x sales. A solid dividend (3.1%) adds to the appeal of this mid-cap stock.

There was no news for ADT in its first week in the Cabot Value Investor portfolio. Shares were down a little more than 1%.

The stock has pulled back about 11% from its highs near 8 in late July, though they still trade above their August and September lows, offering hope that a bottom has already been put in. Given the relatively modest coverage of this mid-cap stock – only six analysts cover it – there may not be a ton of news to drive the share price until the company reports earnings in a few weeks. But we like the value and the fast-growing profits.

ADT has 43% 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 and as well as ongoing pressure on the company to maintain shareholder-friendly actions.

There was no company-specific news for Aviva this week. Shares were down 1.6%, dipping below 12.7 for the first time in two months, though shares seem to have stabilized.

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 yet, the stock remains cheap, trading at 10.4x earnings estimates and at a mere 0.33x sales, with a microscopic 0.05 enterprise value/revenue ratio. The 6.9% dividend yield adds to our total return.

The stock has 10% upside to our 14 price target. 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.

There’s been no news for CNH since it was added to the S&P MidCap 400 index last month, which seems to have been a shot in the arm for the share price. While the stock is up only modestly in the past two weeks, it’s up 11% in the last month, with the index upgrade being the only news.

CNH shares remain dirt-cheap, trading at 7x forward earnings estimates and 0.62x sales. We upgraded the stock back to Buy recently and will maintain our price target of 15, which is 35% higher than the current price. BUY

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.

There was no news for Gates this week, other than that the company will release third-quarter earnings on October 30. Prior to that, the only recent news came a few weeks ago when the company announced that it was introducing something called a “cooling hose.” Called the Data Master Cooling Hose, it’s a product intended to enhance performance and cleanliness in data centers. Specifically, it makes for easier assembly, routing and handling in data centers. Demand for “cooling solutions” in data centers has been on the rise, and Gates is meeting that demand with its new hose. We’ll see how the cooling hose impacts the company’s bottom line.

Whether it’s related or not, GTES shares have picked up steam of late, advancing about 6% in the last month. GTES shares are up more than 60% since they were added to the Cabot Value Investor portfolio – our best-performing position. Yet, trading at less than 11x forward earnings, they still have 15% upside to our 20 price target. 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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