October 31, 2024

With “Spooky Season” Over, Is Another November Market Rally Coming?

As you read this, I am likely fortifying my house in preparation for the 400-500 Trick-or-Treaters that are sure to descend on our place in Vermont in a few hours. That’s no exaggeration – we live on a crowded street that draws kids from all over town, and even adjoining towns, trying to maximize their Halloween hauls. When we bought the house four years ago, we were “warned” that being a Halloween house was part of the deal. The 1,000 pieces of candy I buy every year and the countless ghouls, skeletons, smoke-emitting jack-o’-lanterns and giant spiders I’ve accrued the last few years to adorn our lawn are almost like an annual tax.

Living in such a bustling Halloween hotbed is fun, and it’s certainly a blast for our two kids. But it’s a lot of work, and we’re always happy when the calendar flips to November. And in that way, it reminds me a bit of the market every October. Every year, investors know to expect some turbulence – or more like stagnation this year – in October. And we just have to grind through it and get to the often smoother sailing November brings.

It’s no guarantee November will be better for the market, of course. Next Tuesday’s presidential election is essentially a 50-50 toss-up, and it could be close enough to trigger recounts (ugh) in key swing states that could prevent a winner from being declared for days – perhaps even weeks. While the market probably doesn’t care too much who wins the election, it wouldn’t like that kind of dragged-out uncertainty, especially if it turns into a 2000 Bush-Gore, “hanging chads” situation.

Meanwhile, we’re in the belly of earnings season, as about a third of the companies that comprise the S&P 500 are reporting quarterly results this week. The Fed will likely slash rates again next Thursday, November 7 (as of this writing there’s a 98.2% chance they’ll cut rates by 25 basis points, according to the CME Group’s FedWatch Tool). And two major overseas wars continue to rage, with no end in sight.

The good news is that the U.S. economy remains in fine shape, with 2.8% GDP growth in the third quarter, it was reported on Wednesday morning. That was a tad below the expected 2.9% growth, and lower than the 3% growth in the second quarter. But it’s the latest evidence that there’s no recession in sight. Therefore, this two-year bull market is likely to keep trucking along, with another big uptick likely coming sometime after the election is (mercifully) settled.

We’ve made it through October, the market’s traditional “spooky season,” unscathed – the S&P 500 is actually up roughly 1% this month, with one day to go. For me, that’s like waking up on November 1 to see that the grass on my lawn isn’t too trampled down and that there are only a few candy wrappers scattered about. The lack of damage is a victory in itself.

And next week, with both October and the election in the rear-view mirror, we’ll have a new addition to our Cabot Value Investor portfolio. Until then … Happy Halloween!

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
None

Last Week’s Portfolio Changes
None

Upcoming Earnings Reports
Wednesday, November 6 – Honda Motor Company (HMC)

Friday, November 8 – CNH Industrial (CNH)

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 $39.1 billion, with another 6% uptick estimated in 2025.

And yet the stock is cheap, trading at 10.6x forward earnings estimates and 1.63x sales. The share price peaked at 177 a little over three years ago, in August 2021; it currently trades at 167.

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.

Capital One reported another strong quarter last Thursday, and the stock is up nearly 8% since! Revenue improved 6.4% year over year and narrowly topped estimates, and while earnings per share declined slightly from a year ago, they easily (by 17%) beat estimates. There wasn’t much of an update on the call about the status of the pending deal to acquire Discover Financial (DFS) for $35 billion, though company executives now concede it likely won’t happen before the end of 2024. If approved, the deal would instantly make Capital One the largest credit card issuer in the U.S. The stock remains cheap, trading at 10.6x forward earnings and at 99% of book value. We now have a double-digit gain on the stock, and it still has 10% upside to our 185 price target. If the Discover deal gets approved early next year, that 185 target may prove conservative. 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 13.9x forward earnings estimates and at 1.26x 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 the stock was down about 1%. Shares have been in a bit of a malaise of late, down about 2.6% in October. The company won’t report earnings until late November, so it’s possible the stock won’t budge much until then unless the market takes off after the election. DKS shares have 23% 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.

The first week since early October that Honda cars weren’t subjected to a recall resulted in some minor movement (+1.3%) for HMC shares. There was no other news, however, and the stock’s next move will surely depend on the results of next Wednesday’s (November 6) earnings report. Analysts are anticipating flat sales growth.

Earlier this month, Honda announced two recalls: more than 700,000 Accords and Civics were recalled due to cracks in the high-pressure fuel pumps, raising the risk of the cars catching fire should they leak. Prior to that, the Japanese automaker recalled 1.7 million cars due to a steering issue. Recalls are normal for big auto companies. Two in a month is a bad look. Fortunately, the damage to HMC shares has been limited, with the stock basically falling from 32 to 31 since the first recall was announced.

A better-than-expected earnings report can paper over any of the stains to Honda’s image over the last few weeks. The stock is still dirt cheap, trading at 6.7x forward earnings estimates, 0.36x sales and 55% of book value. It has 45% upside to our 45 price target. The 4.3% dividend yield helps tide us over while we wait for a long-overdue catalyst. 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 10.2x 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, though shares were up more than 2%, getting back a portion of their losses from the previous week when shares were down roughly 7%. That pullback was likely due to the fact that interest rates were on the rise again. It appears that ascension has stalled, with the 10-year U.S. Treasury still in the same 4.25% range it was last week. And with the Fed set to cut the federal funds rate again next week (likely by 25 basis points, as I mentioned in the intro), there’s really only one place for interest rates – and mortgage rates – to go over the intermediate to long term: down. Eventually, that will act as a tailwind for TOL shares; in fact, it already has, with the stock up about 7% in the two months since we added it to the portfolio.

TOL shares still have 21% 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 78.

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.

United shares continued their late-2024 ascent, up another 6% this week on no company-specific news. At more than 78 per share, we now have a 56% gain in exactly six months!

The strength of the airline industry in the midst of a year of record passenger numbers has been a months-long driving force. But the latest catalyst was the October 15 earnings report. The airline reported adjusted EPS of $3.33, down from a year ago but well ahead of the $3.13 consensus estimate. Meanwhile, sales of $14.84 billion came in ahead of the $14.77 billion estimate and did mark a 2.5% year-over-year uptick. On top of it all, 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 big post-earnings runup 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 (6.4x EPS, 0.46x 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) – 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 9.5x earnings estimates and at just 1.25x sales. A solid dividend (3.1%) adds to the appeal of this mid-cap stock.

ADT reported earnings last week that beat on both the top and bottom lines, prompting a 7% boost in shares since we last wrote. 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 are snatching up ADT shares accordingly. And yet the stock remains cheap, trading at less than 10x forward earnings. The shares have 36% 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 2% and are now trading at their lowest level since early August. The stock has been in a bit of a rut – down 5.3% in the last three months – but the overall trend is still up, with shares up 10.8% YTD.

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 10x earnings estimates and at a mere 0.32x sales, with a microscopic 0.04 enterprise value/revenue ratio. The 7.2% dividend yield adds to our total return.

The stock has 15% 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. The stock was up more than 2.5% this past week, and is now up 20% since early August, with the index upgrade being the only news. The next big news will likely come next Friday, November 8, when the company reports third-quarter earnings.

CNH shares remain quite cheap, trading at 8.1x forward earnings estimates and 0.64x sales. We upgraded the stock back to Buy recently and will maintain our price target of 15, which is 31% 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.

Gates shares were up more than 7% on Wednesday after reporting Q3 results that topped estimates. EPS of 33 cents topped estimates of 31 cents, though down from 35 cents a year ago. Its $830.7 million in revenues also narrowly beat estimates, though it represented a 4.8% decline from the $872.9 million in revenues a year ago. At the time of this writing, management had not yet held its earnings call, so we’ll have reaction to those comments in next week’s issue.

As for GTES stock, it is now within a few dimes of our 20 price target, and we have an 85% gain on it in just over two years. It could reach our target within a matter of days (or hours!). Let’s see how it reacts to today’s big earnings move; if it’s anything like United, earnings could act as a catalyst for Gates shares for days to come. We will leave our Buy rating for now, but upside may be more limited now that the stock has nearly reached our 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.

Copyright © 2024. All rights reserved. Copying or electronic transmission of this information without permission is a violation of copyright law. For the protection of our subscribers, copyright violations will result in immediate termination of all subscriptions without refund. Disclosures: Cabot Wealth Network exists to serve you, our readers. We derive 100% of our revenue, or close to it, from selling subscriptions to our publications. Neither Cabot Wealth Network nor our employees are compensated in any way by the companies whose stocks we recommend or providers of associated financial services. Employees of Cabot Wealth Network may own some of the stocks recommended by our advisory services. Disclaimer: Sources of information are believed to be reliable but they are not guaranteed to be complete or error-free. Recommendations, opinions or suggestions are given with the understanding that subscribers acting on information assume all risks involved. Buy/Sell Recommendations: are made in regular issues, updates, or alerts by email and on the private subscriber website. Subscribers agree to adhere to all terms and conditions which can be found on CabotWealth.com and are subject to change. Violations will result in termination of all subscriptions without refund in addition to any civil and criminal penalties available under the law.