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Value Investor
Wealth Building Opportunites for the Active Value Investor

December 13, 2022

Entering The Year-End Reality Distortion Field

There are only 13 trading days left in the calendar year. This means we are entering what is basically a reality distortion field … in which the closer we get to year’s end, the more that calendar-driven technical motivations, rather than valuations and fundamentals, drive share prices. These motivations create artificial selling pressure that can drive already-weak shares down even further.

Traders are either human (so both professional and private investors share these motivations) or are computer-driven (which primarily means momentum-driven). Savvy investors can capitalize on the resulting artificial selling pressure by buying washed-out shares that others are selling.

The first technical motivation is to sell losers to generate capital losses. These losses can be used to offset other capital gains, helping to reduce tax bills. Tax-motivated selling comes not only from taxable advisor-managed and personal accounts but also from mutual funds. These funds distribute their capital gains around year’s end, but managers would rather avoid hitting investors with large taxable events.

Window dressing by professional investors is another technical motivation. These managers want to avoid showing their clients and consultants that they held losers, so they sell these stocks to keep them out of year-end reports. This is particularly true in a year when many managers held previously touted stocks that went on to produce embarrassing and large losses. These managers have a strong career-driven motivation to sell these losers at any price.

Similarly, managers tend to chase performance as the year’s end approaches to maximize their performance-based annual bonuses. This means selling off losers before they hurt performance even more.

A third technical motivation is behavioral. Investors of all types tend to want to start the new year with a fresh perspective – so loser stocks are offloaded without regard to price.

Once the selling pressure fades around year’s end, many of the worst-performing stocks bounce upwards, sometimes sharply. Nimble investors can capture some of the bounce before longer-term fundamentals return as primary drivers in late January or so.

Economic theory says that changes in investor behavior related to the year’s end would be irrational and therefore shouldn’t happen, but behavioral psychologists and real-world investors know that it happens every year. The trick is to not get caught up in it, and if possible, take advantage of it with savvy buying.

As hard as it may seem, this is the time to grit your teeth, wince, and cringe, and then buy the out-of-favor stocks. These might be temporary boosts in positions that can be sold back down to the original stake in January or used as attractive long-term entry points. Names like Citigroup (C), Gates Industrial Corp (GTES), Big Lots (BIG) and Organon (OGN) look best positioned for a new year’s bounce.

Share prices in the table reflect Monday (December 12) closing prices. Please note that prices in the discussion below are based on mid-day December 12 prices.

Note to new subscribers: You can find additional color on our thesis, recent earnings reports and other news on recommended companies in prior editions of the Cabot Undervalued Stocks Advisor, particularly the monthly edition, on the Cabot website.

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Today’s Portfolio Changes

Last Week’s Portfolio Changes
Big Lots (BIG) – Reducing price target from 35 to 25.

Growth/Income Portfolio

Cisco Systems (CSCO) is facing revenue pressure as customers migrate to the cloud and thus need less of Cisco’s equipment and one-stop-shop services. Cisco’s prospects are starting to improve under a relatively new CEO, who is shifting Cisco toward a software and subscription model and is rolling out new products, helped by its strong reputation and entrenched position within its customers’ infrastructure. The company is highly profitable, generates vast cash flow (which it returns to shareholders through dividends and buybacks) and has a very strong balance sheet.

There was no significant company-specific news in the past week.

CSCO shares fell 2% for the week and have 36% upside to our 66 price target. The valuation is attractive at 9.4x EV/EBITDA and 13.7x earnings per share. The 3.1% dividend yield adds to the appeal of this stock. BUY

Comcast Corporation (CMCSA) With $120 billion in revenues, Comcast is one of the world’s largest media and entertainment companies. Its properties include Comcast cable television, NBCUniversal (movie studios, theme parks, NBC, Telemundo and Peacock), and Sky media. The Roberts family holds a near-controlling stake in Comcast. Comcast shares have tumbled due to worry about cyclical and secular declines in advertising revenues and a secular decline in cable subscriptions as consumers shift toward streaming services, as well as rising programming costs and incremental competitive pressure as phone companies upgrade their fiber networks.

However, Comcast is a well-run, solidly profitable and stable company that will likely continue to successfully fend off intense competition while increasing its revenues and profits, as it has for decades. The company generates immense free cash flow which is more than enough to support its reasonable debt level, pay a generous dividend (recently raised 8%) and sizeable share buybacks.

There was no significant company-specific news in the past week.

Comcast shares rose 2% for the past week and have about 17% upside to our 42 price target. The shares offer an attractive 3.0% dividend yield. BUY

Dow Inc. (DOW) is the world’s largest producer of ethylene and polyethylene, the most widely used plastics. Investors undervalue Dow’s hefty cash flows and sturdy balance sheet largely due to its uninspiring secular growth traits, its cyclicality and concern that management will squander its resources. The shares are driven by: 1) commodity plastics prices, which are often correlated with oil prices and global growth, along with competitors’ production volumes; 2) volume sold, largely driven by global economic conditions, and 3) ongoing efficiency improvements (a never-ending quest of all commodity companies). Recent concerns about a recession have sent Dow shares to well-below our estimate of their fair value, even as the company’s long-term prospects and ability to maintain its dividend are attractive. Dow shares are a recommended Buy in our sister publication the Cabot Turnaround Letter.

There was no significant company-specific news in the past week.

Dow shares slipped 2% in the past week and have 19% upside to our 60 price target (same as in the Cabot Turnaround Letter). The quarterly dividend appears readily sustainable and provides an appealing 5.6% yield. The shares trade at a modest 6.3x EV/EBITDA multiple and 11.4x EPS on recession-minded 2023 estimates. BUY

State Street Corporation (STT) State Street is the world’s largest custodian bank, with $38 trillion in assets under custody/administration. About 56% of its revenues are produced from custody, client reporting, electronic trading and full enterprise solutions services for investment managers. The balance is produced from investment management fees on ETFs, foreign exchange fees, securities financing fees and net interest income. The industry has combined into four dominant firms due to economies of scale. State Street’s shares are out of favor and unchanged since 2007 due to concerns over its anemic growth and steady pricing pressure from competitors. However, we see State Street as a solid, well-capitalized franchise that provides critical services, with a slow-growth but steady revenue and earnings stream. Our interest in STT shares is that we can buy them at an attractive valuation. We also find the dividend yield appealing.

Following its termination of its long-delayed $3.5 billion deal to acquire the custody operations of asset manager Brown Brothers, State Street announced a $500 million increase in its share buyback program to be completed by year’s end. The total year-end repurchase pledge is now $1.5 billion, or about 5% of its total share base. This new total essentially offsets its earlier $1.9 billion capital raise for funding the Brown Brothers deal. In that deal, State Street sold shares at around 88/share compared to what will likely be an average of about 75/share for the repurchase. While this is an ugly way for a company to arbitrage its share price, we’ll happily accept the incremental book value/share increase.

State Street shares rose 6% in the past week and have about 16% upside to our 94 price target. The company’s dividend (3.1% yield) is well-supported and backed by management’s strong commitment. BUY

Buy Low Opportunities Portfolio

Allison Transmission Holdings, Inc. (ALSN) Allison Transmission is a midcap manufacturer of vehicle transmissions. While many investors view this company as a low-margin producer of car and light truck transmissions that is destined for obscurity in an electric vehicle world, Allison actually produces no car or light truck transmissions. Rather, it focuses on the school bus and Class 6-8 heavy-duty truck categories, where it holds an 80% market share. Its EBITDA margin is sharply higher than its competitors and on-par with many specialty manufacturers. And, it is a leading producer and innovator in electric axles which all electric trucks will require. The company generates considerable free cash flow and has a low-debt balance sheet. Its capable leadership team keeps its shareholders in mind, as the company has reduced its share count by 38% in the past five years.

There was no significant company-specific news in the past week.

The shares slipped 3% in the past week and have 13% upside to our 48 price target. The stock pays a respectable and sustainable 2.0% dividend yield. BUY

Arcos Dorados (ARCO), which is Spanish for “golden arches,” is the world’s largest independent McDonald’s franchisee. Based in stable Uruguay and listed on the NYSE, the company produces about 72% of its revenues in Brazil, Mexico, Argentina and Chile. At our recommendation date, the shares were depressed as investors worried about the pandemic, political/social unrest, inflation and currency devaluations. However, the company has a solid brand, high recurring demand, impressive leadership (including founder/chairman who owns a 38% stake) and successful experience in navigating local conditions, along with a solid balance sheet and free cash flow.

Macro issues have a sizeable impact on the shares’ trading, including local inflation and the Brazilian currency. Since early 2020, the currency has generally stabilized in the 1.00 real = $0.20 range – a remarkably favorable trait given the sharp declines in other currencies around the world. Recent weakness in the U.S. dollar has not affected the USD/Brazilian real exchange rate. As the company reports in U.S. dollars, any strength in the local currency would help ARCO shares.

There was no significant company-specific news in the past week.

ARCO shares slipped 3% this past week and have 18% upside to our 8.50 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. We expect that activist investor Cevian Capital, which holds a 5.2% stake, will keep pressuring the company to maintain shareholder-friendly actions.

There was no significant company-specific news in the past week.

Based on management’s estimated dividend for 2023, the shares offer a generous 7.0% yield. Aviva shares rose 1% in the past week and have about 29% upside to our 14 price target. BUY

Barrick Gold (GOLD), based in Toronto, is one of the world’s largest and highest-quality gold mining companies. About 50% of its production comes from North America, with the balance from Africa/Middle East (32%) and Latin America/Asia Pacific (18%). Barrick will continue to improve its operating performance (led by its highly capable CEO), generate strong free cash flow at current gold prices, and return much of that free cash flow to investors while making minor but sensible acquisitions. Also, Barrick shares offer optionality – if the unusual economic and fiscal conditions drive up the price of gold, Barrick’s shares will rise with it. Given their attractive valuation, the shares don’t need this second (optionality) point to work – it offers extra upside. Barrick’s balance sheet has nearly zero debt net of cash. Major risks include the possibility of a decline in gold prices, production problems at its mines, a major acquisition and/or an expropriation of one or more of its mines.

There was no significant company-specific news in the past week.

Over the past week, commodity gold rose 1% to $1,786/ounce. Despite all the volatility, the gold price is down less than 2% year-to-date. The 10-year Treasury yield slid to 3.54%. While investors had anticipated the “end-game” in which Treasuries peak at a roughly 5.0% yield (to roughly match or slightly exceed the anticipated inflation rate in a year or so), recent comments from Fed Chair Powell along with resilient labor demand may mean that rates peak above 5%. Similarly, we are seeing a few commentaries suggesting that the 2% inflation target isn’t sacrosanct, but that 3% or possibly even 4% inflation would be tolerable. If this tolerance takes hold, and the economy slows, the Fed’s inflation-fighting resolve may weaken, and gold prices should rise. Investing in gold-related equities is a long-term decision – investors shouldn’t allow near-term weakness to deter their resolve.

The CPI data is released on Tuesday, December 13. The Federal Reserve Open Market Committee meets on Tuesday and Wednesday, which will likely result in a 50-basis point increase in the Fed Funds rate to 4.25-4.50%.

The U.S. Dollar Index, another driver of gold prices (the dollar and gold usually move in opposite directions), ticked down incrementally to 104.89.

Barrick shares slipped 1% in the past week and have about 65% upside to our 27 price target. Our resolve with Barrick shares remains undaunted through the recent sell-off. BUY

Big Lots (BIG) – Big Lots is a discount general merchandise retailer based in Columbus, Ohio, with 1,431 stores across 47 states. Its stores offer an assortment of furniture, hard and soft home goods, apparel, electronics, food and consumables as well as seasonal merchandise. Our initial case for Big Lots rested with its loyal and growing base of 22 million rewards members, its appeal to bargain-seeking customers, the relatively stable (albeit low) cash operating profit margin, its positive free cash flow, debt-free balance sheet and low share valuation. Our thesis was deeply rattled by the company’s surprisingly large inventory glut in the first quarter of 2022, likely burdening it with new and permanent debt.

There was no significant company-specific news in the past week.

Big Lots shares remain high-risk due to the permanent debt balance and the likelihood of a suspension of the dividend.

Big Lots shares fell 5% this past week and have 51% upside to our revised 25 price target. The shares offer a 7.3% dividend yield, although, as noted, investors should not rely on this dividend being sustained.

We reiterate our view that Big Lots shareholders who are not willing or able to sustain further losses in the shares should sell now. There is no reasonably definable floor to a stock like Big Lots when fundamentals and valuation are ignored while investors reduce their risk exposure. HOLD

Citigroup (C) – Citi is one of the world’s largest banks, with over $2.4 trillion in assets. The bank’s weak compliance and risk-management culture led to Citi’s disastrous and humiliating experience in the 2009 global financial crisis, which required an enormous government bailout. The successor CEO, Michael Corbat, navigated the bank through the post-crisis period to a position of reasonable stability. Unfinished, though, is the project to restore Citi to a highly profitable banking company, which is the task of new CEO Jane Fraser.

Mexico president Andres Manuel Lopez Obrador said there are two parties negotiating for Citi’s Mexico retail operations and that a deal would likely conclude in early 2023. We have low expectations for the price of this deal, given Citi’s clear desire to exit and the limited number of legitimate buyers, as well as the involvement of Mexico’s president and Citi’s interest in keeping its Mexico institutional business.

Bank shares have slid in December as investors worry that interest rates will remain elevated, that banks’ zero-cost deposits will be withdrawn (requiring banks to raise the interest rate to retain these deposits) and that rising bond prices will leave banks with underwater bonds that will incrementally weaken their capital bases.

This past week, the yield spread between the 90-day T-bill and the 10-year Treasury bond, which approximates the drivers behind Citi’s net interest margin, narrowed incrementally to a negative 73 basis points (100 basis points in one percentage point), as both 10-year yields and 90-day yields were largely unchanged. This spread is nearly the widest since at least the early 1980s. Our interpretation is that investors are assuming that the Fed rate hikes and other macro drivers will drag down inflation to sub-5% or so in a year.

Citi shares trade at 55% of tangible book value and 6.6x estimated 2023 earnings. The remarkably low valuations assume an unrealistically dim future for Citi.

Citi shares fell 2% in the past week and have about 90% upside to our 85 price target. Citigroup investors enjoy a 4.6% dividend yield. We anticipate that the bank is done with share buybacks until there is more clarity on the economic and capital market outlook, which could readily be a year or more away. 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, with Blackstone retaining a 63% stake today.

There was no significant company-specific news in the past week.

At the current price and based on estimated 2022 results, the shares offer a 12% free cash flow yield (free cash flow divided by market cap). This is a sizeable discount to what the company is worth. GTES shares fell 3% in the past week and have about 28% upside to our 14 price target. BUY

Molson Coors Beverage Company (TAP) is one of the world’s largest beverage companies, producing the highly recognized Coors, Molson, Miller and Blue Moon brands as well as numerous local, craft and specialty beers. About two-thirds of its revenues come from the United States, where it holds a 24% market share. Investors worry about Molson Coors’ lack of revenue growth due to its relatively limited offerings of fast-growing hard seltzers and other trendier beverages. Our thesis for this company is straightforward – a reasonably stable company whose shares sell at an overly discounted price. Its revenues are resilient, it produces generous cash flow and is reducing its debt. A new CEO is helping improve its operating efficiency and expand carefully into more growthier products. The company recently reinstated its dividend.

There was no significant company-specific news in the past week.

TAP shares fell 4% in the past week and have about 32% upside to our 69 price target. The stock remains cheap, particularly on an EV/EBITDA basis, or enterprise value/cash operating profits, where it trades at 8.6x estimated 2023 results, still among the lowest valuations in the consumer staples group and below other brewing companies. BUY

Organon & Company (OGN), a spin-off from Merck, specializes in patented women’s healthcare products and biosimilars, and also has a portfolio of mostly off-patent treatments. It may eventually divest its Established Brands segment. The management and board appear capable as they work to boost internal growth augmented by modest-sized acquisitions. The company produces robust free cash flow, has modestly elevated debt and pays a reasonable dividend.

There was no significant company-specific news in the past week.

OGN shares rose 3% in the past week and have about 70% upside to our 46 price target (using the same target as the Cabot Turnaround Letter). The shares offer an attractive 4.1% dividend yield. BUY

Sensata Technologies (ST) is a $3.8 billion (revenues) producer of nearly 47,000 highly engineered sensors used by automotive (60% of revenues), heavy vehicle, industrial and aerospace customers. About two-thirds of its revenues are generated outside of the United States, with China producing about 21%. Investors undervalue Sensata’s durable franchise. Its sensors are typically critical components that generally produce high profit margins. As the sensors’ reliability is vital to safety and performance, customers are reluctant to switch to another supplier that may have lower prices but also lower or unproven quality. Sensata has an arguably under-leveraged balance sheet and generates healthy free cash flow. The relatively new CEO will likely continue to expand the company’s growth potential through acquisitions. Electric vehicles are an opportunity as they expand Sensata’s reachable market.

There was no significant company-specific news in the past week.

ST shares fell 3% in the past week and have about 74% upside to our 75 price target. Our price target looks optimistic in light of the broad market sell-off, but we will keep it for now, even as it may take longer for the shares to reach it. BUY

Growth/Income Portfolio

Stock (Symbol)Date AddedPrice Added12/11/22Capital Gain/LossCurrent Dividend YieldPrice TargetRating
Cisco Systems (CSCO)11/18/2041.3248.8318.20%5.70%66Buy
Comcast Corp (CMCSA)10/26/2231.536.3515.40%3.40%42Buy
Dow Inc (DOW) *4/1/1953.550.53-5.60%5.50%60Buy
State Street Corp (STT)8/17/2273.9679.868.00%3.20%94Buy

Buy Low Opportunities Portfolio

Stock (Symbol)Date AddedPrice Added12/11/22Capital Gain/LossCurrent Dividend YieldPrice TargetRating
Allison Transmission Hldgs (ALSN)2/22/2239.9942.76.80%2.00%48Buy
Arcos Dorados (ARCO)4/28/215.417.436.80%2.20%8.5Buy
Aviva (AVVIY)3/3/2110.7510.850.90%5.20%14Buy
Barrick Gold (GOLD)3/17/2121.1316.54-21.70%2.40%27Buy
BigLots (BIG)4/12/2235.2416.68-52.70%7.20%25Hold
Citigroup (C)11/23/2168.145.52-33.20%4.50%85Buy
Gates Industrial Corp (GTES)8/31/2210.7111.063.30%0.00%14Buy
Molson Coors (TAP)8/5/2036.5352.5443.80%2.90%69Buy
Organon (OGN)6/7/2131.4227.43-12.70%4.10%46Buy
Sensata Technologies (ST)2/17/2158.5743.52-25.70%1.00%75Buy

*Note: DOW price is based on April 1, 2019 closing price following spin-off from DWDP.

Buy – This stock is worth buying.
Strong Buy – This stock offers an unusually favorable risk/reward trade-off, often one that has been rated as a Buy yet the market has sold aggressively for temporary reasons. We recommend adding to existing positions.
Hold – The shares are worth keeping but the risk/return trade-off is not favorable enough for more buying nor unfavorable enough to warrant selling.
Sell – This stock is approaching or has reached our price target, its value has become permanently impaired or changes in its risk or other traits warrant a sale.

Note for stock table: For stocks rated Sell, the current price is the sell date price.

CUSA Valuation and Earnings

Growth/Income Portfolio
2023 EPS
2024 EPS
Change in
2023 Estimate
Change in
2024 Estimate
P/E 2023P/E 2024
CSCO 48.54 3.55 3.830.0%0.0% 13.7 12.7
CMCSA 35.76 3.76 4.21-0.1%-1.0% 9.5 8.5
DOW 50.25 4.41 5.460.0%0.0% 11.4 9.2
STT 80.88 8.32 9.421.0%0.6% 9.7 8.6
Buy Low Opportunities Portfolio
2023 EPS
2024 EPS
Change in
2023 Estimate
Change in
2024 Estimate
P/E 2023P/E 2023
ALSN 42.46 5.89 6.560.0%0.0% 7.2 6.5
ARCO 7.23 0.66 0.82-0.1%-1.0% 10.9 8.8
AVVIY 10.89 0.55 0.620.0%0.0% 19.7 17.5
GOLD 16.33 0.76 0.971.0%0.6% 21.4 16.8
BIG 16.54 (0.45) 2.890.0%0.0% (36.8) 5.7
C 44.75 6.76 7.61-0.3%1.3% 6.6 5.9
GTES 10.94 1.17 1.310.0%0.0% 9.4 8.3
TAP 52.18 4.11 4.37-0.1%0.0% 12.7 11.9
OGN 27.03 4.78 5.20-1.1%-2.1% 5.7 5.2
ST 43.15 3.68 4.370.0%0.0% 11.7 9.9

Current price is yesterday’s mid-day price.
CSCO: Estimates are for fiscal years ending in July of 2023 and 2024

Bruce Kaser has more than 25 years of value investing experience in managing institutional portfolios, mutual funds and private client accounts. He has led two successful investment platform turnarounds, co-founded an investment management firm, and was principal of a $3 billion (AUM) employee-owned investment management company.