August 8, 2024

This Isn’t the End of the Bull Market

This is the 13^th bull market in the S&P 500 since 1950. If it ended today, it would tie for the shortest – just over 21 months – with the last bull market, the post-Covid-crash rally that began in March 2020 and tidily peaked at the end of 2021. The average bull market, according to statistics from Ryan Detrick of Carson Investment Research, lasts 65 months.

Does that mean this one can’t up and fizzle right now, taken down by a “carry trade” in Japanese equities, one bad U.S. jobs report, and a whole lot of political (presidential election) and social (war in the Middle East possibly spreading) uncertainty? Of course not. We know a bull market can last only 21 months because we just saw it happen.

But here’s the thing: When the last bull market peaked, technically on January 3, 2022, inflation had just spiked to 7% (and was on its way to 9%), the unemployment rate was still well above 6%, the global supply chain had slowed to a crawl, and U.S. GDP was on the brink of two consecutive quarters of negative growth, nearly meeting the criteria for a recession, and the Federal Reserve was two months away from hiking interest rates at the fastest pace in history.

Now? The unemployment rate, while headed in the wrong direction the last four months, is at 4.3%. U.S. GDP has grown for eight straight quarters, including a higher-than-expected 2.8% rate in the second quarter. Inflation is down to 3%. And the Fed is all but certain to (finally) start cutting interest rates next month, perhaps by as much as 50 basis points, most economists believe.

There’s also this: While a bull market has technically been in place for 21 months, it has been the most thinly traded bull market in the market’s history, carried by the Magnificent Seven and a handful of other (mostly) artificial intelligence-related stocks. The S&P Equal Weight Index is essentially unchanged since the start of 2022. The Dow Jones Industrial Average – the most sober and likely most market-reflective of the three major U.S. indexes – is up a mere 7.3% during that time. Small caps are down since the start of 2022.

The thin nature of the 21-month rally is reflected in sector valuations. Nine of the 11 major S&P sectors currently traded at a smaller forward price-to-earnings ratio than the index itself (just under 22). There’s value out there. And there’s also growth: For all the angst about the U.S. economy at the moment, we are at the tail end of a second-quarter earnings season in which large-cap companies are growing earnings by an average of 11.5%. If it holds, it would be the fastest collective corporate earnings growth rate since the fourth quarter of 2021.

For all of those reasons, the last few weeks look more like a deep (and likely healthy, given the AI-fueled valuations) market correction, but not the end of the bull market. And it’s an opportunity to buy stocks at much more of a bargain than you could have three weeks ago. That includes the 10 undervalued stocks that comprise our portfolio. So if you’ve missed the boat on any of them, now is a good time to snatch one or two of them up.

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
United Airlines (UAL) Moves from Buy to Hold

Last Week’s Portfolio Changes
Capital One Financial (COF) – New Buy with a 185 price target

Upcoming Earnings Reports
Wednesday, August 14 – Aviva (AVVIY)

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.

Canadian Solar Inc. (CSIQ) is not only Canada’s largest solar energy company; it’s a global leader in the solar space. And it’s gotten much larger in the last two years, since the Canadian government announced a 50% income tax cut for zero-emission technology manufacturers (which the new 2023 legislation extended by three years). Canadian Solar’s revenues were up 41.5% in 2022, another 2% in 2023 (both record highs), and are on track to tack on another 1.2% this year and a whopping 20.2% in 2025. If it meets those estimates, the company will have gone from $3.5 billion in annual revenues to $8.25 billion in just five years. Earnings per share have more than doubled since 2021, and while they’re expected to take a step back this year, they’re projected to reach new highs of $4.75 per share next year.

And the company is right in the sweet spot for the North American solar boom. It manufactures solar photovoltaic modules and runs large-scale solar projects across Canada, and in 29 other countries, even spinning off a subsidiary – CSI Solar Ltd. – last year that trades on the Shanghai Stock Exchange. The company boasts 61 gigawatt (GW) module capacity, is up to 125GW solar module shipments, and has a project pipeline of 26.3GW. That doesn’t include its battery storage shipments (4.5 GW hours, or GWh) or capacity (20GWh expected by year’s end).

It’s a big company that operates on a global scale, and it’s growing fast. And yet … the stock is a small cap, with a market capitalization of a less than $1 billion. It used to be four times as big, trading as high as 63 a share in January 2021. Today, it trades at 14 a share, and at 6x forward earnings, 37% of book value, and a paltry 0.14x sales. It’s the cheapest the stock has ever been.

Small caps, perhaps they had “meat on the bone” after a nice run-up in July, got pummeled in the Friday/Monday selling. Canadian Solar was no exception. The stock is down 12% in the last week, despite no news. It’s now back to its April lows in the low 14s.

What happened after that April bottom? CSIQ shares rose 38% in the ensuing six weeks, peaking just below 20 in early June. If the market can get its act together in the coming weeks, I expect a similar bounce. Earnings, due out August 22, could lend a major hand, as they did in May when the company blew EPS estimates out of the water, reporting 19 cents per share when a one-cent loss was expected. The average EPS estimate for the second quarter is 13 cents. We’ll see.

CSIQ shares have a whopping 93% upside to our 28 price target. BUY

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.

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, with another 5% uptick estimated in 2025.

And yet the stock is cheap, trading at a mere 10x forward earnings estimates, 88% of book value, and 1.36x sales. The share price peaked at 177 exactly three years ago, in August 2021; it currently trades at 137 a share.

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 was no company-specific news for Capital One in its first week in our portfolio, but COF shares were down 10% as Friday’s weak jobs report and the accompanying recession fears took a chunk out of financials in particular. To me, this is Exhibit A of the type of stock I mentioned in the open: one that was beaten down by last week’s macro fears and can now be had at an even more appealing discount. The stock goes ex-dividend next Monday, August 12, so if you missed the boat last week, you can buy it cheaper now and still get the next dividend payment (60 cents per share – a 1.8% yield).

The stock has 35% upside to our 185 price target. 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 under 15x 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.

Stop me if you’ve heard this before: There was no news for Dick’s this week, and yet the stock fell sharply. Dick’s shares gave back the 6% they had gained the previous week and have now alternated up-and-down-6%-or-more weeks for the past month. Perhaps once the market calms down, Dick’s will finally pick a lane. Regardless, I think the intermediate-term trajectory is up (+36% year to date) and plenty of upside remains – I’ve given DKS shares a 250 price target, exactly 25% higher than the current price. 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 reported another strong, hybrid car-fueled quarter on Wednesday. In its fiscal first quarter of 2025, the Japanese carmaker reported an 8.7% year-over-year profit increase on a 17% improvement in global sales, assisted by a 9% uptick in U.S. sales – thanks to growing demand for its hybrid vehicle models here. A weak yen also had a hand in the company’s profitable quarter, adding nearly 48 billion yen ($326 million) to Honda’s quarterly operating profit. A spike in motorcycle sales in Brazil, India and North America also helped the company offset weakness in China, where total sales tumbled 23% due to escalating competition, rampant price cuts and a shift toward all-electric vehicles – an area in which Honda is still playing catch-up. Still, the company maintained its full-year operating profit forecast of 1.42 trillion yen.

HMC shares responded to the solid quarter by rising more than 3% in early Wednesday trading, though they were still down about 5% for the week thanks to the record 12% implosion in the Japanese stock market on Monday (though that was quickly followed on Tuesday by a 10% gain, the Nikkei’s largest one-day bump since October 2008). It’s easy to get caught up in Japanese (and U.S.) market volatility right now, but let’s focus on the company, which just had another good quarter thanks primarily to the catalyst that convinced us to add it to the Value Investor portfolio – soaring hybrid sales, particularly in the U.S.

HMC shares are off to a slow start for us but have become laughably cheap for a major global automaker, trading at 6x forward earnings estimates and 0.34x sales. The stock has 47% upside to our 45 price target. The 4.5% dividend yield helps cushion the recent decline in the share price. BUY

Philip Morris International (PM) – Based in Connecticut, Philip Morris owns the global non-U.S. rights to sell Marlboro cigarettes, the world’s best-selling cigarette brand. Cigarettes comprise about 65% of PMI’s revenues. The balance of its revenues is produced by smoke-free tobacco products. The cigarette franchise produces steady revenues and profits while its smoke-free products are profitable and growing quickly. The upcoming full launch of IQOS products in the United States, a wider launch of the IQOS ILUMA product and the recent $14 billion acquisition of Swedish Match should help drive new growth.

The company is highly profitable, generates strong free cash flow and carries only modestly elevated debt (at about 3.2x EBITDA) which it will whittle lower over the next few years. The share valuation at about 15.1x EBITDA and 18.2x per-share earnings estimates is still too low in our view. Primary risks include an acceleration of volume declines and/or deteriorating pricing, higher excise taxes, new regulatory or legal issues, slowing adoption of its new products, and higher marketing costs. A strong U.S. dollar will weigh on reported results. While unlikely, Philip Morris could acquire Altria, thus reuniting the global Marlboro franchise.

There was no company-specific news for Philip Morris this week, and PM shares were exactly flat, which qualifies as a victory given the backdrop of the sharp market plunge since last Thursday.

The stock is likely still benefitting from its solid quarterly earnings report two weeks ago.

Revenue improved 9.6% year over year in the second quarter, while earnings per share of $1.59, while down slightly (-0.6%) year over year, beat estimates. The cigarette maker’s smoke-free products continued to carry the day, with nicotine pouch sales – led by its signature Zyn product – up 50.6%, while heated tobacco items (led by IQOS) improved 13.1% in shipment volume. Both offset what were essentially stagnant cigarette sales (0.4% uptick in shipment volume). Smoke-free products now account for 38% of Philip Morris’ total revenues.

The rosy quarter was good enough to prompt the company to lift full-year EPS guidance from 9% to 11% growth to 11% to 13% growth.

PM shares are up more than 8% since the report, reaching two-year highs above 115. It’s within 5% of our 120 price target. The 4.8% dividend yield adds to what is now a solid total return since the stock was added to the portfolio last September. 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 mere 4x forward earnings estimates, with a price-to-sales ratio of just 0.23 and a price-to-book value of 1.21. The stock peaked at 96 a share in November 2018; it’s currently in the upper 30s.

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.

Airline stocks imploded last week, and United Airlines was no different. The combination of escalating overseas tensions and a weakening job market in the U.S. spooked investors in travel-related stocks, and the JETS ETF is down 10% in August. UAL shares have fallen even further down 15%. Given that pronounced decline, and that UAL has fallen for nearly three straight months, down from highs above 55 to 39 as of this writing, let’s downgrade this one to HOLD until it can get its act together.

Again, the company has done nothing wrong (sales improved 5.7% in the recently reported quarter, though those were slightly short of estimates), and there’s been no indication that people are starting to cancel travel plans because of the bad jobs report or swelling turmoil in the Middle East (although United itself did suspend flights to Tel Aviv, along with Delta), so there’s no reason to believe the stock will stay down long. But at this point, it needs to prove it. HOLD

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.

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.

Aviva is an oasis in a desert right now – a steadying force in our portfolio, with little fluctuation week to week but, over time, inching its way higher. Sure, it has dipped along with everything else after touching new two-year highs above 13 last week, but it’s only down to 12, in line with its June and July lows. The U.K.-based life insurance and investment management firm will report earnings next Wednesday, August 14. The 7% dividend yield adds to our solid double-digit return thus far. AVVIY shares still have 16% 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.

CNH reported mixed second-quarter earnings results a week ago.

Revenue declined “only” 16% year over year to $5.49 billion, beating analyst estimates of $5.32 billion. Earnings per share of 38 cents were in line with analyst expectations but down from 52 cents in the same quarter a year ago. The company also lowered full-year profit guidance, down to a range of $1.30 to $1.40 from a previous range of $1.45 to $1.55. Declining crop prices coupled with higher production costs have hit farms hard around the world of late, thus lowering demand for farming equipment.

CNH shares were up 3% initially after the report, but have retreated about 8% in the week since, likely due to the market pullback. CNH shares are quite cheap, trading at less than 7x earnings estimates and 0.54x sales.

Given the recent weakness in the stock (down from highs above 13 in early April), we will maintain our Hold rating for now. HOLD

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 Industrial also reported earnings last Wednesday and its results were also mixed.

Earnings per share of 36 cents narrowly topped estimates of 35 cents and were flat year over year. Sales, however, fell just shy of estimates ($885.5 million vs. $893 million expected) and were down 5.4% year over year. The relatively “blah” report – neither good nor overly bad – was met with some modest buying initially, but shares have sunk 12% in the week since the report. Still, it remains our best performer, up more than 50%, and the stock has 22% upside to our 20 price target. BUY

NOV, Inc (NOV) – This high-quality, mid-cap company, formerly named National Oilwell Varco, builds drilling rigs and produces a wide range of gear, aftermarket parts and related services for efficiently drilling and completing wells, producing oil and natural gas, constructing wind towers and kitting drillships. About 64% of its revenues are generated outside of the United States. Its emphasis on proprietary technologies makes it a leader in both hardware, software and digital innovations, while strong economies of scale in manufacturing and distribution as well as research and development further boost its competitive edge. The company’s large installed base helps stabilize its revenues through recurring sales of replacement parts and related services.

We see the consensus view as overly pessimistic, given the company’s strong position in an industry with improving conditions, backed by capable company leadership and a conservative balance sheet.

NOV reported Q2 earnings in late July, and unlike CNH and Gates, it had a great quarter!

Revenue ($2.22 billion) improved 5.9% from the second quarter of 2023; earnings per share ($0.57) improved 46%; and profit margins increased from 7.4% to 10%. Its adjusted EBITDA margin came in at 12.7%, the highest since 2015. Energy equipment accounted for more than half of total revenues ($1.2 billion) and was up 8% year over year.

Investors liked what they saw from NOV, and shares were up more than 12% in the first week after the report, bringing them to within an inch of a new 2024 highs. Unfortunately, then market forces – and tumbling crude oil prices (as low as $72 a barrel earlier this week) – sent shares tumbling right back to where they were before earnings, in the low 18s.

The stock is 33% below our 24 price target. And shares are still relatively cheap, trading at 11x earnings estimates and at 0.79x sales. 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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