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Value Investor
Wealth Building Opportunites for the Active Value Investor

December 19, 2023

This might be the first time anyone has described singer-songwriter Katy Perry as a sage observer of the stock market. Her song, “Hot and Cold” opens with the lyrics, “You change your mind / like a girl changes clothes.”

This perfectly captures the changes in sentiment in the stock market over the past two months. Going into October, the market was fully locked into the view that elevated inflation would endure, that 10-year Treasury yields were headed above 5% and that there was no hope for small-cap stocks or any group of stocks other than the Magnificent Seven mega-cap tech stocks. Dark days and a hard landing were undoubtedly ahead.

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The Katy Perry Stock Market

This might be the first time anyone has described singer-songwriter Katy Perry as a sage observer of the stock market.

Her song, “Hot and Cold” opens with the lyrics, “You change your mind / like a girl changes clothes.”

This perfectly captures the changes in sentiment in the stock market over the past two months. Going into October, the market was fully locked into the view that elevated inflation would endure, that 10-year Treasury yields were headed above 5% and that there was no hope for small-cap stocks or any group of stocks other than the Magnificent Seven mega-cap tech stocks. Dark days and a hard landing were undoubtedly ahead.

Since then, this consensus view has reversed. Inflation is now presumed to be headed back to the 2% Fed target. Interest rates have slid a full percentage point or more with the consensus convinced that the Fed will cut rates several times next year. Any recession will be mild – a true soft landing. It’s now green lights for stocks through 2024. Backed by this favorable outlook, stocks have staged a broad and crisp rally, surging close to 15%, with many indices either at or very near record highs. Small-cap stocks continue their 21%+ rally.

‘Cause you’re hot, then you’re cold
You’re yes, then you’re no
You’re in, then you’re out
You’re up, then you’re down
You’re wrong when it’s right
It’s black and it’s white.

The frustrating truth is that the future is always unpredictable, always uncertain. Nobody really knows whether we are headed to a soft landing, or a hard landing or any other kind of aviation-like outcome. No one can predict where commodity prices are headed, or interest rates, or nearly any other economic variable. For those who say they can, perhaps they can share their track record.

Katy Perry offers sage advice about the market’s hot-n-cold nature:

I should know (I should know) That you’re not gonna change.

One way to win at the consensus game is to take the other side when it becomes extreme. If, for example, the market is sure that a recession is on the horizon and is pricing stocks for weak earnings and low valuations, then the downside is probably limited but the upside is probably sizeable if the consensus is wrong.

Similarly, if the market is certain that the Magnificent Seven stocks will continue to climb ever-higher regardless of fundamentals or valuation, eventually the consensus will be wrong. A fundamental disappointment might trigger a slide tomorrow, or maybe the new year will bring an enduring loss of favorable sentiment, or perhaps it might take another year.

But following the consensus views, which are based on emotions, seems destined for a bad breakup.

I should know
That you’re no good for me.

The last thing I want to do is fall into the trap that Ms. Perry warns us about:

Someone call the doctor
Got a case of a love bipolar
Stuck on a roller coaster
Can’t get off this ride

May wisdom and good tidings be yours this holiday season, regardless of the source!

Scheduling note:
Due to the holidays next week, the Cabot Value Investor will not be published. We will resume our regular schedule the following week with the monthly edition to be published on Wednesday, January 3, 2024.

Share prices in the table reflect Monday, December 18 closing prices. Please note that prices in the discussion below are based on mid-day December 18 prices.

Note to new subscribers: You can find additional color 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.

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This Week’s Portfolio Changes

Last Week’s Portfolio Changes
Allison Transmission (ALSN) – Moved shares from BUY to HOLD.

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 and generates vast cash flow (which it returns to shareholders through dividends and buybacks). Its announced deal for Splunk will drain most of its cash hoard but we see this as being replenished relatively quickly.

The $2.75 billion patent infringement judgment against Cisco was rejected by a federal judge, and this decision appears to be final.

CSCO shares rose 1% in the past week and have 33% upside to our 66 price target. Based on fiscal 2024 estimates, unadjusted for the Splunk acquisition, the valuation is attractive at 8.9x EV/EBITDA and 12.8x (on July 2024) earnings per share. BUY

Comcast Corporation (CMCSA) 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 worries 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, generous dividend and sizeable share buybacks.

Comcast and the U.S. Chamber of Commerce reiterated their opposition to a plan by the Federal Communications Commission to reinstate “net neutrality.” This plan would, in many ways, treat internet service as a public utility and limit Comcast and other cable companies from being able to control their pricing and service delivery. The size of the economic impact on cable companies isn’t clear, nor is the likelihood, timing or legality of such a plan.

Comcast shares rose 5% in the past week and have 3% upside to our 46 price target. As the shares are approaching our price target, we have moved the shares to HOLD.

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 13.5x EBITDA and 15.6x per-share earnings is 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.

The World Health Organization urged governments to impose the same controls on alternative nicotine products as they currently do on cigarettes. While the WHO has no legal authority over any government’s policies, their views reflect what could be an eventual shift in the politics and reality of nicotine regulation, which would be unfavorable to Philip Morris.

PM shares rose 2% in the past week and have 26% upside to our 120 price target. The shares offer an attractive 5.5% dividend yield. 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.

ALSN shares rose 3% in the past week and have 2% upside to our 59 price target. The shares offer a reasonable 1.6% dividend yield. Given the minimal upside, last week we moved shares of Allison Transmission to HOLD.

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 significant company-specific news in the past week.

Aviva shares were unchanged this past week and have 29% upside to our 14 price target. Based on management’s guidance for the 2023 dividend, which we believe is a sustainable base level, the shares offer a generous 7.8% yield. We anticipate a dividend increase for 2024. On a combined basis, the dividend and buybacks offer more than a 10% “shareholder yield” to investors. 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.

For current and prospective shareholders of Barrick Gold, there is a YouTube video on gold that might be worth watching. Recently released, it is sponsored and produced by the World Gold Council, so it presents, of course, a friendly image of gold. That disclaimer aside, it is capably hosted by actor Idris Elba and gives viewers a tour of various world-class mines, describes the mining process and provides other insights into the world of gold. It’s just over an hour long, so maybe do something else while also watching. Here is the link:

Over the past week, commodity gold rose 2% to $2,037/ounce. Despite the recent spike, gold prices seem stuck between about $1,800 and $2,000. The 10-year Treasury yield fell sharply to 3.98% from 4.28% last week, as the Fed’s comments strongly point to no further rate increases and to a likely start of rate cuts next year. The 10-year Treasury has slid by 1 full percentage point in only a month.

While inflation appears to be contained and weakening, the structural forces behind inflation – war, government spending, crime, oil prices and past-the-peak fading of the benefits of global free trade, in addition to a tight labor market – may not be vanquished. Aggregate inflation statistics include subcomponents which show starkly different pictures of pricing trends, and these trends can and have changed from month to month. Despite the favorable broad trend, there remains a reasonably good chance that inflation could remain above a 3% pace indefinitely. This would imply permanent 4-6% interest rates.

The U.S. Dollar Index (the dollar and gold usually move in opposite directions) slipped about 2% to 102.55.

Investors and commentators offer a wide range of outlooks for the economy, interest rates and inflation. We have our views but hold these as more of a general framework than a high-conviction posture. Investing in gold-related equities is a long-term decision – investors shouldn’t allow near-term weakness to deter their resolve.

Barrick shares rose 5% this past week and remain depressed despite gold prices at the top end of the $1,800 - $2,000 range, indicating that investors have no confidence in gold prices and little confidence in the company’s ability to generate higher cash flow. Barrick shares have 54% upside to our 27 price target. BUY

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. Investors have lost hope in Citigroup, creating an impressive bargain.

The bank said it will separate its Banamex operations in Mexico next year, in anticipation of an IPO in 2025. This unit has been difficult to offload, as none of its few natural buyers were able to agree to a deal. It is unclear what value the market will assign to a stand-alone Banamex but removing it from Citi proper is a clear benefit to Citi shareholders.

Citi shares rose 3% in the past week and have 71% upside to our 85 price target. Since reaching lows in late October, Citi shares have surged nearly 30%, highlighting the merits of holding onto stocks, and possibly adding to positions, on weakness rather than selling along with everyone else. The shares remain attractive as they trade at about 57% of tangible book value of $86.90. The dividend offers investors a 4.3% yield.

When comparing Citi shares with a U.S. 10-year Treasury bond, Citi offers a higher yield and considerably more upside price potential. Clearly, the Citi share price and dividend payout carry considerably more risk than the Treasury bond, but at the current valuation Citi shares would seem to have a remarkably better risk/return trade-off. BUY

CNH Industrial (CNHI) – 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. See our November 30 Alert and the December 5 Monthly letter for more color on our thesis.

CNH’s delisting from Euronext Milan will be effective on January 2, 2024.

CNH’s shares rose 4% in the past week and have 31% upside to our 15 price target. The 3.4% dividend yield offers a worthwhile interim cash return. 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 37% stake today.

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

Gates shares rose 4% this past week and have 30% upside to our 16 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.

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

The price of West Texas Intermediate (WTI) crude oil lifted 4% to $73.65/barrel, primarily due to attacks on commercial vessels in the Red Sea – the gateway to the Suez Canal. Oil production in the United States has returned to its prior high, which has offset the recent extension of the OPEC+ production cuts.

Outcomes in wars are unpredictable. It would seem that the potential for sharp oil price volatility is higher with the increasingly complicated game of shifting geopolitical and economic alignments. A major new catalyst, in addition to all of the others, would be export or production cuts from the Middle East if Iran became directly or even explicitly indirectly involved (including if the U.S. restores its sanctions). Also, American sanctions on Venezuelan oil may return, which would provide at least modest support for oil prices.

The price of Henry Hub natural gas jumped 8% to $2.56/mmBtu (million BTU). The recent sharp price moves indicate the potential volatility of gas prices as winter approaches.

NOV shares jumped 7% in the past week and have 25% upside to our 25 price target. The dividend produces a reasonable 1.0% 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. Our Sensata investment remains an underperforming (from a business fundamentals perspective) work in progress.

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

The shares will likely remain weak or stagnant for the near term due to the company’s weak fundamentals and average leadership. We will wait for a favorable change in investor sentiment but are poised to pull the plug. ST shares rose 6% in the past week and have 59% upside to our recently reduced 57 price target. HOLD

Growth/Income Portfolio

Stock (Symbol)Date AddedPrice Added12/18/23Capital Gain/LossCurrent Dividend YieldPrice TargetRating
Cisco Systems (CSCO)11/18/2041.3250.1721.40%3.10%66Buy
Comcast Corp (CMCSA)10/26/2231.544.5941.60%2.60%46Hold
Philip Morris International (PM)9/18/2396.7995.29-1.50%5.50%120Buy

Buy Low Opportunities Portfolio

Stock (Symbol)Date AddedPrice Added12/18/23Capital Gain/LossCurrent Dividend YieldPrice TargetRating
Allison Transmission Hldgs (ALSN)2/22/2239.9957.6944.30%1.60%59Hold
Aviva (AVVIY)3/3/2110.7510.840.80%7.40%14Buy
Barrick Gold (GOLD)3/17/2121.1317.73-16.10%2.30%27Buy
Citigroup (C)11/23/2168.149.81-26.90%4.30%85Buy
CNH Industrial (CNHI)11/30/2310.7411.68.00%3.40%15New Buy
Gates Industrial Corp (GTES)8/31/2210.7212.4316.00%0.00%16Buy
NOV, Inc (NOV)4/25/2318.820.026.50%1.00%25Buy
Sensata Technologies (ST)2/17/2158.5736.04-38.50%1.30%57Hold

Current price is yesterday’s mid-day price.

CVI Valuation and Earnings

Growth/Income Portfolio

2023 EPS
2024 EPS
Change in
2023 Estimate
Change in
2024 Estimate
P/E 2023P/E 2024
CSCO 49.66 3.87 4.02-0.2%-0.2% 12.8 12.3
CMCSA 44.75 3.93 4.310.1%-0.2% 11.4 10.4
PM 95.18 6.08 6.50-0.5%0.0% 15.6 14.6

Buy Low Opportunities Portfolio

2023 EPS
2024 EPS
Change in
2023 Estimate
Change in
2024 Estimate
P/E 2023P/E 2024
ALSN 57.80 6.96 7.270.0%0.0% 8.3 8.0
AVVIY 10.83 0.37 0.450.0%0.0% 29.1 24.0
GOLD 17.48 0.84 1.111.5%1.5% 20.9 15.7
C 49.61 6.01 5.930.0%0.0% 8.3 8.4
CNHI 11.48 1.69 1.52 na na 6.8 7.6
GTES 12.30 1.25 1.370.0%0.0% 9.9 9.0
NOV 19.97 1.42 1.720.0%0.0% 14.1 11.6
ST 35.74 3.65 3.990.0%0.0% 9.8 9.0

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.

Buy – This stock is worth buying.
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.

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.