DeepSeek Scare for AI Companies Could Be Just What This Market Needs
There are a lot of things the stock market can handle.
In 2024 alone, stocks advanced more than 20% despite two major overseas wars raging, high interest rates, stubborn inflation, escalating unemployment, a toss-up presidential election in which one of the candidates changed midsummer, tepid consumer confidence, etc. That’s because, aside from Kamala Harris replacing Joe Biden as the Democratic candidate less than four months before the election, most of these potential headwinds were known. What Wall Street fears most is the unknown. And that’s why DeepSeek rattled markets on Monday.
Few, if any, people knew the name DeepSeek prior to Monday’s market open. It’s a Chinese tech startup that created an artificial intelligence chatbot at, allegedly, a fraction of the cost of existing U.S. AI assistants. The company claims its large language models are just as advanced as ChatGPT but use Nvidia’s expensive chips in a much more cost-effective way.
That news sent shares of some of the largest U.S.-based AI companies tumbling on Monday. Nvidia (NVDA) was down 17%. Broadcom (AVGO) was down 20%. Super Micro Computer (SMCI) fell 15%. Oracle (ORCL) dropped 13%, and so on. They took the entire market with them, with the S&P 500 down more than 2% on Monday and the Nasdaq giving back 3%.
It appears the selling was overdone, as most of those stocks have clawed back some of their losses in the last two days and the market has stabilized. But if DeepSeek’s assertions are proven true, it could at least cool the AI frenzy that has dominated the market the last two-plus years.
I think it’s a good thing. Now, if you own shares of one of the aforementioned companies, Monday’s bloodbath wasn’t fun. (I can relate – I own NVDA.) But AI stocks were due for a correction – the WisdomTree Artificial Intelligence Fund (WTAI) was up 70% since the start of 2023 entering the week – and they have gobbled up far too many investor dollars over the last couple years. A healthier market requires more breadth, with most sectors participating in the rally.
In the two weeks prior to the DeepSeek news – and since the December inflation numbers came in cooler than expected – we were finally seeing that breadth, as I wrote in last week’s update. More than 200 stocks on the NYSE and Nasdaq rose to 52-week highs. The Equal Weight index was up more than 5%, small caps advanced more than 6%, and value stocks improved 5.5% – all in just two weeks. For those asset classes, the DeepSeek news was merely a flesh wound, as none of them imploded the way some of the highest-profile AI leaders did. For most of the market, this week has been little more than a speed bump.
With zero exposure to AI in our Cabot Value Investor portfolio, our stocks have fared quite well in the last week, up an average of 1.6% since our last update. And as the next phase of the bull market continues to develop despite Monday’s jarring interruption, look for stocks outside the artificial intelligence realm to lead the charge this time. We plan on adding another non-AI stock to our portfolio in our February issue next week.
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.
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This Week’s Portfolio Changes
Dick’s Sporting Goods (DKS) Moves from Buy to Hold
Last Week’s Portfolio Changes
None
Upcoming Earnings Reports
Thursday, January 30 – The Cigna Group (CI)
Thursday, February 6 – Peloton Interactive (PTON)
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.
BYD Company Limited (BYDDY) has long been one of China’s top automakers. What really sent its sales into hyperdrive, however, was when it made the switch to all battery electric and hybrid plug-in vehicles in 2022. Revenues instantly tripled, going from $22.7 billion in 2020 (a record, despite the pandemic) to $63 billion in 2022. In 2023, sales improved another 35%, to $85 billion. In 2024, it’s on track for $106.4 billion, or 25% growth, with another 20% growth expected in 2025. The EV maker has emerged as a legitimate rival to Tesla.
But there’s even greater upside. Right now, BYD does roughly 90% of its business in China, accounting for one-third of the country’s total sales of EVs and hybrids this year. The company is trying to change that, recently opening its full-assembly plant outside of China, with a new plant in Thailand starting deliveries. A plant in Uzbekistan puts together partially assembled vehicles. A plant in Brazil is expected to open early next year. And BYD has plans to open more new plants in Cambodia, Hungary, Indonesia, Pakistan and Turkey. Mexico and Vietnam are possible targets as well. Despite no plans to do business in America just yet, BYD is on the verge of becoming a global brand.
And while BYDDY stock has fared well, it hasn’t grown as fast as the company. At 16.1x earnings estimates, BYDDY currently trades at less than 20% of its five-year average forward P/E ratio (89.6). And its price-to-sales (1.10) ratio is about half the normal five-year ratio. As BYD continues to expand globally, look for its valuation to catch up with its industry-leading performance.
BYDDY shares gave back a mere 1% after a 7% run-up the previous week. There was no company-specific news this week. Earlier this month, however, BYD announced a new partnership with Grab, Southeast Asia’s leading ride-hailing platform. Under the agreement, Grab drivers in fast-growing Southeast Asia will have access to as many as 50,000 BYD cars. In other Southeast Asia news, BYD says it plans to complete construction on a $1 billion plant in Indonesia by the end of this year. Both announcements are the latest evidence of BYD’s global expansion outside of China, which is likely the key to launching the company into the mainstream – and the share price into the stratosphere.
December highs above 72 are still acting as overhead resistance. A break above that number could result in a much longer run for BYDDY shares. The stock has 28% upside to out 90 price target. BUY
The Cheesecake Factory Inc. (CAKE) is ubiquitous. With 345 North American locations, chances are you’ve eaten at one, indulged in their specialty high-calorie but oh-so-tasty cheesecakes and browsed through menus long enough to be a James Joyce novel. But despite being seemingly everywhere already and nearly a half-century old, the company is still growing.
Sales have improved every year since Covid (2020), reaching a record $3.44 billion in 2023. In 2024, revenues are on track for $3.57 billion. But the earnings growth is the real selling point. EPS more than doubled in 2023 (to $2.10 from 87 cents in 2022) and are estimated to swell to $3.31 in 2024, a 57.6% improvement, and to $3.69 this year.
It’s still expanding too, opening 17 new restaurants through the first three quarters of 2024. It expects to open a total of 22 new restaurants by year’s end. Those aren’t just Cheesecake Factories – the company also owns North Italia, a handmade pizza and pasta chain; Flower Child, a health food chain that caters to those with special diets (vegetarians, vegans, gluten-free, etc.); and Blanco, a Mexican chain owned by Fox Restaurant Concepts, which The Cheesecake Factory Corp. acquired in 2019.
Despite some recent strength in the stock, CAKE shares trade at 14.3x 2025 EPS estimates and at 0.73x sales. The bottom-line valuation is well below the five-year average forward P/E ratio of 15.6; the price-to-sales ratio is in line with the five-year average.
With shares trading at roughly 20% below their 2017 and 2021 highs, there’s plenty of room to run.
Despite no company-specific news, the rally in CAKE shares continued this week with the stock up 4% on the heels of a 6% rally the previous week. Encouraging earnings reports from some of its restaurant chain contemporaries – namely Cracker Barrel (CRBL) – have likely helped move the needle. The Cheesecake Factory doesn’t report earnings until late February.
In the third quarter, reported in October, sales improved by 4.2% while diluted EPS expanded by 65%. Same-store sales increased 1.6%. The strong quarter got Wall Street’s attention: six major firms have either upgraded their price target or initiated coverage on CAKE since the report.
CAKE shares have 21% upside to our 65 price target. The 2% dividend yield adds to the appeal. 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. In 2024, the top line is on track to top $13 billion for the first time. It should top $13.5 billion in 2025.
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 17x forward earnings estimates and at 1.5x 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.
Dick’s is on the cusp of reaching our price target!
After breaking above long-held resistance at 235, DKS shares kept on rising this week, and at 248 have nearly reached our 250 price target. While there’s been no company-specific news, on Wednesday Argus Research became the third major Wall Street firm to raise its price target on DKS in the last month, bumping theirs from 255 to 280. Should we bump ours up too? Trading at nearly 17x forward earnings and with no immediate obvious catalysts (earnings aren’t due until mid-March), I’m inclined to say no. But let’s cross that bridge when we get there – which could literally happen by the time you read this.
If DKS does top 250 in the coming days, I will send an alert with a recommendation on what to do. It’s a good “problem” to have. We now have a 24% gain on DKS shares in less than seven months. Given the limited upside to our price target, I’m going to downgrade this stock to Hold. MOVE FROM BUY TO HOLD
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 9.7x estimates – and growing faster than the average bear. In fiscal 2024, revenue improved 10% year over year while adjusted EPS was up 12.7%, which compared favorably to 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 $10.5 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.
As Treasury yields have dipped to near the magical 4.5% threshold, Toll Brothers shares have rebounded, up another 3% this week and nearly 10% in January alone. There’s been no major company-specific news, so right now the falling rates are the primary catalyst. We’ll see if yesterday’s Jerome Powell press conference helps or hinders the improving interest-rate environment going forward.
Mortgage rates remain stubbornly high at just under 7% for a 30-year loan. Until those drop in a meaningful way, TOL’s upside may be limited. Even a dip to the low 6% range for the first time since October would likely have a positive impact on homebuilders.
We are now almost back to breakeven on our TOL position. The stock has 22% 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 7.7x forward earnings estimates, with a price-to-sales ratio of just 0.58.
A company that’s making more money than ever before (gross profits reached a record $15.2 billion in 2023, 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 Airlines (UAL) is coming off another record quarter last week. Revenue came in at $14.7 billion, ahead of the $14.47 billion analyst estimate, while adjusted earnings per share came in at $3.26, well ahead of the $3.00 estimate. Sales improved 8% year over year while net profits increased 64%. Better yet, United upped its EPS guidance for the current quarter, to a range of 75 cents to $1.26 – way beyond the 54-cent analyst estimate.
Soaring travel demand post-Covid, a booming loyalty program, and higher prices for seats, especially in business class, helped buoy United to its best year ever. Meanwhile, its cheaper economy seats saw a 20% sales bump in Q4.
The latest stellar quarter from United pushed shares up another 4.5% last week; the stock was mostly stagnant this week. Having added UAL to the Cabot Value Investor portfolio last May, we now have a 115% gain on it. We sold half our position in November after the stock blew past our 70 price target. It’s just kept on rising since and has actually outperformed Nvidia (NVDA) in the past year.
Is a comeuppance coming? Perhaps. But UAL has shown zero signs of one, even as the market flailed for six weeks in December and early January. And the stock is still cheap, trading at 8.3x EPS estimates and 0.62x sales. So let’s ride our remaining half position until the stock gives us a reason to part ways with it. HOLD 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) 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; in 2024, 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 just 9.9x earnings estimates and at just 1.3x sales. A solid dividend (3.0%) adds to the appeal of this mid-cap stock.
ADT shares advanced 4% this week despite an absence of company-specific news. The stock is up more than 8% in January though is still shy of its October highs above 8 per share.
There’s been no real news since late October when ADT reported earnings that beat on both the top and bottom lines. 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 quickly snatched up ADT shares accordingly – they were trading below 7 prior to the report. They eventually sagged back to pre-earnings levels but are now gaining steam again. But the stock remains cheap, trading at less than 10x forward earnings. The shares have 32% upside to our 10 price target. BUY
Aviva, plc (AVVIY), based in London, is a major European company specializing in life insurance, savings and investment management products. Amanda Blanc, hired as CEO in July 2020, is revitalizing Aviva’s core U.K., Ireland and Canada operations following her divestiture of other global businesses. The company now has excess capital which it is returning to shareholders as likely hefty dividends following a sizeable share repurchase program. While activist investor Cevian Capital has closed out its previous 5.2% stake, highly regarded value investor Dodge & Cox now holds a 5.0% stake, providing a valuable imprimatur as well as ongoing pressure on the company to maintain shareholder-friendly actions.
Aviva has finalized its agreement to buy Direct Line Insurance Group for 3.7 billion pounds ($4.65 billion), creating the largest motor insurance company in the United Kingdom. The deal is expected to be completed by mid-2025. AVVIY shares were down more than 7% in the weeks after its Direct Line takeover was first reported on November 27 – which is normal share price action for the acquiring company. But they have since recovered all of their losses and are up 8% year to date and trading at their highest point since October.
AVVIY shares have 9% upside to our 14 price target. The 6.9% dividend yield adds to our healthy return thus far. BUY
The Cigna Group (CI) is the fifth-largest healthcare company in the U.S., with $229 billion in revenue over the last 12 months. It’s a health benefits and medical care provider with a market cap of $82 billion, 170 million customers in over 30 countries, that pays a dividend (2% yield) and is on track to grow sales by 25% and earnings by 13.5% this year and another 10.8% next year. And yet, the stock hasn’t budged much in two years and trades at a mere 9.6x earnings estimates and 0.38x sales. It’s the cheapest CI shares have been in more than a year.
Why the underperformance? Earnings have been inconsistent, with EPS declining 18.8% in 2023 and by 31.4% in 2021. But that appears to be changing, with double-digit growth expected both this year and next, led by its Evernorth Health Services branch, which reported 36% revenue growth in the latest quarter. And healthcare stocks as a group were the second-worst performer of the 11 major S&P 500 sectors in 2024, up a mere 0.87%. As Baby Boomers reach their golden years, healthcare is more in demand than ever, so the sector won’t stay down long. And CI has a habit of outperforming when times are good.
Cigna reports earnings this morning (January 30), after this update was published. Shares were up 4.5% in the past week ahead of the report and have been in steady recovery, up nearly 10% year to date after a rough December for healthcare stocks, health insurers in particular.
Analysts anticipate 23.5% revenue growth and 15.2% EPS growth for the quarter. Cigna has narrowly beaten earnings estimates in each of the last four quarters. A similar beat today could help add to the stock’s January recovery.
As of this writing, CI has 39% upside to our 420 price target. Keeping our rating at Hold for now, but another earnings beat today could prompt us to move back to Buy in next week’s issue. HOLD
Peloton (PTON) was all the rage during Covid, as people stuck at home snatched up the stationary bike with a built-in, interactive touch screen like hotcakes, and revenues quadrupled in two years. Then, Covid ended, people stopped buying Pelotons, and PTON shares – up 700% in the last nine months of 700% – fell to nearly zero, at a scant $3 per share. The selling was overdone, considering Pelton’s sales only fell off by about a third. Now, the bleeding has just about stopped, and the company is expecting to grow again in the coming year. Aggressive cost-cutting – the company is lowering costs by $200 million this (2025) fiscal year alone – has narrowed profit losses and allowed Peloton to generate free cash flow again. It’s using that cash to attract and retain customers, investing in software updates such as personalized workout plans and private “teams” for every subscriber. It’s offering new apps such as Strength+ and fitness “games.” And it is exploring new strategic partnerships to broaden its reach and perhaps start attracting new customers again.
Meanwhile, the company just underwent a regime change – always an appealing catalyst for turnaround candidates. Former Ford executive Peter Stern has taken over as CEO, assuming the helm from embattled former CEO Barry McCarthy after two mostly unsuccessful years on the job.
Add it all up, and suddenly there are a lot of potential catalysts for Peloton for the first time since the pandemic. And the stock has become grossly oversold, currently trading at 1.15x sales, about a quarter of its five-year average and galaxies below the 20x P/S ratio from late 2020 and even the 6.9x sales shares were going for in late 2021.
Peloton reports 2025 fiscal second-quarter earnings next Thursday, February 6. Analysts aren’t expecting much: a 12.5% decline in sales, though earnings per share are estimated to narrow to a loss of -$0.18 vs. -$0.54 a year ago. And the company has handily beaten EPS estimates in each of the last two quarters, so perhaps the losses will be even smaller.
Meanwhile, David Einhorn of Greenlight Capital recently revealed that his firm started a position in PTON late last year. He likes the company’s ongoing cost-cutting initiatives and its loyal subscriber base, both of which he says give the stock “significant upside.”
Despite that ringing endorsement, PTON shares retreated nearly 8% this week, including a drawdown of more than 5% on Wednesday on no news. Perhaps next week’s earnings can right the ship.
PTON stock has 52% upside to our 12 price target. BUY
Growth/Income Portfolio | |||||||
Stock (Symbol) | Date Added | Price Added | 1/29/25 | Capital Gain/Loss | Current Dividend Yield | Price Target | Rating |
BYD Co. Ltd. (BYDDY) | 11/21/24 | 67.5 | 70.99 | 5.19% | 1.20% | 90 | Buy |
Cheesecake Factory (CAKE) | 11/7/24 | 49.68 | 53.7 | 8.05% | 2.00% | 65 | Buy |
Dick’s Sporting Goods (DKS) | 7/5/24 | 200.1 | 247.41 | 23.65% | 2.00% | 250 | Hold |
Toll Brothers (TOL) | 9/5/24 | 139.54 | 137.62 | -1.36% | 0.60% | 180 | Buy |
United Airlines (UAL) | 5/2/24 | 50.01 | 107.89 | 115.70% | N/A | N/A | Hold Half |
Buy Low Opportunities Portfolio | |||||||
Stock (Symbol) | Date Added | Price Added | 1/29/25 | Capital Gain/Loss | Current Dividend Yield | Price Target | Rating |
ADT Inc. (ADT) | 10/3/24 | 7.11 | 7.61 | 7.03% | 2.90% | 10 | Buy |
Aviva (AVVIY) | 3/3/21 | 10.75 | 12.82 | 19.30% | 6.90% | 14 | Buy |
The Cigna Group (CI) | 12/5/24 | 332.9 | 302.57 | -9.10% | 2.00% | 420 | Hold |
Peloton (PTON) | 1/8/25 | 8.69 | 7.88 | -9.21% | N/A | 12 | 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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