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  • Stocks have fallen significantly, but we're entering a seasonally stronger period.
  • Doug Kass thinks great companies are increasingly available at good prices.
  • Paul Price targets two consumer stocks and one bank trading at a discount to historical valuation.

The stock market has fallen substantially this year, creating opportunities for investors with horizons that stretch out one year or more. Undoubtedly, there will be some ratcheting back in future earnings estimates following the third-quarter earnings season. Nevertheless, some stocks are trading at a historically low price-to-earnings ratio that can insulate them against modestly lowered outlooks.

This year’s “cash is king” mantra is unchanged. However, bargain-oriented investors with money on the sidelines might want to take advantage of lower prices by picking some companies off the discount rack.

Historically, the best six months of market performance occur in the period stretching between November and May. Furthermore, while mid-term election years are notoriously poor performers, the performance of the pre-election and Presidential election years are much better.

The following chart shows how the Presidential election cycle has played out in the past. While there are plenty of reasons why stocks may not turn on a dime and rally after the November election, history tends to rhyme.

CHART-Presidential-Cycle-101922

Some more reasons to buy some stocks

The potential for higher equity prices isn’t lost on Real Money Pro’s Doug Kass. Kass has been tilting his hedge fund increasingly bullish this past month following significantly bullish readings on sentiment indicators.

In his diary this week, Kass said that he remains optimistic about stocks and bonds, writing, “historic drop in stock prices has provided an opportunity to buy great companies at good prices and not-yet-great companies at great prices.”

He lists four reasons for his optimism:

  • "Lower stock prices are the friend of the rational buyer. They provide a better intermediate-term upside reward vs. downside risk and sow the seeds for superior investment performance when stocks resume an upwards trajectory.
  • Warren Buffett famously professed that "investors should be fearful when others are greedy and greedy when others are fearful." Fear is the oldest and strongest emotion of mankind. But it is logic of argument and analysis -- not fear or greed (the two emotions that drive markets) -- which should guide our investment process. Though times like this are challenging, being unemotional when others are losing their heads remains an integral part of my investment methodology.
  • It is my view that the historic drop in stock prices has provided an opportunity to buy great companies at good prices -- but not-yet-great companies at great prices.
  • Though there are currently expanding concerns about financial stress, especially in Europe, I believe that those concerns are overblown as most financial stress indexes put too much weight on the appreciation of the U.S. dollar than actual balance sheet considerations. On the latter score, I do not see excessive conditions -- similar to previous cycles as in mortgage and finance - that suggest a systemic breakdown."

Generally, Kass suggests he’s tilting long because investors have priced in much of what could go wrong, indicating that that path of least resistance could be up because everyone has become largely bearish.

This week, Bank of America’s survey of portfolio managers revealed that they’re holding the highest cash levels since the Internet bust. That normally happens when people hide under desks because they’re convinced things are getting worse, not better. The elevated cash levels prompted Bank of America to write, “FMS [Fund Manager Survey] screams macro capitulation, investor capitulation, start of policy capitulation."

Suppose Kass is correct systematic risk is smaller than some imagine, and Bank of America is correct that cash levels indicate too many have thrown the towel on stocks. In that case, logic dictates some of that cash will eventually find its way back into stocks.

Value stocks to buy

As Kass suggests, many stocks are trading at good prices, particularly based on price-to-earnings ratios relative to historical valuation.

Real Money Pro value investor Paul Price recently highlighted stocks that fit that bill, including two consumer companies, G-III Apparel  (GIII)  and Wolverine World Wide  (WWW) , and one bank, Signature Bank  (SBNY) .

G-III markets consumer apparel and accessories from many well-known brands, including Tommy Hilfiger, Calvin Klein, and DKNY.

Price writes about G-III:

“If you believe we are in for a nice rally here is a stock that appears poised for a huge upturn…Buyers at GIII's Oct. 16, 2022, close were getting more than triple the earnings per share from 10 years earlier at an absolute price which was 18% below what was in effect exactly a decade ago…At a glance at the data below shows a typical P/E for G-III runs about 14.5x. At last week's close that figure was stunningly cheap at just 4.3x its FY 2022 estimate. That valuation was well below what was in effect at the Covid-panic low…Value seekers at 2020's nadir saw GIII run from $3.00 to $35.80 in under 14 months. That is what can happen from absurdly low valuation points…Even a partial reversion towards the mean to 13 times next year's estimate could send GIII to north of $50.”

Analysts expect G-III’s EPS to slip 10% to $3.67 in 2023. Still, if it can deliver on that outlook, its forward P/E of 4.6 remains arguably cheap. Even if they cut that estimate by 20% in the coming months, you’d still be paying less than six times next year’s EPS to own the stock at current prices, which is half the ‘typical’ P/E Price mentions.

Wolverine World Wide owns many popular footwear brands, including Keds, Merrell, and Saucony. Similarly to G-III, Price thinks its shares are undervalued based on its earnings potential.

Price writes:

“If the second half comes in as expected, 10-year per-share sales and EPS will have more than doubled. Dividends rose decently. Total shares outstanding will have shrunk by over 20%...You would expect that outstanding results like that would have resulted in similarly good investor returns. That was true in April 2021, when the shares carved out an all-time high of $44.70. Since then, though, WWW declined to a crazy low $15.11 on Oct. 16, 2022….At that price, the 10-year total return was decidedly negative. What else can you buy today for less than 10 years earlier, even though it is unequivocally much more valuable?

Since 2012, Wolverine's typical price-to-earnings ratio ran about 16.6 times, accompanied by around 1.04% in current yield. At its Oct. 14 closing quote of $15.11, it was offered for just 7 times this year's earnings per share estimate and around 6 times its 2023 EPS projection while yielding 2.65%. Assume a lower-than-average 15 multiple on Wolverine's 2023 estimate, and you come up with a 15-month target price of $37.50. That implies 148% plus dividends in upside potential.”

Analysts estimate Wolverine World Wide’s EPS will grow 8% to $2.14 in 2022 and 15% to $2.47 in fiscal 2023. Similar to G-III, even if those estimates decline 20%, you’re still paying the low end of historical valuation. Over the past five years, its P/E range has been 6 to 41. If 2023 estimates fall 20%, its forward P/E would be about 8.

Finally, Price also picked Signature Bank NY as a too-cheap-to-miss stock. The bank provides a range of traditional bank services to businesses and their owners via 37 private client offices in the metropolitan New York area, Connecticut, California, and North Carolina.

He writes:

“Signature Bank NY went from undervalued to overvalued and then back again -- and now it's a bargain. Its 2012 through 2021 average P/E had declined slightly, to 16.4-times. Amazingly, at Wednesday's closing quote of $148.45, SBNY was offered for just 6.8-times its 2021 EPS estimate and only less than 6.3-times next year's projected earnings….That valuation is lower than SBNY's price-to-earnings at its exact Covid-panic bottom….The bank is not doing poorly. Earnings per share for both 2021 and 2022 are projected to be all-time records…What is SBNY worth?...Assume a still lower than typical 14 P/E on next year's results, and there's no reason the shares can't reach $331 by Dec. 31, 2023. That suggests total return potential of about 125%.”

Analysts expect SBNY EPS will be $22.87 in 2023. A 20% haircut to that estimate works out to a forward EPS estimate of 8.3. Again, this is near the low end of its five-year P/E range of 7 to 23.

The Smart Play

It’s important to note that while Kass is more optimistic than a few months ago, he’s still very heavily in cash. When we discussed cash levels yesterday, he said he’s “been about 75% on average in cash all year.” Also, while he’s been buying opportunistically on down waves, he’s still below 30% net long.

Kass isn’t the only one who, while hunting for some stocks to buy on sale, is still keeping plenty of dry powder. Real Money’s James DePorre wrote today to make sure you have “plenty of cash in reserve.” When we chatted, he said he’s been running 75% to 80% in cash.

Also, Stephen Guilfoyle recently said, “My opinion is that traders still need to remain "cashy," especially going into the wee hours and into weekends. Trade the present? Okay. Trade specific news stories that one finds personally interpretable? Of course.”

Investors should also recognize that while forward P/Es on these stocks appear cheap even when including a 20% downward revision, each could still fall further. There’s no rule guaranteeing stocks stop dropping at a particular valuation.

In short, cash remains king. There could be more opportunities to buy in the future, so consider “dip-toes” trades rather than buying all at once.

For example, if your normal position size is 3%, and you’d like to add the three stocks' Price mentioned above, then buy 1% now and add to that position over time. After all, risk control is paramount in a bear market, the Federal Reserve isn’t yet done hiking interest rates, and earnings season could mean that forward earnings estimates get revised lower over the next few weeks. By buying shares progressively, you’ll be able to test the waters while maintaining flexibility.

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