Why I wasn't surprised to see a big interest-rate cut; Tell me which of these stocks you would like me to take a closer look at: Adobe, Expedia, or Estée Lauder
1) Just as I predicted...
I said in Tuesday's e-mail that I expected the Federal Reserve to cut interest rates by 50 basis points – and that's exactly what happened yesterday.
After an initial pop, the market yawned... And so did I. (Today, the markets are moving higher.)
I didn't have much of an initial reaction because – as I've long said in explaining why I have remained constructive on stocks despite widespread fears of a recession – either the economy will remain strong and therefore the Fed won't cut rates by much (if at all), which is good for stocks... or the economy will slow and therefore the Fed will cut rates, which is also good for stocks.
For more insight on why the Fed cut by double what analysts were expecting as recently as a week ago, check out this post from New York Magazine's Intelligencer yesterday: How Jerome Powell Got The Fed To A Big Half-Point Cut. Excerpt:
...while Wednesday's Fed meeting was supposed to be a triumphant moment for [Fed Chair Jerome] Powell – one where he could unofficially claim victory over inflation that took root over the past two years and take credit for guiding the economy to a so-called soft landing – it ended up being more complicated. The Fed's actions reveal that, even with the economy maintaining a rare balance of low inflation and high employment, it still requires dramatic action to stave off a decline...
A bigger cut was Wall Street's preferred outcome, but it will also give investors pause. (The opposite held true for a shallower cut – one on hand, it wasn't what Wall Street wanted, but it would have been a reassuring sign that the economy was essentially fine, and anything more would risk sending prices back higher.) A larger cut also comes with higher risk. If Powell turns out to get it wrong, and inflation roars back, it would be an embarrassing – and more difficult – coda to an already delicate situation.
2) Three interesting stock ideas, all former market darlings that have pulled back a bit, have hit my radar in the past week...
So rather than doing what I usually do, which is pick the one that most interests me and start doing a deep dive, I'm instead going to lay out a quick summary of each of them today and invite my readers to weigh in on which one(s) they are most interested in and then take it from there.
So without further ado...
Software maker Adobe (ADBE), best known for its ubiquitous Creative Cloud suite of programs, has been an extraordinary performer over the past two decades... but its stock took a beating in 2022 and has traded mostly sideways for the past four years, as you can see in this chart:
Meanwhile, while Adobe's revenues have continued to grow, profits have stalled in recent years – meaning margins have declined. Take a look at this chart of the company's revenue and net income:
Adobe has a roughly $225 billion market cap, a small net cash position, and the stock is trading at very rich multiples: 10.8 times enterprise value to revenues and 43.6 times trailing earnings per share.
My quick take is that this is an incredible company... but given how margins have declined and profits have stalled, I was expecting/hoping to see multiples half of what they are.
3) Up next, online travel company Expedia (EXPE) had a fantastic run for nearly a decade from early 2009 through mid-2017... But its stock today, after a huge crash at the beginning of the pandemic and an even bigger rally over the subsequent two years, is now around levels it first reached nine years ago:
As you would expect, the stock has followed the earnings. In the chart below, you can see a big crash in 2008, a huge recovery, another crash in 2020, and a big recovery. But overall, both the stock and the company's profits have been essentially flat since 2015:
Expedia has a roughly $18 billion market cap, equal amounts of cash and debt, and the stock is trading 1.4 times enterprise value to revenues and 24.5 times trailing earnings per share.
My quick take is that as with Adobe, I was expecting/hoping to see multiples half of what they are.
4) Lastly, global cosmetic maker Estée Lauder (EL) was an incredible growth stock to its peak of about $372 per share in the first few days of 2022... but since then has collapsed by 76%:
Looking at the company's income statement, you can see that revenues have only declined slightly... but profitability has fallen off a cliff – explaining why the stock has done the same:
Estée Lauder has a roughly $32 billion market cap, $6.4 billion of net debt, and the stock is trading 2.4 times enterprise value to revenues and 81.6 times trailing earnings per share (though "only" 31.2 times this year's and 21.3 times next year's consensus analysts' estimates of $2.91 per share and $4.13 per share, respectively).
My quick take is that Estée Lauder was an incredible company... but given the collapse in profits, I'm not sure it still is – I would need to investigate the reasons behind this dismal performance to determine if the company might recover.
And, not to sound like a broken record, I was expecting/hoping to see multiples half of what they are.
So let me know which of these ideas you'd like me to do a deeper dive on – send me an e-mail by clicking here.
I look forward to hearing from you!
Best regards,
Whitney