Up 25% Since The Beginning Of 2023, Will Capital One Stock Continue To Rally?

Capital One stock (NYSE: COF) currently trades at $118 per share, around 34% below (51% upside) its level of $178 on August 14, 2021 (pre-inflation shock high), and seems undervalued. Capital One saw its stock trading at around $104 at the end of June 2022, just before the Fed started increasing rates, and is trading 13% above that level now. In comparison, the S&P 500 gained about 22% during this period. The stock price has remained volatile over the recent quarters due to difficult macroeconomic conditions. However, improvement in the net interest income after the Fed rate hikes has benefited the firm’s prospects.

Amid the current financial backdrop, COF stock has witnessed gains of 20% from levels of $100 in early January 2021 to around $120 now, vs. an increase of about 25% for the S&P 500 over this roughly 3-year period. However, the increase in COF stock has been far from consistent. Returns for the stock were 47% in 2021, -36% in 2022, and 27% in 2023 (YTD). In comparison, returns for the S&P 500 have been 27% in 2021, -19% in 2022, and 20% in 2023 (YTD) – indicating that COF underperformed the S&P in 2022. In fact, consistently beating the S&P 500 – in good times and bad – has been difficult over recent years for individual stocks; for heavyweights in the Financials sector including V, JPM, and MA, and even for the megacap stars GOOG, TSLA, and MSFT.  In contrast, the Trefis High Quality (HQ) Portfolio, with a collection of 30 stocks, has outperformed the S&P 500 each year over the same period. Why is that? As a group, HQ Portfolio stocks provided better returns with less risk versus the benchmark index; less of a roller-coaster ride as evident in HQ Portfolio performance metrics. Given the current uncertain macroeconomic environment with high oil prices and elevated interest rates, could COF face a similar situation as it did in 2022 and underperform the S&P over the next 12 months – or will it see a strong jump?

Returning to the pre-inflation shock level means that COF stock will have to gain around 51% from the current levels. However, we do not expect that to materialize in the short to mid term, and estimate Capital One’s valuation to be around $112 per share. This is because the tough macroeconomic scenario has negatively impacted investor confidence, and raised concerns about a potential slowdown.

Our detailed analysis of Capital One’s upside post-inflation shock captures trends in the company’s stock during the turbulent market conditions seen over 2022 and compares these trends to the stock’s performance during the 2008 recession.

2022 Inflation Shock

Timeline of Inflation Shock So Far:

• 2020 – early 2021: Increase in money supply to cushion the impact of lockdowns led to high demand for goods; producers unable to match up.
• Early 2021: Shipping snarls and worker shortages from the coronavirus pandemic continue to hurt the supply
• April 2021: Inflation rates cross 4% and increase rapidly
• Early 2022: Energy and food prices spike due to the Russian invasion of Ukraine. Fed begins its rate hike process
• June 2022: Inflation levels peak at 9% – the highest level in 40 years. S&P 500 index declines more than 20% from peak levels.
• October 2022 – July 2023: Fed continues rate hike process; improving market sentiments help S&P500 recoup some of its losses
• Since July 2023: Fed keeps interest rates unchanged to quell fears of a recession, although another rate hike remains in the cards.

In contrast, here’s how COF stock and the broader market performed during the 2007/2008 crisis.

Timeline of 2007-08 Crisis

• 10/1/2007: Approximate pre-crisis peak in S&P 500 index
• 9/1/2008 – 10/1/2008: Accelerated market decline corresponding to Lehman bankruptcy filing (9/15/08)
• 3/1/2009: Approximate bottoming out of S&P 500 index
• 12/31/2009: Initial recovery to levels before accelerated decline (around 9/1/2008)

COF and S&P 500 Performance During 2007-08 Crisis

Capital One stock declined from nearly $53 in September 2007 (pre-crisis peak) to below $10 in March 2009 (as the markets bottomed out), implying COF stock lost almost 81% of its pre-crisis value. It recovered post the 2008 crisis to levels of around $32 in early 2010, rising 220% between March 2009 and January 2010. The S&P 500 Index saw a decline of 51%, falling from levels of 1,540 in September 2007 to 757 in March 2009. It then rallied 48% between March 2009 and January 2010 to reach levels of 1,124.

COF Fundamentals Over Recent Years

Capital One revenues decreased from $28.6 billion in 2019 to $28.5 billion in 2020 due to a drop in net interest income. However, it improved to $30.4 billion in 2021 and $34.3 billion in 2022. The growth was primarily driven by higher net interest income.

On a similar note, earnings increased from $11.10 in 2019 to $17.98 in 2022.

Conclusion

With the Fed’s efforts to tame runaway inflation rates helping market sentiments, we believe Capital One Financial (COF) stock has the potential for strong gains in the long term once fears of a potential recession are allayed.

[1] Month-to-date and year-to-date as of 12/11/2023
[2] Cumulative total returns since the end of 2016

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