Cato, You Make Big Bucks by Going Against the Crowd

Understanding stock market psychology is a huge advantage for traders with the temperament to think for themselves. It's not easy going against the crowd, however, so few people really benefit as much as they should, even when their contrarian instincts are correct. Specialty retailer Cato Corp. (CATO) provides a prime example. The graphic below was published during June of 2020. Cato was losing money due to government imposed shutdowns of non-essential businesses. That shouldn't have surprised anyone. Nor should it have tainted their views of what the firm could earn again once the stores eventually reopened. From fiscal year 2010 through fiscal 2019, Cato's EPS averaged $1.79 per share. The company was, and remains, debt-free with plenty of cash on its balance sheet. There are no preferred shares and no defined benefit pension plan to deal with. Management had been generous in sharing its success with its shareholders. Dividends paid totaled more than 50% of net profits in most years. From 2011 through 2019, buybacks had trimmed shares outstanding from 29.5 million to just 24.3 million, all from internally generated cash flow. When the stores closed, management prudently suspended dividend payments. That didn't help the stock price as many shareholders counted on the previously generous income stream they provided. Shares that fetched almost $20 late in 2019 got creamed during the COVID-19 crisis. At the absolute low, after the chart below was created, Cato sank to a stunning $6.07 last October. I originally recommended the stock at just under $7 on the premise that they could earn at least $1.50 per share in fiscal 2021, ending Jan. 31, 2022, and trade for about 14 times by then. Losses continued throughout fiscal 2020. Last fall Value Line gave up on offering analyst coverage of Cato. It was relegated to their small-cap edition, which is nothing more than a statistical presentation. In its last full-coverage report on Cato, Value Line's analyst said she thought Cato would continue to post losses again in fiscal 2021. How wrong that turned out to be. Cato earned 92 cents a share in the quarter ended April 30. It then posted a 62 cents profit a share in the July 31 period. That represented EPS of $1.54 per share in the company's seasonally strong first half. Even a modest second half contribution should bring Cato's full year EPS to at least $1.65, and perhaps, even more. The formatting on the data below reflects the now bare-bones report on Cato, adjusted for its first half of 2021 results. From 2013 through 2019, its pre-COVID-19 years, Cato often peaked at from 18 times to 22 times earnings. Its average multiple was 16.1 times. Assign that typical valuation to Cato and the shares could recover to north of $26 again within six to 12 months. That goal is not farfetched. CATO topped out between $26.88 and $44.89 during each of the six calendar years from 2013 through 2018. As of Aug. 19, Cato had surged by greater than 173% from last October's nadir. Even so, simply hitting my new goal price of $26.56 would add another 60% from here. What were the keys to making great profits with Cato? Catching the lows meant buying when almost everybody hated retailers in general, and Cato in particular. Investors needed to assume a resumption of normalized operations during the worst of the panic and forced closures. Traders needed to go with their own earnings estimates for fiscal year 2021 and beyond rather than counting on professional opinions that proved to be way too pessimistic. People needed to assume uncertainty risk about how long the shut-downs would last. Patience was required. Cato didn't make its final bottom until almost seven months after most other stocks had made theirs. Being temporarily early can be very taxing on investors' Note: Industry rival Vera Bradley (VRA) is due to report its Q2 numbers on Sept. 1. I loved it in May 2020, at under $5, for most of the same reasons I liked Cato. VRA's profits held up better than Cato's after its stores reopened. I cashed in on some great option gains last November when my short put positions all expired worthless. Since then, I made even more on put expirations in February, May and August of 2021. Vera Bradley reached as high as $13.62 this year after bottoming out last summer at $4.06. As of Aug. 20, VRA was hovering about $11. VRA traded between $20 - $40 per share in past years and, like Cato, appears well on the way to a major profit rebound. Earnings beats in upcoming quarters could send its shares much higher.

Cato, You Make Big Bucks by Going Against the Crowd

Cato benefits by going against the crowd, which isn't easy.

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