Top 5 Stocks To Buy For The First Fed Rate Cut

Federal Reserve: Rates and the economy

The long-anticipated decision to cut interest rates arrived yesterday when Jerome Powell of the Federal Reserve announced it would lower short-term borrowing costs by 0.50%. Discussion around the Fed’s decision dominated news headlines over the summer, as mixed economic data contributed to market volatility and traders speculated on the degree to which the Fed would cut rates. While the Fed did not explicitly hint at the pace at which it will continue to ease the cost of debt, the central bank is expected to keep lowering rates throughout the remainder of 2024 and into 2025.

The Fed began its aggressive cycle of monetary tightening in March 2022, to combat rapidly rising inflation as a result of the pandemic, and hiked rates 11 times until July 2023, where they remained until yesterday.

Interest Rate Hikes vs. Inflation

Typically, the market falls the first week after the first rate cut. Thereafter, the months, quarters, and year following history has shown the market rallies. If history is correct, this should be a buying opportunity.

Market Returns After Fed Rate Cuts

A declining rate environment will likely have far-reaching effects for investors in the coming weeks and months, as equity markets metabolize the shift in the monetary regime.

S&P 500 Sectors That Perform Well in a Declining Rate Environment

Certain sectors tend to outperform in a declining rate environment due to the positive effects of lower interest rates on their cost structures, profitability, and demand for their products or services. Key segments that tend to benefit include Homebuilders, Tech, and Financials.

When interest rates are lowered, homebuilding stocks tend to benefit for several reasons:

• Reduced Mortgage Rates: Lower interest rates typically lead to more affordable mortgages, which increases home affordability. This surge in demand can result in higher sales for homebuilders.
• Boosted Consumer Confidence: Lower rates can stimulate economic activity and improve consumer confidence, motivating people to invest in new homes.
• Improved Profit Margins: Homebuilders can experience reduced costs on existing debt and construction projects, enhancing profitability due to cheaper borrowing costs.

Tech stocks generally perform well when interest rates are cut:

• Future cash flows: Tech firms are often valued based on future earnings potential. Lower interest rates increase the present value of those future earnings, driving up stock valuations.
• Reduced Borrowing Costs: Lower rates make it cheaper for tech companies to borrow, enabling them to fund innovation, expansion, and operations at a lower cost.
• Shift to Growth Stocks: Investors, seeking higher returns, often flock to growth sectors like technology in low-rate environments as safer assets like bonds yield less.

Consumer finance companies can often benefit when interest rates are lowered for a few reasons:

• Increased Borrowing Demand: Lower rates make credit cheaper for consumers, leading to higher demand for loans, credit cards, and financing products. This boost in lending activity can drive revenue growth for consumer finance companies.
• Reduced Defaults: Lower rates can make debt servicing easier for consumers, potentially reducing defaults and delinquencies on loans, which benefits lenders and finance companies.
• Refinancing Opportunities: Lower interest rates may prompt consumers to refinance existing loans at better rates, providing additional business to finance companies that offer refinancing options.

The SA Quant team has identified five top Quant-rated stocks that are well-positioned for the first rate cuts. The stocks explored below also score well across other factor grades and represent a mix of sectors.

1. Zeta Global Holdings Corp. (ZETA)

• Sector: Information Technology
• Market Capitalization: $6.27B
• Quant Sector Ranking (as of 9/18/24): 4 out of 556
• Quant Industry Ranking (as of 9/18/24): 2 out of 191
• Quant Rating: Strong Buy

Zeta Global provides a cloud platform that leverages AI to streamline marketing efforts for companies across 15 verticals, including retail, financial services, and telecom. As a top Quant-rated application software stock, ZETA’s gains in the past year have been enormous, delivering 246.90%, handily beating the market and underwhelming tech sector (XLK) in the period.

Zeta saw strong growth in Q2, with an adjusted EBITDA climbing 44% compared with Q2 2023. Key expanding verticals include automotive and insurance, which have grown faster than the company’s overall year-on-year revenue growth rate of 33%. Other impressive growth metrics include a forward ROE growth of 19% and a forward long-term EPS growth rate of 34%, which exceeds the sector median by 131%.

ZETA Stock Momentum Grade

Zeta’s quarterly price momentum has been extraordinary, and despite the gains, the company has been able to maintain an attractive forward PEG ratio of 1.44 which is a -22% reduction to the sector median. Wall Street’s optimism about the stock has resulted in eight upwardly revised EPS estimates in the last 90 days. Zeta is a standalone solid option, and a rate cut could continue to fuel gains for the company.

2. AppLovin Corporation (APP)

• Sector: Information Technology
• Market Capitalization: $38.86B
• Quant Sector Ranking (as of 9/18/24): 2 out of 556
• Quant Industry Ranking (as of 9/18/24): 1 out of 191
• Quant Rating: Strong Buy

AppLovin Corporation is another top Quant-rated application software company focused on advertising so that app developers and mobile gamers can enhance their marketing for business growth. Offering end-to-end software solutions, this ad tech’s customers can leverage AI for data-driven marketing decisions. With unique tools that allow developers to increase user engagement for revenue generation, AppLovin’s diverse portfolio of free games and applications and its aggressive acquisition strategy have resulted in extraordinary gains, returning 180% on a trailing one-year basis, and 190% since it was selected for Alpha Picks in November 2023.

APP Stock Profitability Grade

APP reported total revenue growth of $1.08B in Q2, largely driven by its software platform generating $711M, which is a 91% increase year-on-year. This has translated to exceptional profitability, with a trailing EBITDA margin of 42% and a ROE of 71%. While APP’s valuation is stretched relative to its other characteristics, as is the case with most tech stocks, the company is still offering favorable TTM and forward PEG ratios of .01 and .82 respectively, indicating its ability to continue delivering value to investors based on its long-term growth projections.

APP Stock Revisions Grade

Wall Street analysts have expressed their conviction in the bullish case for APP, with 15 upwardly revised EPS estimates in the last 90 days, and zero downwardly revised estimates. APP’s exceptional growth, profitability, momentum, and relative value make this a well-positioned stock that could continue to capture gains in the new rate environment.

3. M/I Homes, Inc. (MHO)

• Sector: Consumer Discretionary
• Market Capitalization: $4.58B
• Quant Sector Ranking (as of 9/18/24): 8 out of 500
• Quant Industry Ranking (as of 9/18/24): 2 out of 24
• Quant Rating: Strong Buy

MHO is an Ohio-based builder of single-family residential homes to 211 communities in 17 markets, with a diverse customer base consisting of first-time, move-up, and active adult buyers. The stock has exploded by over 87% in the last year amid strong earnings results and growth. MHO reported record-setting revenue, income, and gross margins in Q2 based on strong underlying fundamentals driven by a housing shortage in all 17 markets, and increasing numbers of millennials and Gen Z buyers. Revenue increased by 9% to $1.11B, a second quarter record, with MHO’s affordable Smart Series segment accounting for 53% of sales.

MHO Q2 EPS of $5.12 beat by $0.53, for the seventh beat in eight quarters, and earnings are projected to grow by 20% in FY24 and revenue by +10%, according to consensus estimates. MHO ended the quarter with record shareholder equity of $2.7B. MHO has an ‘A’ Valuation Grade driven by a P/E ratio of 8.44x and EV/EBITDA FWD of 6x, trading at a significant discount to the sector like, in light of high earnings growth potential and rock solid investment fundamentals. MHO’s collective positive attributes make it well-positioned within a sector likely to keep making strides in the new interest rate environment.

4. Green Brick Partners (GRBK)

• Sector: Consumer Discretionary
• Quant Sector Ranking (as of 9/18/24): 7 out of 500
• Quant Industry Ranking (as of 9/18/24): 1 out of 24
• Market Capitalization: $3.55B
• Quant Rating: Strong Buy

Green Brick Partners is a top Quant-rated homebuilder that specializes in the acquisition, development, and sale of residential properties, primarily in the Sunbelt. The stock has performed strongly in 2024, delivering 55% YTD and 85% on a trailing one-year basis. GRBK has been an industry leader in terms of gross profit margins and has one of the least leveraged balance sheets among its peers. The company has seen year-on-year EBITDA growth of 25% and operating cash flow growth upwards of 52% reported last quarter.

In addition to solid growth and profitability, GRBK is extremely attractive in terms of value, trading at 2.6x its forward book value, which is a -9% reduction to the sector median. Forward and TTM P/E ratios of 10x and 11x represent a -41% and -26% reduction to the sector median, respectively. In Q2, the company delivered a positive earnings surprise in excess of $57.98M and experienced three positive EPS revisions in the last 90 days. GRBK is an established homebuilder in a high-growth region as millennials enter the peak homebuying years. With the added benefit of a rate cut, GRBK is poised to continue on its positive trajectory.

5. Woori Financial (WF)

• Sector: Financials
• Quant Sector Ranking (as of 9/18/24): 4 out of 681
• Quant Industry Ranking (as of 9/18/24): 1 out of 69
• Market Capitalization: $8.65B
• Quant Rating: Strong Buy

Woori Financial Group is South Korea’s largest Financial Services company, operating across segments including retail and investment banking, asset management, and insurance among others. Woori has a strong global presence, with its footprint across Asia, as well as Europe and the Americas. The company has had a strong year, delivering 25% on a trailing-1-year basis, nearly 19% YTD. Key performance drivers for WF include a 14% increase in net income year over year that was undergirded by a significant increase in non-interest income, primarily from core fees across banking and non-banking subsidiaries. Cost-optimization and growth in core deposits in Q2 also helped strengthen WF’s profitability, which is currently an ‘A+’ grade.

WF Stock Factor Grades

In addition to growth and profitability, WF is currently offering significant value to investors, trading at 4.4x forward earnings, a -63% decrease relative to the sector median and a TTM P/B of 0.4x. The company delivered a positive earnings surprise in Q2, beating EPS estimates by $0.59 and providing a $136.7M earnings surprise. WF’s exceptional value and profitability, and proven ability to drive growth outside of interest income make this a great Financials pick in the wake of the Fed’s 50 bps rate cut.

Concluding Summary

The Federal Reserve’s decision to cut interest rates by 0.50% marks a significant shift in the monetary landscape, presenting opportunities for investors in key sectors. Financials, Tech, and Homebuilders all stand to potentially benefit from the new environment, as cheaper financing can have a positive effect on profitability and cost structures, as well as consumer demand.

Homebuilders may thrive as lower interest rates reduce borrowing costs, making it more affordable for companies and individuals to finance property purchases. Tech stocks may benefit from a lower cost of capital, as high-growth tech stocks tend to rely on borrowing to fund their innovation, and cheaper financing will allow companies to invest back into R&D. In the Financials sector, segments may benefit from increased investment activity and cheaper financing costs, as well as heightened consumer borrowing.

To capitalize on this dynamic, five well-positioned stocks have been highlighted: Zeta Global Holdings Corp, AppLovin Corporation, M/I Homes, Inc, Green Brick Partners, and Woori Financial. These companies are top Quant-rated stocks, with positive factor grades, representing a blend of sectors that are well-positioned for the lower interest rate landscape.

We have many stocks with strong buy recommendations, and you can filter them using stock screens to suit your specific investment objectives. Consider using Seeking Alpha’s ‘Ratings Screener’ tool to help find stocks that achieve diversification into desired sectors you like. Alternatively, if you’re looking for a select number of Quant Strong Buy recommendations on a monthly basis, you might want to explore Alpha Picks.

• I am Steven Cress, Head of Quantitative Strategies at Seeking Alpha. I manage the quant ratings and factor grades on stocks and ETFs in Seeking Alpha Premium. I also lead Alpha Picks, which selects the two most attractive stocks to buy each month, and also determines when to sell them.