Rising interest rates have been a key economic theme over the last two years as the Federal Reserve continues to fight inflation, which hit a 40-year high in June 2022. It sent the stock market tumbling last year as investors reconsidered their growth expectations and found refuge in money market funds, which suddenly offered attractive returns with next to no risk.
But the Fed has been successful so far, with inflation falling substantially in 2023, and the pace of its interest rate increases has slowed as a result. The stock market has also bounced back, though many individual stocks remain well below their all-time highs.
Many economists and stock market experts believe the Fed might be finished raising interest rates now, and the central bank could even start cutting them in 2024. With the new year right around the corner, many beaten-down stocks could be set for substantial gains if those estimates prove correct.
Below are two names that will benefit, and investors might want to own them ahead of 2024.
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1. Cohu: Down 29% from its all-time high
Cohu (COHU 2.44%) is a semiconductor service company providing testing and handling equipment to chipmakers around the world. That equipment plays an increasingly important role in the quality control process, given the complexity of modern chips, and it helps ensure end-users receive defect-free hardware.
Cohu uses a mix of advanced technologies like true infrared and artificial intelligence (AI) to identify cracks as small as five micrometers, even if they are beneath the surface of the wafer. For context, the average human hair is 70 micrometers thick! The company's AI can also differentiate between cosmetic scratches and actual defects, which wouldn't be possible without technology, given the tiny size of the subject matter.
Like many of its customers, Cohu experienced a slowdown this year as rising interest rates force households to tighten their belts, driving less demand for big-ticket purchases like computers, cars, televisions, and smart devices. The company's revenue declined 16% in the first half of 2023 (ended June 30) on a year-over-year basis, which followed an 8% decline in 2022.
If Wall Street's estimates are correct, there won't be any improvement in the remainder of 2023. Cohu's full-year revenue is expected to come in at $654 million, which would be a 19% drop compared to 2022.
But there are some positives investors can look forward to. First, the company remained profitable thanks to careful expense management. Wall Street estimates it will bring in $1.73 in earnings per share this year, which means its stock trades at a very attractive price-to-earnings (P/E) ratio of 20.5. That's a 30% discount to the Nasdaq-100 index, which trades at a P/E ratio of 29.2.
Investors don't like paying a premium for companies that aren't growing, hence the steep discount on Cohu stock. However, analysts see a return to growth in 2024, with revenue expected to climb 12% to $736 million. Cohu's earnings per share could also soar 42% to $2.47, which makes the stock even cheaper on a forward basis.
If a reduction in interest rates stokes a stronger economic environment, there might even be upside to those forecasts because it could make chip producers feel more confident about investing in more equipment to expand their manufacturing capacity.
Over the next few years, Cohu is aiming to grow its annual revenue and earnings per share to $1 billion and $4, respectively, on average. Therefore, the company predicts a constructive environment for its business in the future.
2. Upstart: Down 92% from its all-time high
Banks and financial institutions have been incredibly hard-hit by the rapid rise in interest rates. Investors have already watched a number of U.S. regional banks collapse this year, but even loan originator Upstart Holdings (UPST 1.42%) -- which operates a capital-light business -- has suffered a significant slowdown.
Upstart doesn't lend any money to customers; it uses its artificial intelligence algorithm to write loans on behalf of its funding partners, which include banks and non-bank lenders.
Upstart's data suggests its AI models are more effective at determining the creditworthiness of a potential borrower than traditional assessment methods like Fair Isaac's FICO scoring system. In fact, the company says it approves 43% more loans at an interest rate that is 43% lower, on average.
It's because Upstart's models consider more than 1,600 data points when making a decision, as opposed to just five used to determine a FICO score. Plus, because Upstart is powered by AI, 87% of approvals are instant and fully automated, which is a win for both the customer and the bank funding the loan because human-driven assessments can take days or weeks.
When interest rates began to soar last year, investors grew concerned that Upstart's models weren't battle-tested in challenging economic conditions. Now that the interest rate situation has stabilized, the company has published data that suggests loans approved by its AI are still performing as expected.
However, Upstart is grappling with a fall in demand for credit as consumers shun new loans due to soaring borrowing costs, mixed with a lesser appetite among banks for unsecured loans, which accounts for most of Upstart's business at the moment.
In the second quarter of 2023 (ended June 30), the company saw a 66% year-over-year drop in the number of personal loans and a 74% drop in the number of car loans it approved. However, both categories were up compared to the first quarter of 2023, which suggests a recovery is underway.
Nonetheless, Upstart is on track to generate just $530 million in revenue this year, according to Wall Street's estimates, which would mark a 37% plunge compared to 2022.
But like Cohu, the new year is looking more positive for Upstart because analysts expect a robust 39% revenue growth. There could be upside to that number as interest rates come down because that would spur consumer demand and also free up funding as banks venture out on the risk curve in search of higher returns.
Longer-term, Upstart is eyeing a $4 trillion annual opportunity for originations across personal loans, car loans, mortgages, and business loans. Since the platform has only originated $34 billion in loans to date, it has only scratched the surface of that addressable market.
Anthony Di Pizio has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Upstart. The Motley Fool recommends Fair Isaac. The Motley Fool has a disclosure policy.
