Doubts about Capital One Financial's (COF -0.32%) foreseeable future are more than understandable. Credit card delinquencies are on the rise in the United States, reaching their highest rate in nearly three years just last quarter. Paired with record-high credit card debt of $930 billion in the U.S. alone against a backdrop of sky-high interest rates, the stage seems set for trouble.
Even Capital One CEO Richard Fairbank is worried enough to warn investors that charge-offs of soured credit accounts will likely swell to 2019-like levels later this year following a measurable uptick in the first quarter's credit charge-off rate, from $845 million (2.2% of the loan portfolio) in the comparable quarter a year earlier to $1.7 billion this time around (4.1% of the loan portfolio).
Given the headwind, it's no surprise the stock's not made any net progress since the latter part of last year.
Level-headed investors, however, may want to use this lull as an entry point, recognizing that the credit market is a highly cyclical one that will improve sooner or later, and likely sooner than later. One genius stock-picker has already made the move, in fact.
Capital One's challenge is anything but permanent
Don't misread the message. The next couple of quarters could be rough. Heck, the next couple of quarters probably will be rough.
But Capital One's been here before and bounced back just fine.
The last time the credit environment's been this challenging was back in 2008, when the subprime mortgage meltdown was creating a broader ripple effect. Capital One's subsequent charge-offs pushed the company into the red for a couple of quarters. Take a closer look at what happened shortly after that stumble, though. Capital One bounced back -- in spades.
COF Revenue (Quarterly) data by YCharts.
Astute investors will notice that while Capital One's revenue ultimately recovered from that cyclical setback, net income didn't. Rather, it stagnated, save the extraordinary loss linked to COVID-19 in early 2020.
Don't read too much into that apparent headwind either, however. Remember, that was the point when interest rates were dialed back to multiyear low levels and stayed there for several years, crimping lenders' profit margins as a result. Although the abrupt slowing of economic growth over the course of the past few months will hurt Capital One's near-term bottom line, there's more to be gained in the more distant future from recently raised interest rates.
Effective Federal Funds Rate data by YCharts.
If that doesn't convince you, maybe this will. Last quarter, Warren Buffett's Berkshire Hathaway (BRK.A -0.59%) (BRK.B -0.74%) added 9.9 million shares -- nearly $1 billion's worth -- of COF stock to its portfolio at a time the fund was trimming its other financial sector holdings. Perhaps Buffett and his team see the same thing analysts see down the road -- a rebound from the impending profit lull followed by a move to record-breaking profitability.
Data source: Thomson Reuters. Chart by author.
The tough part for most people is just being patient enough to ride the stock into that eventual success.
Don't overthink it
It's not exactly a new phenomenon. Indeed, it's quite common for investors to price a stock based on the underlying company's present condition while ignoring its plausible future. People also tend to forget that the ebb and flow of creditworthiness is closely linked to economic cycles themselves.
Buffett and his acolytes aren't most people, though. They understand capitalism itself prompts economic recoveries, even if it means taking a step back to fix what's broken. Berkshire frequently outperforms the broad market specifically because it bets on proven companies that are temporarily out of favor.
In this vein, also know that value-minded Buffet and his team were able to scoop up COF shares at a mere 8 times this year's expected per-share earnings and a little over 7 times next year's projected bottom line, which suggests the stage is already set for a cyclical recovery. That's a bargain, to be sure, and you can get the same deal.
Bottom line? Don't overthink this one or draw any sweeping conclusions from the stock's recent lackluster performance. Long-term investors should simply jump at the chance to step into this undervalued name while it's still unloved. That window of opportunity isn't apt to remain open very long, particularly now that Berkshire's tipped its hand. The only thing you may need to worry about is above-average volatility, as Capital One confirms the next couple of quarters will be as dicey as feared.
