Motley Fool Hidden Gems Investing - 1 Stock for National Taco Day

Episode Date: October 4, 2022

And another high-profile IPO company gets taken private. (0:21) Asit Sharma discusses: - Poshmark's all-cash deal that values the company at less than half of its IPO price. - Private market valuations coming down - National Taco Day and Chipotle's strong business (11:00) Alison Southwick and Robert Brokamp talk with senior analyst Rich Greiner about the fundamentals of value investing. Got questions about stocks? Call the Motley Fool Money Hotline at 703-254-1445. Stocks discussed: POSH, REAL, CMG, VTV, VBR, META, BKNG  Host: Chris Hill Guests: Asit Sharma, Rich Greifner, Alison Southwick, Robert Brokamp Producer: Ricky Mulvey Engineers: Dan Boyd, Rick Engdahl Learn more about your ad choices. Visit megaphone.fm/adchoices

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and we celebrate National Taco Day with a closer look at Chipotle. Motley Fool Money starts now. I'm Chris Hill. Joining me from the great state of North Carolina, Motley Fool Senior Analyst Asit Sharma. Thanks for being here. Chris, thank you for having me. Poshmark, the online clothes retailer, is being acquired by Naver, which is an internet company based in South Korea.

This is an all-cash deal that values Poshmark at, let's call it $1.2 billion, which is less than half of what the company was valued at when it went public of January of last year. I saw this news, Asit, one of the first thoughts that went through my head was, well, it's an acquisition and I think we've all thought for a while that we're going to see more acquisitions in the coming months. My second thought was, Naver is getting Poshmark at a deal. They like this business and they like this price. Yeah, it's a good business at the right price. Maybe it wasn't the right price for shareholders who bought in last year. That was a little bit harder to see, Chris, I think. I mean, I looked at Poshmark's business

model and several of its peers at that time, and it seemed like a market that was open for evolution. You have resale fashion and the idea of a social network merging in Poshmark, And several of its competitors had interesting business models, have interesting business models as well. You've got The RealReal, ThredUp, which is also dealing in resale. You have luxury companies like Farfetch. But one thing they all have in common is negative operating margins since they went public. None of these companies yet seem to be able to turn a positive dollar, which hasn't helped public shareholders. But as you point out, it's made it quite a deal for a company like Naver, which has some very interesting AI capabilities. They're very

good at image recognition. They're very good at sorting. Their expertise might lend itself well to optimizing this platform that Poshmark has. In addition, you combine a really massive Korean network with a big user base here in America. There's all sorts of things they can do together. The press release listed a number of strategic benefits of the deal. But if you bought this company at the IPO, you could probably chalk this one up to experimentation with the fashion world, which is always a roll of the dice. It doesn't matter how the technology changes. Retail fashion is a difficult business. It absolutely is. And you can look at traditional apparel retailers that are publicly

traded and any one of them can have a good six-month period. If you're especially gifted at timing the stocks on these, and I don't know anyone who actually is, there have been points in time where it was a great eight months to own The Gap or a great 15 months to own Abercrombie & Fitch. But over the long haul, it's such a fickle industry. And as I've said in the past, I love my children, but I would not want to be part owner of a business that is dependent on their ever-changing fashion tastes. Yeah, it becomes so difficult because that top line, as you point out, is never absolutely stable. It changes along with consumer preferences. What you end up with are companies that are consistently trying to improve

the bottom line, cut costs somewhere. We saw that with The Gap. We've seen fashion store closures for those with brick-and-mortar models. Even in this deal, at the bottom of the press release, after talking about a lot of these great strategic synergies, they talk about run rate cost savings through post-closing rationalization of public company costs, meaning, hey, as a public company, you weren't able to cut costs in a way that would have satisfied your shareholders. We understand there's pressure there. We don't have that. We're a private company, so we're going to slash some costs after we acquire you. So, this model, as much as this looks like a new version of a model that is iffy, is always going to be problematic, I think. Now, the flip side of this is, in the

future, as companies get a better handle of monetizing young users, maybe we'll see something emerged that is able to generate a positive margin, growing cash flows. But as yet, that magical formula hasn't yet appeared, at least in the public markets. We've gotten some consumer-facing data over the last few days around automotive prices, around home prices, both of which are coming down. Sort of the common theme being, hey, if you've been waiting to pay a little bit less for a car or a house, you're probably going to be rewarded for your patience in the near future. The Poshmark deal makes me think that it's the same for companies too. For larger businesses

that are looking to acquire tuck-in acquisitions, they're getting them at a lower price. Yeah, we're seeing valuations not just in the public market, but in the private markets too, which they're interrelated, really collapse over the past nine months. And so this is a good time if you've got cash on the balance sheet to deploy it. A lot of times we are very critical of companies when the markets are flush that seem to acquire their way to growth. But when your competitors are on sale, when you've got potential synergies, companies that can make a greater whole than the parts, that's the time to put capital to work. And you can't blame a company like Nava, which wants to grow out of South Korea for putting its cash to work. There are some fire

sale bargains out there. Just look for the companies that are bleeding cash. Those may be able to be picked up for a song. And that's where you see four to five years down the road, the most strategic parts of those assets get merged into a bigger company. And they have a net benefit that makes economic sense for the buyers that are offering the deal on the table today. Today is National Taco Day, so happy National Taco Day to all who celebrate, and hopefully everyone does because tacos are amazing. I looked at a five-year chart of Chipotle and maybe I shouldn't have been surprised, but stock up 400% over a five-year period that includes the start and the height of the pandemic. I don't want to just turn this into

touting Chipotle, but I don't know. It's a business that has done an effective job of taking a popular product and turning it into a profitable business over a sustained period of of time. It's funny how they're able to consistently generate these nice profits. The opposite side of business models, you have something that's extremely cash generative, cash flows are really stable. I almost feel like, Chris, Chipotle was done a favor when it had those viral outbreaks a few years before the pandemic and had to learn to deal with straightened circumstances with customers that didn't want come in the door. They became much more efficient. They learned how to keep that restaurant margin,

which is the margin that each store generates on its own. Forget the big corporate fixed overhead. To keep that at a pretty reasonable level, and you combine that with just continued, relentless store expansion, decent same-store sales growth, and now menu innovation with the new leadership, newish leadership regime, you got a formula there that is going to keep pushing up those returns. I don't want to turn this into a cheerleading session for Chipotle either, but I will note for skeptics out there, none other than Bill Ackman, who's got a pretty decent track record, at least on consumer-facing investments. I think that's become his No. 1 choice. For a while, it was Starbucks, but he's really fond of Chipotle

now as a company with a lot of pricing power, very resilient in a time of inflation, just an all-round consumer-facing investment. It's hard not to sing its praises. We have a little bit of leeway here on National Taco Day. Although, you know what? You bringing that up reminds me, it's been years, nay, sir, it's been decades since I bought some canned old El Paso ingredients, spread those with some hard-shelled tacos on a sheet of aluminum foil, and pop that in the oven. Maybe that's what I'll do for National Taco Day. That's one way to celebrate, I suppose. I'm actually reminded of the last time I was in your state. In Asheville, North Carolina, there's a phenomenal local taco joint called Billy Taco. I so enjoyed my meal there,

I thought, it's probably just as well I don't live in Asheville, because I think I would come here four or five times a week for breakfast, lunch, and dinner. Then I'd absolutely have a weight problem. Yeah. You and I should meet in Asheville next year on National Taco Day, a foodie's paradise. I think they picked up a couple of James Beard awards in the last few years. We should do that. There's always time to work off the wait later. I like the way you think. Asit Sharma, thanks so much for being here. Really appreciate it, Chris. This was fun. Poshmark being taken private at a much lower price is only the latest example of

value investing on the rise. Motley Fool senior analyst Rich Grieffner joined Robert Brokamp and Alison Southwick to talk about the fundamentals of value investing, as well as a couple of stock ideas. In 2022, stocks of just about every type are down, but some are holding up better than others. While the S&P 500 is down 24% and the NASDAQ is down 32%, value stocks, at least as measured by the Vanguard Value ETF, are down just 14%. Okay, not great. But after many years of underperforming growth, value investors are finally enjoying some outperformance, even if it's only relatively speaking. Here to explain the benefits and perils of value investing is Rich Griefner, a senior analyst

here at The Motley Fool. Welcome, Rich. Thanks a lot, bro. More benefits than perils. Good. I'm glad to hear that. I mentioned the Vanguard Value ETF, which basically just differentiates value from growth based on the stuff that you might expect. Criteria like book to price, price to earnings ratio, sales to price ratio, things like that. But how do you define value? For the purposes of this conversation, I think that definition works great. I think that's the definition that most people would understand intuitively. When you're buying value stocks, you're looking for something that's cheap relative to its current level of earnings, sales, book value, cash flow, a cheap stock. In your opinion, what explains why value

stocks are holding up better than the overall market this year? I think you got to take a high-level look at this. As you said, growth has just been trouncing value for the last five, six years. We're outperforming a bit this year, but big picture, still some ground to recover. But really, value stocks tend to perform better in periods where the stock market as a whole doesn't do as well. And I think that just goes back to the nature of what we were talking about. When you're investing in a value stock, that is a company that's trading cheap relative to its current level of earnings or cash flow. That means the expectations priced into the stock are pretty low. So if things don't work out that great, that's okay. I wasn't really

expecting performance to be that great anyway. Whereas for a growth stock, your expectations were pretty high. If things don't perform as you anticipated, you're going to get a lower multiple on top of lower-than-expected earnings, and that's how you get some of the big stock price decreases we've seen. Now, when you look at the overall value indexes, a couple of other reasons why they're doing better is that they tend to have higher weightings to some of the sectors that are doing better. So far in 2022, the only sector that's making money is energy, and you'll find more energy stocks in value indexes than growth indexes. Utilities, which are down 6%, consumer staples down 11%. So, that's

one reason. Many people are also saying that one of the reasons why they're doing better is that value stocks, in general, do better when you have an environment where interest rates are going up and inflation is going up. Is that something you buy into as well? Yeah, for sure. A lot of it goes back to what I was talking about previously, where the expectations are so low that when the outcome isn't that great, that's OK, I wasn't really expecting it. Another factor is, as you mentioned with interest rates, the stock market is a discounting mechanism. For these value stocks, a lot of them have current earnings power. Maybe the earnings power in the future isn't that great. But

growth stocks, you're really banking on those future earnings increasing significantly. When the interest rate is higher, the discounting mechanism is greater, meaning there's more emphasis placed on current earnings. Right. Another way to think of it is growth stock is like a longer duration asset. The longer your duration of the asset, the more sensitive it is to interest rates. When rates went down, that was part of why growth stocks did better. But now that they're going the other direction, it's a bigger drag on growth stocks. You said that way more eloquently than I did, but yes, thank you. Just because a stock looks cheap doesn't mean it will be a good investment.

Tell us what it means for a company to be a value trap. Sure. Yeah. The value trap is the bane of the value investor. You're buying a stock based on its current earnings power, and you're making the assumption that that current earnings power is sustainable, but with the value trap, it turns out, whoops, that earnings power wasn't sustainable. it looks like you overpaid. And that wouldn't be so bad if that revelation occurred in one fell

swoop. The stock goes down, you realize, whoops, I made a mistake, you sell out. The reason why the value trap is so pernicious is because it's death by 1,000 paper cuts quarter after quarter after quarter. The results aren't quite as good as you expected, but you can still justify holding the stock to yourself because it wasn't that bad. And the stock price has dropped, so it's still cheap. And that happens all the way down. And then a couple of years later, you're looking at your portfolio, and you're just wondering, why do I own this thing? As someone who does, I think I have somewhat of a tilt toward value. So it has been, as we've pointed out, a rough several years up until around this year. And a little bit last

year, you started to see some of the outperformance. Do you think this is the beginning of a longer trend of value outperformance? Or do you think that once things settle down, like we get back to normal inflation rate, normal interest rates, the economy returns to normal, that growth will once again get back on top? I wish I knew the answer for sure. I will say, it's funny you say get back to normal interest rates, but the 10 years at what, 3.6, 3.7, that is the normal interest rate. The near zero interest rates of the past 10 years, that's the abnormal environment. Inflation is a bit higher than a normal rate. The economy performing a bit worse than normal rate, but interest rates, this is where we're supposed to

be. I don't know what the future holds, but I will say, looking back historically, as far back as the records go, value as a class has tended to outperform the rest of the market and growth. I guess that'd be my bet going forward, is that trend will continue. Do you think there are other characteristics of value stacks that investors might find compelling besides just the plain old returns? Yeah. Besides wanting to make money in stocks, as we mentioned, they tend to hold up better in periods where the stock market as a whole doesn't do so well. If the recent stock market performance has you feeling a bit unnerved and you want something that's

historically held up better, has been more stable, you might want to consider increasing your allocation to value stocks. Again, as you look at some of the sectors that have held up better, it makes sense, especially when you look at something like consumer staples. These are the traditional blue chips. They're a little bit more value-oriented, maybe pay a little bit of a better dividend. They're the type of companies where people are going to keep shopping at those places, regardless of what's going on. It's a nice ballast to your portfolio. Alice, when it comes to value investing, what comes to mind for you? Rich, I always think of value investing

as being for the super wonky investor, for people who like to cozy up with financial statements before bed. But does being a value investor take more research and fundamental analysis and work and effort? Or can anyone just lean into value a bit more? Yeah, Alison, you're not wrong. You've got to go with the investing strategy that appeals to you and to your personality type. I think value investing, if you like numbers, if you like going through data, if you crave a bit more certainty, I really want to know and understand what I'm buying, and you want investing to be more of a science than an art, I think value investing appeals to a lot of folks like that. If that's not you, if you say,

that's not me, but I do want some more value exposure, there's lots of good index funds, lots of good value index funds. Burrow mentioned one up top, where you can investigate a diversified exposure to this class without having to curl up next to financial statements, as you said. I mean, there's nothing wrong with wanting to curl up next to a financial statement. it. Hey, look at my bookshelf. I'm right there with you. Yeah. It's just funny. When I think of a growth investor, I think of, like, I'm the most optimistic person in the room. Whereas the value investor I see is someone who's a bit more like, well, I'm the most realistic

person in the room. Ask me about all the discounted cash flow. Yeah, it's not as much fun as a cocktail party. It's not as much fun in general. I mean, being being a growth investor. Sorry, I'm not helping you sell it, am I? It's a tough sell, that's the point. If it was an easy sell, everybody would do it. Being a growth investor is more fun. Of course, I want to own companies that are growing quickly, that everyone likes, the stock price is going up, that's more fun. But if it's a trade-off between having fun and making more money, I'm going to choose making more money. Since you mentioned the ETF, I should

provide the ticker. The value of Vanguard ETF is VTV, and that will be a large-cap value ETF. If you're looking for small and mid-cap, the Vanguard small-cap is good. The ticker is VBR. It's good because it's a mix of both mid-caps and small-caps, so you can get a good amount of value exposure through owning those ETFs, and I should say that I own both of them. But what if you're looking for individual stocks? Let's close with that. Rich, what are some value-oriented stocks that you find particularly compelling nowadays? I've got two companies I'd like to share with you these two companies they're both trading for about call it 10 to 11 times trailing free cash flow and just

to provide some context that is the price you might pay for a mediocre business nothing special that's growing at a GDP rate three to four percent that is not the case for these two companies they are two of the best companies in the world just they have all the characteristics that you would really want in a business. Good management team, great balance sheet, high return on invested capital, good reinvestment opportunities, great free cash flow generation, and they're being priced as if they were mediocre business. So something's off. I think that price is a bit wrong. First company is Booking Holdings. It is the world's largest online travel agency or OTA.

OTA is a beautiful business model. Basically, they're the ones that aggregate travel accommodations. So your hotel, your flight, your rental car, your activities while you're there, all that stuff. And it allows consumers to compare, price it out, plan, and purchase their trip online, which is clearly the direction the world and this industry is headed. And OTAs have really just beautiful business models where it naturally leads towards a situation where there's one or two big winners in the market. And that's because they benefit from a very powerful network effect where the OTA with the broadest portfolio of travel accommodations is going to attract the most travel purchasers to the platform. And then the platform with the most travel purchasers is

going to attract more suppliers to come on, yada, yada, powerful network effect. And booking is really special. It's got a dominant position in Europe, unlike the U S where the landscape is dominated by a lot of major chains in Europe. There's a lot of local mom and pop hotels, And they really rely heavily on booking for marketing and distribution of their inventory. Did you say two companies? Sure. I do have a second one. I'm sorry, Rich. I was promised two tickers. So I would like to hear about the second company, please.

Okay. And if you guys have like a boo sound effect or like people getting angry, you may want to prep that in advance. My second company is one you undoubtedly know. It's Meta Platforms, formerly known as Facebook. And that look from Allison is basically the reason why I'm recommending it. Everyone knows what's wrong with meta, right? TikTok is taking share. Apple's new tracking changes have impeded Facebook's ability to serve targeted ads.

There's ethical concerns. They're laying off staff. They're investing billions of dollars into the metaverse, which may never pan out. I'm sure there's a few things I've overlooked there. You guys can probably speak to them. that's all it's always dangerous to say that's priced in i'll just say everyone knows about that stuff right that's the first thing you think of when you think of facebook or think of meta it's something negative it's in the news all the time negative negative negative if you take a step

back this is a business that three billion people use their products and services on a monthly basis they're quite literally connecting half the world the company despite investing tens of billions of into this metaverse. It is generating tons of free cash flow. It's on pace to generate something like, call it $35 billion in free cash flow this year. And despite what you might read in the press, it's going to grow. That number is going to grow. Great business, visionary management team, excellent balance sheet, all the attributes that you would want. There's a lot of hair, but if things aren't quite as bad as everybody fears, there's a lot of potential upside here as well. There you go. The growth stocks of yesterday

are the value stocks of tomorrow. You got it. That is a great way to end the interview. Rich, thanks so much for joining us. Thank you, guys. I appreciate it. As always, people on the program may have interest in the stocks they talk about, and The Motley Fool may have formal recommendations for or against, so don't buy or sell stocks based solely on what you hear. I'm Chris Hill. Thanks for listening, We'll see you tomorrow.