Motley Fool Hidden Gems Investing - 529s for 5/29

Episode Date: May 29, 2024

On May 29, there is one investing account that deserves a celebration. First up, (00:21) Ricky Mulvey and Bill Barker break down earnings from Chewy, Dick’s Sporting Goods, and CAVA. Then, (16:16) Robert Brokamp discusses the fundamentals of 529 Plans and saving for college with Roger Young, CFP and Thought Leadership Director at T. Rowe Price. Check out Pivotal with Hayete Gallot: https://pivotal-with-hayete-gallot.cohostpodcasting.com/ Companies discussed: CHWY, DKS, CAVA Host: Ricky Mulvey Guests: Bill Barker, Robert Brokamp, Roger Young Engineers: Dan Boyd, Austin Morgan Learn more about your ad choices. Visit megaphone.fm/adchoices

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the show, but first up, we're talking retail. And to do that is Bill Barker. Bill, thanks for being here. Thanks for having me. I think the big theme of the earnings that came out today is that consumers aren't dead yet. Retail stocks like Chewy, Dick's Sporting Goods, and Abercrombie & Fitch all up double digits on earnings beats. Let's focus on Chewy, though. Sales are up 3%, but the number of active customers are down 2%. You wouldn't know it looking at the chart. Why are these pet investors so happy about a company that's losing customers? Well, this is a story that is distinct from the other two in that the stock is not building on strength, as Abercrombie & Fitch and Dick's

Sporting Goods are, which we'll talk about in a minute. This is a stock that is bouncing back from essentially all-time lows, post-IPO lows more or less achieved very recently. Finally, there's a decent report, some guidance met and exceeded, and some guidance reiterated for the rest of the year. Stock has a lot of work to do. Even after today's 27% move up, it's still off for the year slightly. This was the first chapter in what could be a story back. there's a long way to go for Chewy to ever regain the heights that it had during the pandemic and the expectations that the stock had priced in during that time. But it was a good report. And although fewer customers buy a hair, they're spending more. So, if the loyalty of the

existing customer base is augmented by people buying more and more, spending more and more on their pets. Part of that's inflation. Part of that is just increased support of pets and the new offerings that Chewy has. Altogether, it's a good story. This was a very easy act to follow in terms of Chewy's recent performance. As a Chewy investor, I was happy to have a little bit of a breather. Still in the red if I look back any amount of time, but it was nice. Nice to see a little green today. The company also might have a bit of a tailwind mentioning for the first time since 2022, quote, we observed a positive balance between pet adoption and relinquishment. It sounds like the balance is starting to shift after a bunch of people

adopted pets during the pandemic and then gave them up because they made a bad choice. I don't want to get into that because that gets me to the dark place. Let's talk about the share repurchase program bill. Chewy announced its first-ever stock buyback, $500 million authorized. The amount of time is still to be determined. Are you taking this as a sign of maturity from a former growth company? Well, they are finally making money. Stock repurchase is, first of all, authorization does not necessarily translate into actual stock buybacks a lot of the time. But it is a show of some confidence that stock will be higher in the future than it is today, and that capital might be allocated, capital that's available because of actual earnings profits. So, it's a thoroughly

good sign, and it'll be an even better sign if it's actually employed. So, I generally always like to see stock buybacks executed. The announcement is the first step in execution. So again, a good first step for the company. Also making up a little bit of the dilution from share-based compensation. You mentioned Autoship earlier, and Chewy is very much an Autoship story, where I think about three-quarters of their revenue come from Autoship. But they've also got some other growth initiatives, pet insurance, vet clinics, pet telehealth, where you can spend 20 bucks to talk to a vet for 20 minutes. Are any of these growth initiatives interesting to you? They're all possible avenues of growth. I would guess that not all of them will stick,

that they're going to try as everybody else does, whether it's PetSmart or all the other competitors, adding the availability of pet insurance and vet clinics into the mix. I think there's a reason why everybody does that. It's good to have confidence in one stop for all of your pet needs. Whether they end up being more successful than the competition, which they need to do to maintain all of those, I don't know. I would bet against all of those being home runs. But I think that that is a good place for them to experiment with their growth story. Let's talk about Dick's Sporting Goods. Dick's Sporting Goods is one of those quiet market beaters. It's up 17% this morning at

the time of this recording. Comparable sales, up 5%. That was more than double what the analysts expected. Seems like the customers are really shelling out on shoes. Nike, the popular on-running shoes, Hoka, Adidas. Is this a shoe story? Is there anything else driving the growth over at Dick's Sporting Goods? Well, I think in the great battle between whether people are spending money on stuff or experiences, Dick's employs both. You're buying the stuff in order to have more athletic experiences. Most of the time, some of it is for fashion, and they're doing okay there. That'll come and go. I think that it's a good sign when people are out exercising more. Dix, you say that they've been quiet. It's certainly not

quiet today, up 15% or so. I think the stock has more or less quadrupled in the last three to four years. Most of that has been on multiple expansion. It is continuing to grow, and it had some nice post-pandemic growth when people got back outside. But it's a lot of multiple expansion. It hasn't expanded to dangerous levels by any means. It's around 16, 17X earnings. It lived in a 9X, 10X earnings valuation for quite a while until recently. I think some of that might have to do with the story changing, where Dick's Sporting Goods is not really opening up a lot of stores. Since Lauren Hobart became the CEO back in 2021, they've slowed down on expanding their

square feet, they've repurchased a lot of shares, it's still profitable. Retailers don't need to open up a lot of stores to return money to their shareholders. Could this be a next Home Depot or AutoZone-type story for those holding Dick's Sporting Goods shares? Well, for the shareholders of Dick's Sporting Goods, I hope so. It's been a remarkable way to maintain great returns. In AutoZone's case, really dramatic and debt-fueled repurchases just relentless over the last 20 years. They've opened plenty of stores. Home Depot is much more static in their number of stores, but they expand their square footage. If Dick's comes close to either of those,

and I think you're right that the capital allocation story, as long as they can hint toward that kind of model, that is part of what is fueling this multiple expansion. Now, how much further the multiple expansion can go, I'm not sure. But certainly, Home Depot and AutoZone are higher than that. You're saying we're not the first people to notice this? I've noticed they've started having more noticeable commercials on TV. Maybe it's just what I'm watching. Yeah. I don't watch a ton of live TV outside of live sports. I don't think I've really seen many Dick's Sporting Goods ads on any live sports right now.

Well, I've been watching the French Open and some tennis, and they've got a couple of celebrities, Katherine Hahn being one, which is an interesting choice. It's not the first name I would have associated with Dick's. But anyway, they are gaining presence, and they are looking to attract more audience. So, I think it's working. You mentioned the multiple expansion. I threw some flowers, Lauren Hobert's way, but any warning flags that you think its investors should watch before I get too excited about this company and put it on my watch list? I don't see any warning flags. I guess the multiple expansion is the newest and most

interesting part of this dramatic stock performance in the last couple of years. But I think of that more as being interesting in its past multiple than the present. The present multiple doesn't wake me up and cause me concern. The past multiple probably should have alerted me to the opportunity here. Let's talk about Kava, which also reported today. It was moving down a little bit. I think it was like 2% this morning down. Are you a Kava fan? Have you had Kava? Yes, I am a Kava fan. It's good food. Chipotle with a different cuisine, more or less. I like Chipotle and I like Kava. I'm not surprised that they're having great success opening as many restaurants as fast

as they are. It seems to be working out quite well for them and their investors. If you look at the two-year customer growth, it's quite a bit for Kava. Same restaurant sales up 31% over the past two years. Traffic growth up 17% over the past two years. But I have a quibble with this one, which is that the number of people going into Kava restaurants for this growthy story has declined over the past year. The explanation that was given was the shift in holiday weeks. So, actually, it's up. But what did you make of this decline in same-store traffic for Kava? Is this something that should keep its investors up at night? Not up at night. Investors don't seem to be too afraid of this report. I think that

holding on to the exceptional growth that they had the year before is an achievement. The two-year number is very impressive, but fueled mostly by last year. They didn't relinquish all that extra traffic. They just maintained it more or less. The holiday week stuff is something I've seen many, many, many times over the years. I don't know exactly where it was. I think you know, Easter was in both, you know, holiday periods. I think they have not put out much to be concerned about. If they do lose traffic again in the coming quarter, then I would expect that that would be a cause for more concern. And given the multiple on this stock, you know, it can not have very many questions around it and maintain the kind of multiple

that it's got. Let's talk about the multiple. The stock's at 11 times sales, which sounds like a software company, not a restaurant, with a fairly low operating margin. You've mentioned the comparison to Chipotle. What needs to be true about this company's growth for that kind of multiple to make sense for its investors? That it does something that looks like Chipotle, I think, which is easy to say and harder to do. The comp group for Cava, to the extent that investors say, well, the comp group is Chipotle, and therefore, you wouldn't have suffered by buying Chipotle when it had 350 restaurants and holding to today. You would done extraordinarily well. But the comp group includes more restaurant concepts than just

Chipotle. If it ever starts looking a little bit more like everybody else, then the multiple comes crashing down, to the extent that it can say, we're early in the game, Chipotle, minus the people getting sick at our restaurants episodes that Chipotle suffered through, then they're going to be a darling. I want to tie these companies together. This may be a bit of a shoehorn, Bill, but I think you're seeing some CEO incentives play out. The incentive that I'm thinking about specifically is, how much stock does the CEO of the company own. For Chewy, it's about $10 million. Over at Dick's Sporting Goods, with Lauren Hobert, it's about $58 million. Brett Shulman, a co-founder-CEO at Kava, has about $81 million.

Do you think we're seeing any of the incentives play out with how the stocks have performed, or the capital allocation decisions that these leaders are making? Well, I need to know a little bit more than just how much in dollar figures they own today. Because in the case of both Kava and Dick's, you're talking about stocks that have doubled, tripled, quadrupled over relevant time periods. Whereas Chewy, once upon a time, was 10X the price that it is. If the CEO had all that invested the whole way through, he's got 10%, 15% of what he once upon a time had. In terms of the allocation, what their annual compensation package looks like, I would certainly want to know that for each of these

companies before investing in them. But today's numbers are a reflection, at least in some part, by what the stock has done prior to today. I think that the fact that Chewy's CEO has got 10 million is more a function of everybody having lost a lot of money owning this stock rather than his not being fully enough invested in it. It's just so much easier to jump to conclusions, though. Anyway, Bill Barker, thanks for breaking it down. Appreciate your time and your insight. All right.

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All right. Up next, Robert Brokamp breaks down the basics of 529 plans and saving for college with Roger Young, CFP and Thought Leadership Director at T. Rowe Price. Roger, let's start with you just giving us the basics of a 529 college savings plan. Well, thanks, Robert. Glad to be here. A 529 plan is a tax-advantaged way of saving for college or other appropriate educational expenses. That list has actually grown over the years. The basics of it are, you put in money, you don't get a tax break at that point. But if you use the plan for qualified expenses over the years, when that money comes out, you don't pay any taxes on the earnings or the principal. So, you could think of it a little bit

like a Roth IRA account for education, obviously with different rules than a Roth IRA, but similar in terms of the tax benefit. And so, the benefits of it, from my mind, are obviously the tax aspect, but also from a perspective of earmarking that money for college. I've talked to so many people who have said, it was just comforting to see that money was set aside and ready for when the college bills came up. Whether it was enough is another matter, but having that money there is a huge advantage. Studies have found that having an account earmarked for college at all really increases the likelihood that that child's going to go to college. So very, very nice benefits, both psychologically and financially. And of course,

you can invest the money, which tends to have better growth potential than just putting in a savings account. And there are ways that it discourages you from taking the money out for other things. Not too punitive, but there are penalties if you don't use it in the appropriate way. I have been a big proponent of 529s and used them myself and seen a lot of people use them very successfully. Yeah. And just so everyone knows, 529s generally are sponsored by the states, but you don't have to participate in your state's plan. But that probably is the place to start because you might get a deduction on the state tax return, not federal, but state. But the rules vary so widely, you definitely need to understand your state's rules. So, let's say we've sold

people on the benefits of saving for college, but then the next question they have is, well, how much should I be saving? And you recently issued a report, co-written with your colleague, Judith Ward, providing people with sort of a starting point to think about if they have a newborn. Tell us a little bit about those guidelines. Yeah, starting point is a great way to put it. And just up front, rules of thumb like this, I was very reluctant to put out a number, so to speak, on how much you need to save per month for your child's education. My colleagues won me over and said, a lot of people just have no idea of what the ballpark of that number ought to be. If we give them a number that's reasonable with certain caveats,

that's at least a place to start and then think about, well, why is my situation different? The number that we came up with for a monthly amount to put in from birth of your child up through college even, is about $260 per month. What does that get you, potentially? What are the assumptions? We're talking about a public college. We're talking about with room and board. We're expecting that you might get a 6% return, not guaranteed, of course, but a 6% return on the money you put in. We're assuming that college costs inflate at around 5% per year. Hopefully, those are somewhat conservative assumptions. The other thing that we're assuming is that you're aiming to pay for half of that sticker price of college.

Sticker price is an important concept because most people don't end up paying necessarily the sticker price. Some people do, but a lot of people don't pay the full sticker price. So, on average, the parents end up kicking in about half of that money towards the sticker price of college. Where does the other half come from? Roughly 25-30% of it tends to come from scholarships and grants, so free money, so to speak, towards college. And then the other, call it 20-ish percent, comes from other sources. And that can include loans and student income and other gifts from other people. So, given the actual experience people have and the statistics showing that about half of that money tends to come from the parents, we based it on getting

to that 50% number. So, in those assumptions, you heard a lot of things that people might be thinking, well, my situation's different. I want my kids to go to a private school, or I'm willing to start out with community college and have them living home. I think my kid's going to get a huge scholarship, or I don't think they're going to qualify for any scholarship at all. So, lots of levers on that, but the $260 a month is a starting point to consider. Yeah, I'm totally on board with recommending that people don't try to save for every last penny before someone goes to college, for the reasons you cited, for sure. A couple others to consider might be that when your kid goes to college, you're generally in your late 40s, early 50s.

ideally, you're in your peak earning years. So, hopefully, you have higher income. So, some of it can just come out of cash flow. And when your kid goes to college, some of your household expenses will drop, maybe just slightly, but a little bit. In my own personal experience, I have four kids. Last year was our first year as empty nesters, and our grocery bill and our restaurant bills were much lower than when we had four kids at home. Maybe the water bill will be a little lower. So, it's not major, but every little bit helps. The milk bill went down in our household. It's so funny you say that, because that's the thing my mom said. My parents also had four kids, and she said it took her a while to stop buying so much milk once we all went to college.

Anyways, so there are other ways to do it. I would say that I think, obviously, one issue is that the assumption that you provided assumes a good bit of financial aid. and many people listening to this podcast probably won't get a whole lot of aid. So what do you think about in terms of how people should assume or, or maybe probability weight, the possibility that they'll get any financial aid? Yeah, that's a good question. And it's really hard to assess that when you're starting out the savings plan, right? You know, I had, I became a father at age 30. My financial picture changed up and down a lot over the next 20-some years. It's hard to know, are we going to qualify for need-based financial aid? What type of college

is my kid going to go to? If they're going to a school where they're in the top 20% of applicants, they might get some scholarship money. If you're really determined, my kid's going to go to a Ivy League or very high, top-tier school, they don't give merit-based aid at all, right? So, yes, I would say, be cautious about the amount of aid that you assume, and especially if you're a high earner. What I've said to people over the years is, you just don't want to be in a position where you have high income and little savings. That's a bad combination, and you're in for a bit of a rude awakening, and that might limit the options you have heading into the college years. And of course, make adjustments over the

years. If your kids' aptitude and desires are going to change, and you'll see what that looks like, and you'll see what your own personal situation looks like. And then as you get closer, you use the college net cost tools on their website. Their calculators can give you a much better idea of what to expect both for need-based aid and potentially for the merit aid. I'll just further elaborate on some of the points you made. When it comes to the financial aid formulas, income is the biggest determination, much lower than savings. Having a high income but not much savings is really going to put you in a bad situation. Parental savings actually don't count so much. Kid savings do factor in. That's a consideration when you think about who

owns the assets in terms of saving for college. I love the suggestion of going to a college's financial aid website because most of them will have a calculator there or point you to a calculator. You put in your information and it gives you an idea, not a guarantee, just an idea of how much aid you'll get. It's very helpful, especially as you get closer and you have a better idea of what your financial situation will be in those college years to give you an idea of how much aid you'll get. Let's move on to some other sources of savings, and that could be grandparents or other well-meaning relatives. And you've written about this as well. How can grandparents or other people help save for college? Well, interestingly, for grandparents,

the situation has gotten better recently. In fact, with this school year, if they put money into their own 529 account, so they're the custodian and the beneficiary is the grandchild. When that money gets spent, gets taken out to pay for college, that's no longer punitive in terms of financial aid for the grandchild. Up until this year, it was. It could have a big effect because it would be considered income of the student, which is the most painful in the financial aid calculation for a family. But that has gone away, which is nice. There have been other changes to those financial aid calculations that maybe we'll come back to, but the 529 is increasingly a good way for a grandparent. The other thing that's interesting

for a grandparent with a 529 is, you can maintain control over that money in a 529, which you can't necessarily with other types of gifts. If you're worried about things like estate taxes, it gets that money out of your estate. Now, again, that's probably not an issue for most of the people listening. But for some people, they think, oh, wow, yeah, I want to do that as much as I can. I want to take advantage of, you can put five years of gifts in at once and all of that. So, yeah, there's definitely a population where if you're a grandparent and that's a priority for you and you have the means to do it, it's a great way to help out and pay it forward to another generation. Yeah. And that change to what is the

FAFSA, the Free Application for Federal Student Aid, just took place this year. I'll point out that some colleges have their own forum. Some colleges have the CSS profile. That's like 200 or so, mostly private, some public schools. And as I understand it, they still might factor in grandparent assets. But overall, I think it's almost like too big of a loophole, right? Where you as the parent should not own the 529 if you think you'll get aid. It really should be the grandparent, although you're giving up control for that. I almost wonder if at some point that's a loophole they're going to close, but we'll see. Yep. For now, it's something to use as a planning technique. As always, people on the program may have interests in the stocks they talk about,

and The Motley Fool may have formal recommendations for or against, so don't buy or sell anything based solely on what you hear. I'm Ricky Mulvey. Thanks for listening. We'll be back tomorrow.