Motley Fool Hidden Gems Investing - Apple Flexing Its Balance Sheet

Episode Date: June 7, 2022

Target rips off the band-aid, while Apple shows off some new features. (0:25) Tim Beyers discusses: - CEO Brian Cornell taking a head-on approach to dealing with Target's inventory problems - Prepping for getting the all-important back-to-school and holiday shopping seasons right - Apple's newest features (including chips) unveiled at WWDC - Ripple effects from Apple Pay getting into the "buy now, pay later" space - Prospects for an Apple VR headset in 2023 (15:08) Alison Southwick and Robert Brokamp discuss how you can "recession-prep" your investments and your mindset. Stocks discussed: AAPL, AFRM, TGT, TSLA, BRK.A, BRK.B Host: Chris Hill Guests: Tim Beyers, 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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Because we have your number. Chris Hill. We've got some takeaways from Apple's big event and some thoughts on Target's latest announcement. Motley Fool Money starts now. I'm Chris Hill. I'm joined today by Motley Fool Senior Analyst, Tim Beyers. Thanks for being here. Tim Beyers. Thanks for having me, Chris. Fully caffeinated, ready to go. We're going to get to Apple in a second, but we got to start with Target. Target, and for those who might have missed it, did not have a great earnings season. Target came out in their most recent earnings report, Brian Cornell saying, we got the inventory

wrong, and the stock took a big hit. Target came out today and basically said, here's how we're going to fix this. We are going to take a short-term hit and we are going to clear out our inventory. In related news, for anyone listening who is looking for patio furniture or maybe a new flat-screen TV or some household appliances, you might want to check your local Target because it really seems like a lot of things are about to go on sale. Everything must go, Chris. Everything must go. That's what it reminded me of, sort of the old-school commercial, oh, we made a mistake with our inventory, and now we have to clear it out, and we're passing the savings on to you,

except this appears to be actually happening for real with Target. Right, right. Our loss is your gain. It does remind me of a 1970s Crazy Eddie ad. Go look those up if you don't know what I'm talking about. Let's hit some of the numbers. So, Target is estimating in the upcoming quarter an operating margin of around 2%, not great, especially when the average operating margin is closer to 5%. By the end of the year, Target says closer to 6%. They do feel like they're going to clear this out, but boy, is there a lot of inventory to clear out here, Chris. $15.1 billion with a B of inventory as April 30th. That was up 43% over the same year-ago period, so really not great. However,

this is not just a target problem, Chris. What's interesting to me about this, it's not big macro, but it's big macro adjacent because this is not the only company that has been talking about inventory gluts. Walmart's been talking about inventory gluts. Lots of retail has been talking about inventory gluts. By the way, I think the last time I was on the show, Chris, one of our lead stories was some guidance that had been updated within a month of the previous guidance, and that was Snap, and it was dramatic. We were talking about positive EBITDA, and then all of a sudden we're talking about negative EBITDA, that was snapped. Now with Target, they said not a great quarter, but they had not taken the operating margins down.

Now they've taken them down into territory we have not seen yet. The way I look at this, Chris, Target is going to have to not just clear out inventory, they're going to have to rationalize and start re-planning stores for what consumers really want. It is a signal that the consumer's buying patterns and desires have changed, and Target's not ready for that yet, and neither are a lot of other retailers here. It makes me wonder, who's going to miss next? That is absolutely a thought I had earlier today when I was digesting this news, because I think you're right, we are going to see this from other retailers. In terms of Target itself, I like this move. I like that Cornell and his team have basically

said, we are ripping the Band-Aid off right now. We are going to take this hit. By the way, the stock is only down about 2% or 3%, which indicates to me that the sell-off that we saw in the stock in the wake of their earnings, I don't want to say it was overdone, but maybe it was almost completely done. Because absent that, the announcement this morning is something that could have sent the stock down 10%, 15%. Again, I like they're ripping off the Band-Aid now in part so that they can get ready for the two most important seasons of the year if you're a retailer, and that's back to school and then the holidays at the end of the year. No doubt. I think this also reflects that Target delivered sweet and sour news. They just delivered

the sour first. But here's the sweet news, on the back end of the year, they do say, Chris, that they're going to get to that 6% operating margin. I think that drawdown or at least the lack of drawdown is a reflection that there is some belief that they will be able to do that because they are ripping off the Band-Aid. Let's be clear, if they do pull that off and they come up with an operating margin that is better than they historically do. If they do recover to that level, it's going to be an awfully good fourth quarter for Target. It's bad news, but to your point, it could also be very good news if they do this well. Last thing I'll say before we move on to Apple, I mentioned the sales of household items, patio furniture, etc. You look at shares

of Target, the job Brian Cornell has done running this company for eight years now, this very much looks like a stock on sale for perfectly valid reasons. I don't look at what has happened to Target stock as irrational. I view it as completely rational. But if you think they're going to write this ship in the second half of this year leading into 2023, you could come up with worse entry points for the stock than this. Hey, you know what? You can get paid to do it. It's a 2.24% dividend yield right now. Odds of them cutting that dividend, I think, are very, very low, Chris. Completely agree with you. This is a well-run business. It's a great brand. People are not going to stop shopping at Target

if they do rationalize the stores and fix the inventory problems. You're going to get paid for a pretty nice return. Apple held its Worldwide Developer conference yesterday. What was your headline for the event? We can get into a couple of the nuts and bolts, but I really hope nobody went into this event hoping for some massive reveal because there kind of wasn't one. Maybe it's setting up for something big coming in 2023, but what was your headline for yesterday's event from Apple? This is really interesting that you say that because I would say I disagree. I don't disagree, but I recognize that my geekish enthusiasm for this is because I have geekish enthusiasm for things like really fast chips. The M2 is here,

which is my hemline. I think, my goodness, that looks like a crazy good chip. I'm recognizing now we're talking about this, Chris, the things I'm excited about are the things that nobody except for people who really care about this stuff really care about, but it does have practical implications. Let's get into what those things are. The M2 chip does make the MacBook Air a highly attractive computer from my perspective here. It's going to start at $1,199. This is the new MacBook Air. It's also the 13-inch new MacBook Pro, and they will be based on the M2 chip. The M2 chip, in my opinion here, Chris, it just looks amazing. It's a slightly larger chip, but it has a much better power profile. There's some really interesting stuff here.

it's an 18% faster CPU, 35% more powerful GPU, 40% faster neural engine, 50% more memory bandwidth. Essentially, what's happening here is the M2 chip is designed basically in a smaller form factor, I should say, to deliver more compute power in a more efficient way such that it is consuming less power, and it can be very useful in a small form factor, like the MacBook Air. I find this really interesting. It's also just kind of geekily fascinating to me that this is a chip that's made at the five nanometer level, or I should say nanometer level. And Apple has been ahead in this area where they are producing chips and the most advanced processes to deliver, really, I would say, if not the best, one of the best combinations

of performance and power, and you're going to see it in the new machines. The only question for me, Chris, is how is Apple going to manage some of the supply chain constraints such that we're going to see in stores the new Airs, the new MacBook Pros, are they going be able to get enough equipment to actually be able to put this on the shelves. But boy, does it look compelling. I don't disagree with anything you just said. I'm just saying, if you're working in the marketing department at Apple, you didn't get a ton to work with yesterday. Apple Pay is now going to be doing buy now, pay later. Yeah. Affirm Holdings took a hit. This is the 800-pound gorilla

stepping out of the room saying, oh, this is a business we think we want to get into here. How threatened do you think those businesses are? Or do you think that, look, this is just a given that any financial service, any payment option is going to have buy now, pay later? Chris Hill So, yes, to what you just said, any financial service is going to have buy now, pay later here. But this is Apple going full Draymond Green, to use the NBA analogy here. Draymond Green for the Golden State Warriors, for those who don't know, when he makes a big play, he does the flex on the sideline here. This is Apple flexing its balance sheet here. Chris, for those who don't know, $51.5 billion just

in cash and short-term investments on Apple's balance sheet. They have tons and tons of money. They also have plenty of additional money beyond that. Apple can do a lot with its balance sheet. If they want to fund buy now, pay later to put more iPhones, more MacBook airs more equipment into the hands of more people. They can do it easily. Incidentally, Chris, this has been something that enterprise hardware companies have done for years. We haven't talked about this company a lot, but IBM famously carried a lot of debt on its balance sheet, but most of that debt, Chris, was for equipment that was basically lent out to companies on installment enterprise plans. You're buying boatloads of IBM servers

and other equipment. IBM is carrying debt, but essentially, they're just giving you equipment so that they can generate cash flow from that. It just happens to have a net debt effect on the balance sheet. This is absolutely nothing new. It just so happens that Apple is an extremely rich company and you're getting to see them flex the power of their balance sheet to just throw their weight around in this market. Last thing before I let you go, it seemed like Apple was dropping breadcrumbs yesterday and pointing towards a VR headset coming in 2023. Was that your read on yesterday's event? If not, when do you think we're going to see a VR headset from Apple? Because that really does seem like a device they should be and

probably are working on. Maybe I'm naive here, Chris. I thought the integration of the iPhone and the Mac. Essentially, the essential seamless integration where from your iPhone to your Mac, if you want to send a message or take a call or use your iPhone as the camera on your Mac. I thought just the seamless integration between those two took me to the place of your iPhone is your window into the world. I don't know that they want to have a device that replaces the iPhone, especially since the iPhone is getting better and is an interesting device for doing things like augmented reality, because that's your central point of contact. I mean, I will not disagree with you here. I certainly think there's something to be said for Apple getting

involved here. And really, because they are highlighting the work that they're doing around gaming, it makes a lot of sense that Apple would have a headset in this area. But that iPhone, making the iPhone more important and increasingly so, especially with things like augmented reality, feels like a way to keep putting more iPhones and progressively more advanced iPhones in people's hands. So I didn't have that same read. However, I wouldn't rule it out. Tim Beyers, always great talking to you. Thanks for being here. Thanks, Chris. Tim referenced the big macro, and one topic in the big macro that's been getting more airtime

lately is the prospect of a recession. Alison Southwick and Robert Brokamp discuss how you can recession prep your investments, and more importantly, your mindset. Today, we're going to talk about growing fears of a recession and how to recession-proof your finances. Joining me is Dr. Offalizer, aka Robert Brokamp, not an actual doctor. Bro, you're sort of the glass maybe half full, but it's probably also poisoned kind of guy, aren't you? Well, I don't think I'm that bad. But yes, I would say that I have a tendency to contemplate sort of worst-case scenarios when it comes to money. I would suppose a psychologist or financial therapist would likely point out that such

tendencies have some root in our childhoods. That's probably true for me. I had a very solid middle-class upbringing, very happy childhood, very grateful to my parents. But at one point, my dad's business did go under. We had a couple of pretty rough years. I saw the toll that took on my parents and their marriage. It definitely taught me that you can't rely on the good times lasting forever. That's not an experience that's unique to me and my family, which I think is important for everyone to plan for the less than awesome. I listened to the Daily Stoic podcast by Ryan Holiday, and he points out that the Roman philosopher Seneca called this the premeditation of evils and wrote that we should project our thoughts ahead of us at every turn and have in

mind every possible eventuality instead of only the usual course of events. And I suppose in more modern business terms, this is often called a premortem as opposed to a postmortem, during which a team imagines that you have a project or maybe a whole organization. You're imagining that it's failed, and then you work backwards to determine the possible threats and what can be done about them ahead of time. Yes, I know, this all sounds very doomy and gloomy, but the truth is, a key part of financial planning is preparing for potentially bad outcomes, because they may happen. When it comes to economic recessions, which is the topic of this podcast, it's not really a question of if, but when, because we haven't yet eliminated the boom and bust cycles

of the economy. I didn't mean to call out your pessimism as necessarily a bad thing. I just wanted to call it out so that our audience understood just how uniquely well-credentialed you are to talk during this episode. If anyone is concerned about things going south, it's you, Dr. Offalizer. You can probably get away with saying we're in a recession when the country has experienced two quarters of declining GDP. The first quarter of this year, GDP in this country declined for the first time since the start of the pandemic. But there are other factors economists consider when putting their finger to the wind of our economy. So, Bro, what is causing economists to say that a recession is on its way now? Yeah, so you're right. Two quarters of

declining GDP is definitely a sign of trouble, and so it's a good rule of thumb. Officially, though, recession has occurred only when the folks at the National Bureau of Economic Research say so. The NBER is a private nonprofit research organization made up of 1,700 economists. They're the folks who officially designate when recessions begin and end. Here's one definition offered by the NBER. A recession is a significant decline in economic activity spread across the economy, lasting more than a few months, normally visible in real GDP, real income, employment, industrial production, and wholesale retail sales. So, in that context, real means inflation-adjusted. And you can tell from the definition, the downturn has to be pretty spread

out throughout the economy to be a recession. And inflation is the real boogeyman here. The Fed is raising interest rates and intentionally slowing down the economy to curb inflation. And many experts are skeptical that inflation can be brought to heel, so to speak, without tipping the economy into a recession. An example is that in an interview with Bloomberg recently, former Treasury Secretary Larry Summers said, if you look at history, there's never been a moment where inflation is above 4% and unemployment is below 5% where we did not have a recession within two years. We definitely meet both of those criteria. You likely have heard that J.P. Morgan CEO Jamie Dimon recently said that he's preparing the bank for a, quote, economic hurricane,

saying, you better brace yourself. One of my favorite economists, Mark Zandi at Moody Analytics, recently said on his podcast that he thinks there's a one in three chance of a recession over the next 12 months. Now, to be sure, there's plenty of good things going on in the economy. As an example, last Friday's jobs report was really good. But now is definitely a good time to take a look at your finances and get on defensive footing, at least in the short term. So, is the thinking here that things have been so good, now we need to keep it from being so good, but we're going to pull back too hard and swing the other way? Yes, exactly. I mean, the fear is that

because inflation is so high, the Federal Reserve really has to put the brakes on the economy and sort of rein in some excesses. And it's too difficult to do the soft landing. It'll probably have to go a little too much in the other direction. All right. Well, before we get into what our listeners can do to recession-proof their finances, it's probably helpful if we give a little more context to recessions in general, some history. Fun fact time, recessions used to be much more common. Yeah, the NBER provides data on recessions that go back as far as 1857. Since then, we've had 34 recessions. Basically, we have a recession on average every 4.8 years. However, there's more than a decade between two of the last three

recessions. And the last expansion, which is kind of the opposite of the recession, it's what the term economists use to describe the times when the economy is growing, that expansion lasted from 2008 to 2020, and that was the longest expansion on record. I'll also point out that the last recession, which was caused by the pandemic panic of 2020, lasted just two months, and that was the shortest recession ever. I really am a summer child. I didn't think about that, but as long as I've been investing, things have actually been pretty good. All right. Just a little more context and history here. I'm going to name an asset or other fun economic indicator, and you tell me whether it tends to go up or down in a recession. Feel free to play along at home.

All right. First one, stocks. The answer, of course, is they tend to go down. The average decline during the recession since the 1920s is around 35%. You have to understand that stocks are a leading indicator. Very generally speaking, they tend to decline six months before a recession and bottom out six months into a recession, but that's very general. Every recession is a little different. I think back to the dot-com crash, the stock market started dropping a year before the recession, and then we had three calendar years of declines before the market recovered. All right. Interest rates? Down, usually. The Fed is raising rates now to slow down the economy. They're generally successful, so then they have to reverse course to stimulate the economy when

it's declining. However, we all hear a lot nowadays about the 70s, stagflation, when we had high inflation and not great economic growth. And there were some instances there, particularly in the 73-74 recession, where the economy went down, but interest rates kept going up because the Fed still had to fight inflation. All right, bonds. So, bonds actually go up because bond prices move inversely to interest rates. Plus, During the recession, the stock market is going down. You'll see that there's often a flight to safety during a recession, which means people sell their stocks, buy bonds, drive up the price of bonds. But it does depend on the quality of the bonds. Treasuries hold

up well. Lower-rated bonds, like junk bonds, actually go down like stocks. They're usually not as much. Home prices. Take a guess, everyone. They actually generally go up. That might be surprising. But when you look back to the six recessions since 1980, home prices only went down in two of those. In one of those, the decline was less than 1%, so it was basically flat. Research from Mark Hulbert of MarketWatch found that since 1952, home prices on average actually grew more during bear markets and stocks than during bull markets. I think people will find this surprising because they look back to the 2000 and 2009 period,

which has come to be known as the Great Recession. That's when stocks and houses went down, but actually, historically, it was pretty much an outlier. Last one, inflation. Does it go up or down? Down, we hope. That's the whole point of this. That's the whole reason the Fed is trying to put the brakes on the economy, to bring inflation down. Generally, they succeed, although again, people often point to the 70s, that it took really high interest rates. The 10-year Treasury reaching 15%, 16% in 1981 before inflation finally came down. I know it's tempting and often inaccurate to think, but this time is different.

But I don't know, Rove, what do you think? Could this time be different? To a certain extent, yes. And I would say that's because if you look at anything that's going on now and you attribute it to the pandemic, such as the supply chain issues and the shutdowns in China, we could possibly start seeing inflation come down over the next several months. In fact, the bond market is currently predicting lower inflation than it was, say, a month or two ago. On the other hand, food and energy prices are soaring partially due to the war in Ukraine. We have no idea if that's going to shake out. There's some other geopolitical challenges going on. One example is that India, which, like Ukraine and Russia, is a big wheat exporter,

is experiencing extreme heat. We're talking day after day of 100-degree temps, reaching as high as 120 in some places. The heat has so damaged its wheat crop that it put an embargo on exporting its wheat, so food prices could stay higher for longer. If the current inflation and thus the Fed's efforts to slow down the economy were just due to the aftershocks of the pandemic, I'd say if we do have a recession, it may not be so bad. But these international factors could keep inflation higher for longer. What can people do to come out relatively unscathed or even ahead from a recession? I'll just start with that boring yet important foolish advice to make sure that you protect any money you need in the next few years by

keeping it mostly in cash, short-term bonds, maybe treasury, something like that. What you should do beyond that depends a lot on where you are along the road to retirement. If you're a decade or more away from retiring, the number one risk of a recession to you is your income, in other words, your job. Now is the time to shore up your human capital. Look for ways to demonstrate your value to your employer and your customers. Keep an eye on how your company is doing so you can anticipate any layoffs. Maintain a professional network. Keep your skills up to date in case you need to hit the job market. Make sure you have an emergency fund to pay the bills in the meantime. If you're near or in retirement, the concern is more for your portfolio, since

you'll be using it as a paycheck if you're not already. This is where asset allocation and diversification becomes really important. It starts with building what we call an income cushion, which is five years' worth of a portfolio-provided income in cash or short-term bonds, so you can live off of that. But also, having a mix of different types of stocks and own enough of them, at least 25. I prefer even more with some index funds thrown in. You have to think of how you diversify the stocks that you own. Just an example, for every stock like Tesla you own, you should also own something like Berkshire Hathaway. By the way, those are two stocks that I personally own. You can invest in growth-oriented tech stocks,

but also have some solid dividend-paying consumer staple stocks. You don't want too much of your portfolio relying on just one sector, industry, or style of investing. According to Morningstar, the average stock allocation in target date funds for retirees is 46%. To me, that's a bit conservative than I think is necessary, especially for the Motley Fool audience, which tends to be a little bit more aggressive. I think 60% in the stock market is a good starting point, and then you can adjust for your situation. Finally, I'll just add that one of the best things retirees can do for the longevity of their portfolios is to not sell stocks when they're down. That means retirees may have to cut back on spending during a recession.

I know, Dr. Offalizer, that my last question here could be quite painful for you to answer. But couldn't the case be made that a little recession now and then is actually good for us in the long run? As an investor, can I view this as an opportunity? I would say absolutely. I have to say, I see economic expansions and boom times as sort of like the holiday season. We all spend more, we eat more, we go to parties, we travel, see relatives, our credit card balances go up. We really don't spend too much time thinking about budgeting or things like that. Also, coincidentally, December is actually one of best months for the stock market, historically speaking. And a recession is like January 1st.

You wake up the next day, it's a new year, it's time to revisit the budget, pay off the debt, make some resolutions about how we can get better with our money, maybe better in our jobs, take a look at our portfolios, reassess our asset allocations, maybe do some rebalancing. Once a year, you should look at your portfolio and determine whether you are taking the right amount of risk for you. It's essentially hunker down for the winter, but look forward to spring because an expansion in bull market follows every recession just as reliably as the change of season. Economic winter may be coming or not, but if so, it never lasts forever. In the meantime, with every contribution to your 401k and IRA, you're able to invest in companies at cheaper

prices. All right. Well, the good news for you, our dear listeners, and Dr. Offalizer here is that we're not actually done talking about market downturns and dark times. In the coming weeks, we're taking you to school with Morgan Housel. He's a partner at the Collaborative Fund and author of The Psychology of Money. Every episode, we'll focus on a different market crash, what led up to it, how bad did it get, and what lessons you can glean to help weather any financial storm. So, get on the bus, kiddos. Summer school starts next week, and I promise you'll actually enjoy 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.