Motley Fool Hidden Gems Investing - Betting On Big Remodel

Episode Date: March 28, 2024

Home Depot buys a distribution network for landscaping, roofing and pools. (00:14) Bill Barker and Deidre Woollard discuss: - Why Home Depot is buying a distribution network. - The cyclical nature of home remodeling. - If RH’s lofty goals are attainable. (13:34) As a tribute to Daniel Kahneman, we revisit his 2013 conversation with Morgan Housel Companies discussed: HD, RH Claim your Epic discount: www.fool.com/epic Host: Deidre Woollard Guests: Bill Barker, Morgan Housel, Daniel Kahneman Producers: Mary Long, Ricky Mulvey Engineer: Tim Sparks Learn more about your ad choices. Visit megaphone.fm/adchoices

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Willard here with Motley Fool analyst, Bill Barker. Bill, how's your Thursday going? It's going great. Thanks. Well, one of the things that's happening today, an acquisition on a Thursday. Usually we see them come in on a Sunday night. It involves one of my favorite companies, Home Depot. I got up and went to the computer. I'm excited about it. I'm interested in it. So let's talk about what it is. It's a company called SRS Distribution. And if you haven't heard of it, you're in good company. They're spending a reported $18.25 billion. Biggest acquisition the company has ever made. So, SRS Distribution, why is this appealing? Well, as it declares in the press release, a leading residential specialty trade distribution

company working across professional roofing, landscaping, and pool contractor supplies. So, But a healthy amount of the professional outdoor and roofing work goes through SRS. It's a segment of the market that is getting more interest lately, including from Bradley Jacobs, whose next venture, QXO, is going to be doing work and rolling up some of this very fragmented part of the market and expands Home Depot's already healthy professional services sales. Brad Jacobs, the only man who loves the letter X as much as Elon Musk. All of his companies seem to have an X in them. I want to talk a little bit about what this means for where Home Depot is going.

So, they talked about it expands the total addressable market by $50 billion. I mean, we all raise our eyebrows a little bit at total addressable markets. But there's something that's been happening with Home Depot recently. You know, it hasn't been a great few quarters really for, you know, for Home Depot and others because the home improvement market has stagnated. So I'm looking at SRS. It's got these 760 branches around the country. Home Depot has around 2300 stores. So this seems like a really big swing. I mean, Home Depot, they hardly ever add stores.

On the update call, they talked a little bit about maybe they add more stores because of this. But my question is, is Home Depot sort of shifting as it goes more towards pros? Does Home Depot and Lowe's become less like each other as it goes deeper into this direction? To a degree. It's already been very heavily into the professional segment. You mentioned a $50 billion increase in the total addressable market. That's now up to, I think, a trillion, right, as Home Depot declares the whole addressable market for its services. So, you know, it moves it by 5%.

And, yeah, they've got some expanding sales opportunities, and they are big, except in comparison to what Home Depot already does. So, although the biggest acquisition, as you point out, it's not something that's transformative, it's additive at the margin and at the right margin, at the place where Home Depot already has experience and can just have more buying power and serve more people and probably won't move the needle a lot. But since Home Depot is not in the adding stores business and hasn't been for well over a decade, that money, all those profits have to go somewhere. They can go into buying back stock, they can go into dividends, they can go into acquisitions. If you're not going to grow your store count, and they've grown the square footage of the existing stores, but This is one of the relatively few expansion opportunities that they would have if they're just going to be very happy at the store count they have.

Yeah. And I think one of the things that's interesting here is you get a 4,000 truck delivery service here. So really you get a lot of, it's less about driving people to the branches and far more about delivering to pros wherever they may be. And Home Depot has made a lot of moves toward pros that I've found interesting. You know, they've made portals for pros for like construction jobs and things like that. But the thing that I'm really starting to think about is the cyclical nature of the world, right? Everyone was spending on, and is still spending on travel. And we had spent on nesting during the pandemic, then that was ending. Now, you know, maybe we're hitting the start of another cycle. It's too soon to say. One of the

things I track is the, it's called the Lyra. It's the leading indicator of remodeling activity. Comes out from a joint center for housing studies at Harvard. They're saying this might be the last year of the low. Do you think Home Depot is getting ready for an upswing in projects? Well, they're very long-term oriented. So, this is a purchase that is looking forward decades. needs. Going back to Brad Jacobs, this is an area that he's focused on, he sees opportunities in the same area. I don't know if it's been a modest cyclical downturn, certainly since the peaks of 2021, it's been a big fall-off since there. But going back to pre-pandemic, align tracks to where we are today, fairly normal growth. It's a cycle that they're more

weighted toward the residential and do-it-yourself part of the cycle. This smooths things out a little bit, but there's a big overlap between the professional services and the homebuyer aspect of the business. So, it mitigates a little bit of the cyclicality of the business, but it's pretty closely aligned. I'm going to take us in another direction, still in the home area, but we're going to level it up, folks. We're talking about restoration hardware. No, it's RH. Long way from that tiny little hardware store in Eureka, California. One of my favorite earnings calls, but just because of the sort of hyperbolic nature of Gary Friedman, who I enjoy the way he talks.

I'm not sure I believe in his vision. They missed on earnings and revenue, but the market got really excited because they're forecasting revenue growth of 8% to 10% year over year. This is a business that sells very, very expensive couches. they're building these fantastic experiential real estate places. I don't know. The market loved the guidance. I'm not sure I believe it. No. I understand why you would say that, because he does wander toward the hyperbole quite frequently. I think that one of the the references, was the most dynamic and transformative outdoor furniture supply there's ever been

this season. And maybe, maybe not. I don't know that the entire outdoor furniture market is quaking at Restoration Hardware's, or RH's, spring line. But if they are, then RH will do very well. Yeah. He, he's a positive guy on a, on a call. And so I would take everything with a grain of salt. He's succeeded with a lot of optimism, but boy, you know, if you think Home Depot is cyclical, take, take a look at RH. Well, and also they're just spending so much money on, on, on everything, on, on building these estates that people visit that he thinks we'll, we'll sell furniture and they've got, they're working on planes. They're working on yachts. The thing that, that, that sort of perked my interest, of course, it's about housing is that

he said that they're going to get into RH condos and homes. I don't know. You know, I'm, I'm, I'm vaguely intrigued because the aesthetic is so interesting. And he talks about, you know, we're, we're scaling luxury. We're bringing taste to the American market. Is there a world for RH homes? We'll find out, I guess. I don't know. I mean, it's worth a swing, I guess, at a small scale. They've taken some big swings with membership models, and that's worked out well for them. I just think the company is cyclical on steroids. When things go well, they are going to go very well for RH. When they slow down, they're going to be taken down more than the next guy, particularly as they operate in the high-end. The high-end American consumer

is doing pretty well right now. The stock market is supplying people with more funds, more confidence in the near-term future. I imagine it's going to be a good season, and they did increase their guidance. But if you look longer-term, taking, say, this year's expected sales and comparing that to pre-pandemic, there's been about 4% growth. There was a huge surge, a huge pull forward, and now, a couple of steps back, go longer-term over the last 15 to 20 years, it has grown top-line about 8% a year. So, keep those numbers as better guidelines for how to value the company than the most recent quarter and the most recent guidance. Yeah. I think that's really interesting. I think the other point here is, this isn't a

business where you're not buying a couch every year. I think there's a long span in between, and I think that's something to watch as well. It depends on how many dogs you have. I know that our couches go faster than most because of the multiple dogs. Hopefully, most people there aren't suffering frequent couch turnover the way some of us are. Certainly not yearly. Well, not if you're spending RH prices, you're not. You're keeping the dogs off the couch at that price. Well, we've got an outdoor item from RH, and the dogs spend a little bit of time on but they're not damaging that one too bad. I think, look, it's cyclical. People, as you say, they don't buy a slightly better couch every year or add to the existing couch that they have.

But there are times when various macroeconomic events lead people to spend more on their houses that they're already in or move, and that leads to a lot of new furniture sales when people are moving. That's been stuck a little bit as the interest rate situation has not led to a lot of home turnover lately. When that loosens up, that's going to be good news for REH. They seem very positive, even though they missed their numbers for the quarter. This is another example of the fact that the believed future is more important many times to a stock's price than the observed past. Very, very true. Thanks for your time today, Bill. Thank you.

We talk about a lot of stocks on the show, but it's just a peek at the Motley Fool's investing universe. This year, we're rolling out a new offering. It's called Epic Bundle. The service includes seven stock recommendations every month, model portfolios, and stock rankings, all based on your investor type. We're offering Epic Bundle to Motley Fool Money listeners at a reduced rate as a thanks for listening to the show. So for more information, head to fool.com slash epic. We'll also include a link in the show notes for you. Yesterday, Daniel Kahneman, a founder of behavioral economics, passed away. As an academic, Kahneman was highly decorated. He was the author of the bestselling book, Thinking Fast and Slow, a professor at Princeton,

a Nobel laureate, and a recipient of the Presidential Medal of Freedom. Kahneman was a psychologist first. His research exposed mental biases like loss aversion and challenged the economic idea that humans are fully rational actors. Today, as a tribute to the man and the thinker, we're playing an excerpt from a 2013 conversation between Kahneman and full contributor Morgan Housel. We hope you enjoy it. Dr. Komen, you won the Nobel Prize in economics, but you're not an economist, you're a psychologist. From what I understand, that's the first time that's ever happened in that award for economics. To me, that's a confirmation that so much of what is important

in economics and in investing has less to do with numbers and spreadsheets and Greek formulas as it does what's going on in our head and fooling ourselves. So just to get a background of your career, from what I understand, the first time that your work intersected with economics was in the early 1970s, when a colleague brought to you an economics paper. And the first line of the paper was, quote,

the agent of economic theory is rational, selfish, and his tastes do not change. Which for a psychologist, that's ridiculous. So what happened next? Well, nothing happened immediately. But I found that very surprising, actually, because, you know, the economics building was next door. I was at Hebrew University Jerusalem, and we had one building, and economists were next door. And I learned from that one sentence something I hadn't known before, that they sort of lived in a different intellectual world than we did.

You know, for a psychologist, it's obvious that people are not fully rational. I mean, it's, and that they're not selfish, and that their tastes change. So, you know, it was just a collection of statements that seemed almost absurd. And I had no idea at that stage that a lot of my career would be dedicated to that conversation. You know, that sort of happened almost by accident later. So let's talk a little bit about your book, Thinking Fast and Slow. The theme is, throughout the book, is that there are two types of thinking, fast and slow, system one and system two. tell me about the difference between the two well fast thinking is as I think

most of the way that we think I mean it's what you your memory delivers to you you you start talking and you talk you don't have to deliberate about one word and then the other you walk you don't deliberate and decide you know to put one foot in front of the other most of what we do is sort of comes automatically most of what we do is highly skilled and an emotional and to some I mean some of it is emotional much of it is highly skilled and all that is automatic there's just an awful lot of automatic stuff that goes on then there is on a system too so I say you know if I say two plus two a number came to your

mind that system one if I say the relationship between China and Japan now Now, it's not one word that came to your mind, but a whole set of words, I mean a whole set of ideas. I mentioned that you were thinking islands, you were thinking war, you were thinking navies, you might have been thinking about the history of China and Japan. A lot happened that you were not, it happened at once. Those are not explicit thoughts, but you're ready for a whole topic as soon as I mention something.

That's system one. I mentioned the word mother, you know, your mother. You're having an emotion at system one. So there's an awful lot that system one does. And system one has judgments and opinions and attitudes and impressions that are generated, they're not, you know, they're generated like when I said, think of China and Japan, that a whole lot happened at once.

you were not conscious of it all at once, but your mind was ready, was getting ready with it. So that's the idea, that there is that thing going on in our minds silently. And then you have system two. And system two is the effortful one. And it depends on the allocation of attention. It's what we are paying attention to mostly. And it's involved in computations. It's involved in difficult decisions. It's involved in controlling yourself and not telling somebody to go to hell. That demands system too. So it's all part of that effortful system. What's the relationship between the two of them? And that's the interesting part. I compare that, and maybe that image will, it's not in the book, but I now wish

it had been. I compare it to a newspaper room. So you have the reporters and they're writing stories and they're interpreting the world. And then you have an editor. And in my story the editor is sort of lazy and is badly overworked. And what the editor does mostly is endorse the stories and send them to the printer. now occasionally the editor will stop a story thinks think more slowly assign it to another reporter or altogether stop it you know like not telling somebody to go to hell now if you look at at what the product is the newspaper is really written by the reporters now it's not that the editor has no role it's not

that you know the editor is very important figure but the newspaper was but basically produced by the reporters. So that's the theme, one theme of the book is. And basically, it's not that the editor produced the newspaper, the editor is to a large extent in the business of endorsing emotions and responses and impressions that come from somewhere else. And the editor also is in the business of defending

defending what's in the paper to the public. So here with that story and he endorsed it without really thinking about it, but now there is flack about it. Now he's asked, why did you publish that story? And he's not going to say, well, I just sent it to the printer. He's going to find a reason for why that story got,

and that's the way our mind works. So we believe the thing that we believe and we have the opinions that we have, not so much because we have reasons for them, You know, if we had reasons for religious beliefs and people would change their religious beliefs, if we had reasons for our politics, we would change our views and arguments.

I don't want to say that nobody ever changes their minds, but people really change their minds. And that's because our beliefs comes from somewhere else. And we believe the arguments that are compatible with our beliefs. It's not that we believe in things because we have the argument for them. So a lot of things.

System one comes first, system two endorses and rationalizes. So that's part of, you know, that's a big theme in the book is this view of how the mind works. So is system one my gut and system two is my head? Is that a fair way to think of it? Well, system one is extraordinarily clever.

I mean, it's not, you know, system one knows about the world. I mean, your knowledge about the world, all your skills are in system one. You know, you drive without paying attention. That's system one, because you have learned to drive. You maneuver social situations without getting into too much trouble most of the time.

That's system one. And it demands a lot of alertness to cues. So the guts, you know, to say system one is the gut, that suggests that there is no thinking there. The best thinking we do is system one. Creativity is stuff that comes from your memory, it's in that sense system one. It's just, it doesn't work the way we think it works.

But it's not that system two is more elevated than system one. Actually, I don't want to say the reverse, but system one is much better at what it does than system two is good at what it does. That is, you know, the automatic memory system really does an awful lot of stuff very quickly. You've written about hindsight bias

with the financial crisis in 2008. What can you tell me about that? Well, there's something I actually find shocking, and this is, there are not quite a few people who say I knew, you know, there was going to be a crisis. And I think that's perverse. It's a perverse use of the word no. And that's because we use the word no for something, you know, when I believed in something

and my belief was true. You know, those are the two conditions under which we're allowed to say the word no. I believed it with very high confidence. But in fact, they didn't know that there was to be a crisis. they thought there was going to be a crisis. Then there was a crisis. And then all of a sudden they knew it was going to be a crisis. But there were people who were just as smart and as motivated and so on who didn't think there was going to be a crisis. So what is very important about this is whether you conclude that the crisis was really knowable. And given

the number and the quality of the people who fail to see it, the fact that there are many people now who are sure that they knew it doesn't convince me. I think it wasn't knowable. It was much less knowable than we tend to think because of the ease with which we can explain it. You know, everybody who didn't predict it looks, you know, blind in retrospect. That's hindsight. So if we suffer from hindsight bias and we think that the past makes sense and it was predictable, does that make us more optimistic about the future?

If we think we understand the past, then we have to think we understand the future. Oh, yeah. It makes us way overconfident about our knowledge of the future. And overconfidence is everywhere. I mean, if you're going to pick among the biases of judgment, then thinking that we know when we don't, that's a big one.

And thinking that we control things that we don't is another big one. So optimistic overconfidence accounts for a lot of the mistakes that are made. In the financial context, there is a really frightening study that was published a couple of years ago. It shouldn't really surprise you, and maybe it won't. But here is the way it goes.

There is a study being conducted at Duke, I think, for many years now, where they pick the CFOs of, I think, the biggest 500 companies. And they send them a questionnaire every year. And it has a lot of questions, including forecasts. And one of the things that they are asked to forecast is they are asked to set an 80% confidence interval for the S&P 500 over the next 12 months.

And they have thousands of those judgements because many people come year after year. And, well, in the first place, they have no idea what the SNP is going to do. The correlation is negative between their judgment and what actually happens, and it's barely significant. I mean, it's nothing. They have no idea.

The thing that's worse is how overconfident they are. So when you set an 80% confidence interval, if you are at least aware of how ignorant you are, and you do that many, many times, then 80% of the time, the truth will fall inside your confidence interval, and 20% of the time, you'll be surprised. In fact, pretty sure that I have that correct,

they have not 27, 20% surprise, they have 67% surprises. They have no idea. And their confidence intervals are way too narrow. Now let me tell you where the true confidence interval ought to be for the S&P 500, because I asked the authors of that study to compute it. So for somebody who has no idea,

looking I think at the last decade or so, that was not counting the last two years, I think I had the computation done in 2011. Somebody who doesn't know anything about the S&P 500, and that's everybody, you know, should the correct confidence interval, there is a true answer to that, the correct confidence interval,

is that the S&P with 80% probability is going to grow between minus 10 and plus 30. And what's striking about this is that this sounds you are saying nothing. And it is saying nothing because you know nothing. So that's what the confidence interval ought to be if you know nothing and you know that you know nothing. But those CFOs don't know it.

So to put it in a practical sense, what are some things that I can do and everyone else can do to help live a better, more fulfilling life, based off of some of the stuff that you have found? I would say there are a number of things, actually, that you can do. One of them is we do tend to neglect our experiencing self.

I think we do too much for, you know, we do too much to build up a resume. And I don't mean that in a narrow way. The resume, what I mean by that is each of us has a story, has a narrative, and the narrative of our life. And it's our prized possession, and we do a lot to keep it looking good.

And we may be doing too much for it. There is also a matter of living, of living your life. And there are decisions that you might make differently. For example, in the life-work balance, there are decisions you might make differently if you are thinking of the experiencing self. and not only of accomplishments and goals and things like that. 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 Deidre Willard. Thanks for listening! We'll see you tomorrow! Thank you.