Motley Fool Hidden Gems Investing - Capital Market Earnings Crashout

Starting point is 00:00:00 Welcome to Motley Fool Hidden Gems Investing. I'm your host, Tyler Crowe, and today I'm joined by longtime Fool contributors, Lou Whiteman and Matt Frankel. So, earnings season is in full swing here. We got a whole bunch of companies reporting, even related to the oil market. We're going to touch into Halliburton's earnings, but more on like a state of the oil market sort of analysis. We'll also hit in the mailbag. But today we're going to start with the two companies that reported earlier this morning. And we could say were the duds of the earnings reports so far because they were MSCI and Equifax. Shares of both stocks were down more than 10% in pre-market trading. And as of we're recording right now, MSCI is still down

Starting point is 00:00:48 about 11%. Equifax is down about almost 7%. So obviously the market didn't like what they were seeing. The funny thing was, is as I was looking at the results, just as a cursory glance before I got to talk to you guys, is it looked like they both posted improving results and even MSCI's earnings per share was up almost 20%. So guys, what happened here? I mean, Matt, I know you looked at Equifax, Lou, you looked at MSCI. What was going on? Yeah. And I mean, Equifax earnings on the surface, at least, were not a dud. I mean, 11% year over year revenue growth, earnings per share grew 13% on an adjusted basis and beat estimates. Revenue from the U.S. mortgage business is up 25%, which is nice to see given the state of the mortgage market. The company

Starting point is 00:01:34 actually doubled its AI-driven cost reduction estimate to $150 million through 2028. Cost reductions are a good thing. The stock was down, like you said, double digits in pre-market. It's rebounded a little bit, but it's still down despite the earnings beat. A few potential reasons and things to flag here. There was $100 million charge related to a credit miscalculation glitch that happened in 2023. Gap earnings were down 4% year over year as a result. So that's worth noting. The adjusted EBITDA margins actually fell in all of the segments of the business year over year. Essentially, you know, rising compensation costs, incentives, they're both rising faster than revenue. And, you know, most importantly, there's no easier way to make a stock

Starting point is 00:02:22 go down than to lower your guidance. And while they didn't really lower their guidance, they kept their full year. The third quarter guidance was a little softer than expected. The adjusted EPS estimate would actually represent a sequential decline. And investors aren't thrilled. So really, this was a solid quarter with a disappointing outlook and margin trends that seem to be scaring investors. Kind of a similar story over at MSCI. I don't know if people know this one as well. This former Morgan Stanley unit, it's a market data and analytics company separate from Morgan Stanley now. They grew revenue and earnings by double digits. The earnings number was a little light relative to expectations. Guys, I'm tempted to blame AI here. The company said that expenses

Starting point is 00:03:03 were up 9% primarily due to, quote, higher IT costs, among other expenses. So, you know, maybe they are adding to their tech stack. There are also some accounting things going on. They recognize some amortization on related to acquisitions. Tyler, as you said, stock is down double digits. The market just has this one wrong, period. I'm just going to say it. Company is in growth mode. It launched twice as many products in the first half of 26 as it did in all of 2024. Growing does come with costs. The costs are investment in the business. There's nothing wrong with the core business here. I want to pick at something a little bit because reading through the lines of both of these, you know, Matt, Equifax says that, you know,

Starting point is 00:03:44 these AI driven cost reductions of 150 million, but then their margins were down. Lou, as you said, like the higher IT costs, it's all kind of like, some of it seemed to me implying like, you know, tech costs, IT costs, AI costs, token, whatever costs you want to associate with, you know, using AI in their business seems to be rising. And, you know, the whole theory here was that, you know, AI costs were going to drive down personnel costs, you know, put, you know, the big doomer sort of approach was people out of jobs. But it appears that, you know, this is actually starting to, you know, for high data companies doing a lot of data processing like Equifax and MSCI. It is becoming a real cost headwind. And I'm curious your thoughts,

Starting point is 00:04:32 how is this going to play out? You know, people continuing to jump into these frontier models that are getting incredibly expensive and are they going to have to kind of change their AI strategies? Well, with Equifax in particular, it would have been easier if they gave the explanation MSCI did that, you know, higher IT costs while lowering personnel costs and things like that. But their margin compression was specifically blamed on rising compensation and incentive costs. So it's a bit of a head scratcher. I mean, there are a few possible explanations to, you know, in order to, you know, train AI models and things like that, they need to bring on some new talent that could definitely be a part of it. But yeah, it's kind of

Starting point is 00:05:15 a two-way street, right? When it comes to AI cost savings by making your business more efficient and having to pay more for the personnel that are putting those cost reductions in place. So it remains to be seen if that's kind of a temporary margin headwind as they ramp up these AI savings or if it's something that is worth further discussion. Yeah, I don't think we know yet if it's ongoing.

Starting point is 00:05:41 There's definitely gonna be investment. Just like I said, investment and growth. There's always one-time investments as you're implementing. Is it one-time investments or is this tokens and it's just gonna be an ongoing thing? I don't know if we know the answer to that. I don't think the companies know the answer to that yet. But for now, I think there's at least an argument to be made that this is more investment capital than it is just permanent ongoing expense. All right. I want to put a last question here

Starting point is 00:06:09 because we've got two companies, stocks are down quite a bit today in particular. Equifax is actually down 34% over the past year. MSCI has done a little bit better than that. So looking at stock prices right now, where the businesses are right now, which one do you think is the better buy today, Equifax or MSCI? Yeah, so on the surface, Equifax is definitely the cheaper stock. It trades for like 18 times forward earnings last I looked versus about 24 for MSCI. But there are concerns. I mean, dependence on the mortgage market for growth, for one thing, those margin trajectories I mentioned, it's a bit of a head scratcher that their compensation costs are rising while AI is making the business more efficient.

Starting point is 00:06:51 MSCI is a more expensive stock, but you get what you pay for. It's a higher margin business. It honestly has a more defensible moat, which is validated by its record high revenue that we're seeing or retention rate that we're seeing. It's more of an expense problem with them than anything else with rising IT costs and things like that. To be clear, I'm not buying either of these right now and don't really have any plans to, but I'd probably lean toward MSCI if I were forced to choose one today.

Starting point is 00:07:17 Yeah, I just don't want to buy a credit bureau. More of an ethical stance. I want them to be disrupted out of business, so I'm not going to buy it. But that's not a business case. Look, MSCI is a fantastic company. It scores really well on our Hidden Gems Moneyball database, which I think is a great place to go to screen for ideas. Definitely MSCI would be my choice. It's been on my radar for a while. I'm talking about it now, so I'm not going to take advantage of this drop, but it's a really good company. Coming up at the break, we're doing an analysis of the oil market. You know, there's this small set of companies out there where even if you don't really have a financial stake, like owning the stock, or I don't know if you're one of those people, short stocks does that too. It just, listening to what they have to say about their respective markets can be incredibly illuminating. And Halliburton is one of those companies.

Starting point is 00:08:10 It may not be on everyone's radar as a potential stock to buy, you know, being a oil and gas service company, but often it's market commentary that it provides. It gives a rare window into the oil market that we can't really get elsewhere because they work with the biggest companies in the world, the ExxonMobiles, all the way down to the Wildcat drillers. And they can really give you a sense of like what the vibes, if you will, of the market is at any given moment. And, you know, with the war in Iran escalating again, traffic through the state of Hormuz is grinding back to a halt. It seemed like a good time to check in with what Halliburton was saying on its most recent earnings report, which came out earlier this morning. So, guys, we had a task of looking through the earnings report, a little bit of market commentary. What were some of the key takeaways for you when you were looking at this report? Yeah. So, I mean, a few things to unpack here. I mean, Halliburton's international strength, especially when it comes to Latin America and Europe, it's helping to offset the disruption they're seeing from the Middle East. They're keeping their Middle East crews in place, which really kind of sets them up nicely to capture demand once the war de-escalates,

Starting point is 00:09:17 which hopefully happens. And hopefully we actually get a lasting agreement at some point and the war doesn't start and end another 72 times or whatever it is. It's also worth quantifying the disruption, which management did, they said on the call that rerouting due to the Hormuz situation and other conflict-related disruptions could cost $0.07 to $0.09 of earnings per share. But they did sound very optimistic when it comes to the next quarter. Most interesting part about this report, and maybe I'm just showing my ignorance of the oil market is, but it was the North American numbers they posted. North American revenue was flat at $2.2 billion, due in part to lower specialty chemical activities, but also due to decreased drilling activity in the Gulf of Mexico. That really

Starting point is 00:09:59 surprised me. Given the geopolitical backdrop, everything we're talking about with the Middle East, I thought that was interesting. Now, I know that CEO Jeff Miller said he was encouraged by signs of drilling and fracking are picking up in the U.S. So I guess maybe it's just a timing thing that we're getting there. It just takes time. There's a lot of noise about, you know, the global picture, but North America is Halliburton's largest market. So I think that that is good for the stock if it's picking up. I'm just surprised that given all of the attention that North America was flat and it's just now starting to ramp up. Yeah. The Gulf of Mexico, Gulf of America, whatever you want to call it these days,

Starting point is 00:10:38 that's kind of been a weird sticking point for a lot of major oil and gas drillers because, you know, it takes like 10 years sometimes to get one of these from exploration to production. And so it's committing that much capital that long has been challenging when you've got fracking companies. It's like, well, you know, in 30 days I can have a well up and running. Yes, it's less oil, but, you know, the turnaround on the investment is much sooner. So I can see why that might be the case, but you would think with oil prices rising that would start to ease a little bit. But we haven't seen that. And, you know, one of the reasons we haven't discussed the oil market as much and, you know, and has been the challenge of kind of translating what we're seeing with the closure of the Strait of Hormuz, the Iran conflict and a lot of the Russian-Ukraine conflict as well.

Starting point is 00:11:25 You know, it's been hard to translate that into something that's thesis altering for a company on the long term basis because we kind of see these as hopefully things will get better sooner than later. And I think the prevailing sentiment was that things would get resolved in Iran, Middle East area, so that movement of oil would serve relatively short order when things kind of started to happen. And there was some supply and demand responses to soften the blow of the closure of Strait of Hormuz. But now we're several months in. Fighting's escalating again. And we just got a report today from Quartz that said that the U.S. Strategic Petroleum Reserve is now at a 45-year low. So I want to ask, and we can go in any direction you want here, because oil, straightforward moves, the Middle East in general has some wide implications on other markets and not just oil here. Has anything happened in the past days, weeks, months related to this conflict or the broader conflicts of Ukraine and Russia as well that's changed your position or thesis on anything in your portfolios?

Starting point is 00:12:30 It doesn't necessarily mean, are you looking more at oil companies? Are you, you know, what is something that you're seeing or maybe changing your thesis based on what we've been seeing? Yeah, so I'm not much of an energy investor in my own portfolio. So I'm not going to be buying oil stocks based on this. But you're right, this does affect a lot of other areas of the market. Any company that depends on shipping costs, it could be potentially affected here. And you're right, the Strategic Petroleum Reserve, or SPR,

Starting point is 00:12:58 It ended the week at the lowest level since 1983, and it now sits at about 44% of authorized capacity. So even if oil prices cooperate, you're talking about years for a full refill in the most likely scenario. I mean, the biggest thing, the biggest takeaway for me is that this doesn't specifically change anything right now, but it gives the U.S. a lot less of a shock absorber if the conflict escalates or if something else goes wrong. And remember, we're at the beginning of the worst part of hurricane season right now. That can cause oil disruptions. The point is, there's a lot more that can go wrong for oil than the Iran war. So keep that in mind.

Starting point is 00:13:36 And we now have less of a cushion to bolster prices artificially, I guess you would say. And I'm not buying energy here. I mean, to me, this year is the reason you have energy, just kind of lurking in the portfolio for a decade. And so now is not the time to buy. I don't think I've made any moves yet, but I am watching closely because I do think kind of what Matt was saying, the macro implications could get interesting for a lot of different companies. The biggest surprise of 2026 in energy to me, bigger than the Middle East war, was China's demand flexibility. I'm oversimplifying it a bit here, Tyler, and you can tell me if I'm wrong.

Starting point is 00:14:12 But the way I read it is the biggest reason we didn't see oil spike to 200 or whatever, the way oil experts thought it might if the strait was closed, was Chinese demand just came out of the market, which kind of took the pressure off others. We know nothing about Chinese reserves. We don't know if that demand pullback is sustainable, if they're just tapping into massive reserves they have, if there's something else going on. We now have the Red Sea potentially closing to go along with issues in the strait. We don't know what China is going to be able to do from here. It's impossible to predict, but we do at least have it on the radar as a potential headwind that does finally zap to consumer in the U.S. And that would have a lot of ripples through the economy. Yeah, when it comes to the oil market, it always seems like the price of oil tends to move the most when you see like reports of American drilling activity, American storage activity.

Starting point is 00:15:06 There seems to be some sort of oil price movements when we get those sorts of reports, in part because it's the most information we get when it comes to oil in general. Like you said, the Chinese inventories, consumption, things like that, those numbers are, I don't want to say they're necessarily state secrets, but they're not nearly advertised or published like we see here in the United States. And to that point, there's been a lot of either draws on capacity or not filling unknown capacity that they've had for a long time that has been, you know, in some ways a massive sell for this. I think the numbers I saw was something like five million barrels per day of Chinese imports just kind of went away for reasons undetermined other than they just said we're going to stop buying. Whether or not that was going into storage or actual consumption, we don't really know. So it's coming up after the break. We're going to dip into the mailbag. Hey, everyone.

Starting point is 00:16:06 Quick reminder, if you want to get your question answered live on air, go ahead and email us at podcast.fool.com. That's podcast with an S at fool.com. Also, the email is in the show description. Three requests that we always have is, number one, keep it foolish, keep it short, and three, keep it as impersonal as possible so we don't get in trouble for giving individualized advice. So today's question comes in from Thomas Hanks. And this is actually kind of oriented towards you, Matt.

Starting point is 00:16:33 So we wanted to make sure you were on when we did this. The question is, hello, fools. I believe on one of your episodes, Matt said he had exposure to different banks through ETFs. I was wondering if you could tell us which banking financial ETF he likes. And I had looked up a few and I was looking at the tickers are XLF and VFH. And I know XLF is a state street ETF and VFH is Vanguard. cards. They're both financial ETFs. Could you discuss the pros and cons of each or let me know if there are better choices? I've been wanting to hold it long term and obviously lower expense

Starting point is 00:17:04 ratios. Thanks, Thomas. So I did a quick cursory glance. And to be honest, over the past 20 years, I think the difference in performance on a net basis for both of these was something like 10 or 15% difference in terms of total performance. So part of me says it's splitting hairs here, but guys, what are some of the things that may be different about these two ETFs or if maybe there's some better alternatives out there? Well, first of all, I had no idea Tom Hanks was a fan of the show. That's pretty awesome. That would be great, right? So those two, yes, you're right. I actually ran a statistical correlation and they have a 0.99% correlation between the performance of the two over the long term. So you're absolutely right. It's hard to make the

Starting point is 00:17:52 case for one versus the other. They are rather different despite the similarities in performance. The XLF is by far the most popular financial sector ETF. It is a more concentrated play. It owns about 75 stocks. It's market cap weighted. And both of these also have a lot of exposure to insurance and payments processing. Berkshire Hathaway is the largest holding in the XLF. the Visa and MasterCard are among the top 10. So it's not pure banking exposure. So really the big thing, and the VHF has, it's more than 400 stocks and significantly more exposure to small and mid caps. But like you said, the long-term returns are the same. The big thing you want to look at is how directly do you want to invest in banks versus the financial

Starting point is 00:18:37 sectors? Like I said, the financial sector includes insurance, payment processing, and other things. You might want to look at the one with ticker symbol is KBE. That's the SPDR S&P Bank ETF. Expense ratio is a little higher, 0.35%. That's not outrageous. And it has an equal weighted approach to bank stocks, meaning that JPMorgan Chase and a regional bank would have the exact same weighting in the fund.

Starting point is 00:19:01 So you might want to take a look at that one. Then there's another one that's called the KBWB. It's the Invesco KBW Bank ETF. That only has about 25 stocks, mostly large banks. the top 10 positions are 65% of the assets. So if you just want to invest in the large banks, that's one that could be worth a look. But yeah, the two you mentioned, they're the lowest cost options. They're the most diverse options and the performance is very similar. Right. Matt did a good job breaking it down. But I think those are the two things,

Starting point is 00:19:30 just no matter what sector it is that you want to look for in ETFs. A, what is actually in there? There's a lot of examples of things that have a name, but if you actually look at what's in the portfolio, you might be surprised. So always go to their website, it lists their holdings and see if it is actually, if you're getting the exposure you want. To Tyler and to question you, Thomas said, you know, I focused on expense ratios, but said, I'm willing to pay a little more for upside. I'm with you on the expense ratios, but Thomas, personally, and this is just me, given that upside is never guaranteed and actively managed funds for the most part tend to lose to the market over time. I'm less willing to pay a little more for the potential upside. So I think that trust your

Starting point is 00:20:16 gut there with just get low fees. And that's the one thing you can guarantee. Yeah, I would add to that. I'm not willing to pay more for potential upside for the reasons Lou just mentioned. I am willing to pay more to invest in exactly what I want. Like I said, pure banks versus kind of a mix of banks and insurance companies and things like that. So I am willing to pay a little bit higher of an expense ratio to get exactly what I want in my portfolio. Always the, probably the most important things when it comes to ETF and whenever we have these sort of questions, it's always going to be, you know, the fees and, you know, exposure to what you want. It's, when we're talking about ETFs, it's pretty much going to distill down to that in any given moment. As always,

Starting point is 00:20:55 people on the program may have interests in stocks to 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. All personal finance content follows Motley Fool editorial standards and is not approved by advertisers. Advertisements are sponsored content and provided for informational purposes only. To see our full advertising disclosure, please check out our show notes. Thanks for producer Dan Boyd and the rest of the Motley Fool team. For Lou, Matt, and myself, thanks for listening, and we'll chat again soon.

Motley Fool Hidden Gems Investing - Capital Market Earnings Crashout

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