Motley Fool Hidden Gems Investing - Capital One Applies for a Credit Card

Episode Date: February 20, 2024

Capital One wants Discover for a $35 billion dollar all stock deal. (00:21) Ricky Mulvey and Jim Gillies discuss:  - How a merged Capital One and Discover would compare to the big banks.  - The investor reaction to the proposed merger.  - Home Depot’s earnings.  - The end of an activist story at a company that makes garden rakes. Plus, (16:47) Robert Brokamp and Alison Southwick continue their conversation with Jason Moser and Bill Mann. They cover the stocks that got away and the ones that broke their hearts. EXCLUSIVE NordVPN Deal ➼ https://nordvpn.com/motleyfool Try it risk-free now with a 30-day money-back guarantee! Companies discussed: DFS, COF, HD, GFF, UA, LULU, NVDA, TDG, JD, EB, U, IOT, ONON Host: Ricky Mulvey Guests: Jim Gillies, Alison Southwick, Robert Brokamp, Jason Moser, Bill Mann Producer: Mary Long Engineers: Dan Boyd, Jim Gillies Learn more about your ad choices. Visit megaphone.fm/adchoices

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you're listening to Motley Fool Money. I'm Ricky Mulvey, joined today by the aforementioned Jim Gillies. Jim, thanks for being here. Thanks, Ricky, for that intro. Let's indeed ask me those questions. The story this morning that is unavoidable is that Capital One wants to And there will be questions among U.S. regulators because the headlines are acting like this is a done deal. Let's set the terms out first, though. It's a $35 billion all-stock deal. The combo would surpass JPMorgan Chase and Citigroup by credit card volume, according to Bloomberg. First and foremost, why does Capital One want this business?

Well, the famous or infamous word, I guess, would be scale. Discover is the smallest of the four U.S. major global payment networks, so they're about to get bigger. They want to leverage the investments, they being Capital One, leverage the investments in their network they've put down for the last decades. They can do that by getting larger very quickly with, as you say, an all-stock deal. They are claiming, and you should always look at these claims with a very healthy dose, a very healthy shaker of salt, let's put it that way. They're claiming strong returns on invested capital, post-deal synergies totaling about $2.7 billion, I think, through 2027, or it'll take until 2027 to fully realize that. But I think empire building's a thing, Ricky.

And, you know, this is Capital One taking the next step on building their position to challenge the folks, as you mentioned, like JP Morgan and Citigroup. But the shareholders of Capital One aren't too happy about it. Even with these advertised synergies and scale building, they're going to get access to essentially a payment network that they didn't have before, where they had to go out to Visa and MasterCard to get their credit cards out there. And yet they don't seem too happy about it. Well, I mean, last I saw, it was down, what, 1% or 2% Capital One. Yeah, they're kind of reacting a little bit, or some people are reacting and say, oh, we want to get out of the way of this. I think that's a little silly. Capital One is not richly valued right now, frankly. I think it looks pretty decent. I think Discovery is also similarly reasonably valued. Stock Advisor Canada

has a recommendation on Discover Financial, for example, and the analyst covering that, buck hartzell is very enthused about the company i don't think he's terribly thrilled about it going away it's a scale building these types of acquisitions do happen all the time which i suppose is a nice little softball to you to ask about regulatory issues yeah let's do it okay well there you go well that's usually you do a softball question not a softball answer for a softball question but this is all the headlines are making this sound like it's a done deal from what I've read this morning. And then there's a little bottom paragraph where it's like, oh, it still has some regulatory hurdles to clear. There's a lot of big mergers that have been

falling apart lately. And it seems like it seems like those watching this story, those invested in Discover, like Buck Hartzell, maybe he still has some hope that this could be a standalone company. Well, OK, so on the subject of regulatory approvals or not, look, in a world where Amazon buying iRobot can fall apart because of regulatory concerns. Admittedly, that was the European Union who were saying, hey, Amazon's going to delist all their rival vacuum folks on their platform, and that will hurt iRobot, which is a little silly, but whatever. I have to think that Capital wanted Discover, who jointly released the press release today. The CEO of Discover is widely quoted in the press release. Three members of the Discover Financial Board are going to be joining

Capital One Board. I would like to think basic due diligence has had both parties run this up the flagpole in terms of legal and probably regulatory expert folks. Now, my take on this is, look, again, Discover is the smallest of the big four. Visa, MasterCard, Amex, all much larger than Discover. On the banking side, which is kind of more where Capital One is held, Capital One is like number 10 in the U.S. in terms of total deposits. Discover is at 26. The deal will move them to about number six in the U.S. after, of course, the big four, J.P. Morgan, Bank of America, Wells Fargo, Citigroup, and I think U.S. Bank is number five. So, this would move them up to number six, but they'd still be one-third in terms of deposit

base. They'd be one-third the size of Citigroup and Wells Fargo, less than one-third, actually. And so, if you prevent this on an anti-competitive basis, you're kind of sending a second message. The second message is, the big four are all that matter, and we will block anyone coming to any semblance of scale with the big four. And so, I think that actually would send a worse message. Now, it doesn't mean that it won't get regulatory scrutiny, and they might have to hive off one or two things to make it sure. But I think it's not the same, obviously, but Microsoft buying Activision Blizzard, where there was some concerns about that going on there, I think this will take longer than is expected, but I think it'll ultimately get done.

But that and two bucks spicy coffee down the street. So what do I know? A few bucks at the Capital One Cafe. There you go. Go get a coffee and do your banking. Let's go to Home Depot earnings. So on Friday, J-Mo made Home Depot his radar stock. He said he was going to be curious about the inflationary story.

Not much of an inflationary story on the call. In fact, we have disinflation, which was interestingly brought up. I think it has to do with lumber. But why is disinflation a problem for Home Depot right now? I don't think it is. I don't think it is. No. I mean, disinflation is just a slowing of the rate of inflation. It's not deflation. Disinflation is arguably what we've been doing for the past two years, trying to slow the rate of inflation, right? That's why we've hiked, we being the federal banks of both of

our countries, hiking rates. I don't think it's that much of a problem. I think these companies, like Home Depot, have seen all manner of economic environments before. And I think the long-term investor just looks at this and doesn't particularly care. Investing is an expectations game. And expectations, they were already set. They were going to be light. They've been light for the last year. They'll be light again this year. But you knew they were going to be light. And I think I'm going to go on a bit of a sermon here. Yeah. Home Depot is probably one of my favorite, if not my favorite, case study for a company that transitions from growth mode to cash cow. No one noticed. Well, they noticed, but it was 16 years

ago now. Fiscal 2008, which their fiscal year is ending in February, it's always weird. This is a company that had been in major growth mode. They'd been growing their store base by something like 8% a year or something like that before that. And 2008, they only did about $2.5 billion, $2.2 billion in free cash flow in that last year of growth mode. And their store count was just over $2,200. Today, and their CapEx was $3.6 billion, which is actually higher than what the most recent is. Today, the store count has gone like nowhere. I think they've grown it at 0.3% annually for the last 16 years, but cashflow has exploded. Home Depot is a story of a dominant company in effectively an oligopoly. You can argue it's an oligopoly. Yes, there's mom and

pa hardware stores everywhere, but whatever. They've turned into cashflow mode and the cashflow exploded. In the last 16 years, since they went from rapid store growth, plow all their cash flow into growing the store count to, we're just going to do maintenance, very slow growth. I think they're calling for 12 stores this year. They're probably going to close a couple as well. Net store growth probably won't be 12. They have produced $143 billion in free cash flow over the past 16 years. They have thrown all of it at share buybacks, which has reduced the share count by 41%, and ever-rising dividends. They've just jacked their dividend to $9 a share for this coming year. When they stopped their major growth trajectory, like I said, in 2008, they were

at $0.90 a share. So they have tenfolded their dividend. On a dividend-adjusted basis over the past 16 years, Home Depot, mature giant cash cow company, has given investors 20% annualized returns. Please tell me again. I know there's a bunch of growth-focused investors who like to say, oh, well, when this happens, it's a sign of a company maturing and all the good stuff is gone. Again, it's been about 16 years, 20% annualized. I'm picking a straw man, obviously. But please tell me how much better the new growth changing the world has done over the 20% annualized put up for the past 16 years at pokey no growth home depot who still has their competitive position unchanged by the way i go on i'll wait yeah they offered i i want to meet i

want to meet this this straw man who's who's ready to who's ready to go to town on home depot oh i could give you a name or two so but well what is it we'll talk after the show we'll talk after the show yes yeah i mean but what you just described is why home depot is able to essentially uh offer a soft forecast and the stock does not flinch. That's always the story. Earnings beat expectations, stock forecast is down, and then the stock gets pummeled. Let's go to Griffin Corp, which is a story you haven't heard. It's not going to be in the headline of today's show, but we're slacking this morning. I offer up some stories. You give some takes on it. You wanted to talk about, and I'm quoting now, a maker of fine residential and commercial garage

roll-up doors and garden rakes run by a well-comped and nepotistic management team guilty of church and i was like you know what we can talk about some other things but i feel like jim wants to talk about this story okay what's the this is an activist story seems like the activist play has worked out give us give us the story with uh with griffin corp here sure so yes griffin corp is that very thing they are well comped and one of the reasons why the activist Voss Capital showed up a couple of years ago is they're like, do you see what these guys are getting paid, basically? And they pointed to a myriad of compensation plans that seem to basically need a pulse and they'd be met in full. In fact, the pulse might be optional on a couple of them.

They pointed out, Voss Capital, that is, pointed out that the CEO, who is a gentleman, Rob Kramer, i believe his name is the ceo and chairman uh that he he made more for this tiny little company i think today it's barely a four billion dollar company and again they they make roll-up doors garage doors garden rakes garden hose uh they own the hunter douglas uh fan you know ceiling fan brand um that guy made more than the ceos of some other companies you've heard of one we've already talked about home depot starbucks and disney okay yeah like you know bobby your favorite your favorite entertainment CEO, Bob Iger. I was going to say, I'm going to hold off on the Bob Iger love right now. And you know, they said the board was compromised, was full of

cronies. And they, so they basically, I came to this story about a year into the activist fight. They'd already had one fight, you know, and they were, they were calling for a division to be sold off. It was, I recommended it in hidden gems, Canada in January of 2023. And I think a day later, like one market day later, the, they announced the deal with the activist. Cause I was gearing up for another fight. And I love a good activist fight. They announced that the head of Voss Capital, who'd already got one of their directors onto the board anyway in the previous fight, they were announcing that the lead for Voss Capital was himself joining the board. And they announced a standstill agreement. We're all going to work together and kumbaya,

and we're going to bring everything together. We're going to create shareholder value for people. and then they so they sold off the previous division but you know they were in the middle of a strategic review that strategic review disappointed everyone except apparently me when it came out a couple months later because everyone is expecting a sale with the company instead it came out that oh we're going to give you a two dollar a share special dividend and we're going to up our buyback program stock promptly fell fell from the mid 30s to the mid 20s very nice time to add by the way but since then they've paid that special dividend they've hiked the regular dividend twice. They have indeed been very aggressive in operational

improvements that has led to more cash flow, and that cash flow has led to better buybacks, a little bit of debt repayment. They got serious about board refreshments. They actually got rid of a couple of the directors who had been there forever and ever. The reason I call them nepotistic is the CEO is the son-in-law of the former CEO, who himself was the son of the former CEO before him. I'm not scared by that kind of stuff, because frankly, I think when you have people so nakedly looking out for their own self-interest, it may behoove you to align yourself with their self-interest. But the thing that came out this morning that I think is kind of the end of the activist story, and so why Griffin is going forward is going to have to

earn its place in your portfolio based on performance alone, is the word came out that Voss Capital is selling 1.5 million shares to Griffin themselves at a 3% discount to the market. So that's nice. I like that. But this will take their holdings from about 2.8 to 2.9 million shares down to, well, down by 1.5 million. It'll take them below the 5% threshold where you have to report. And the lead of Voss Capital is leaving the board. Now, they gave all the right words and said, we're going to keep on owning shares. However, they can now sell without needing to file a form for the rest of their holdings. So it'll be interesting. But this is a stock, again, Griffin Corp, maker of garage doors and yard implements. The stock is up. Basically, it's a

double over the past year. It's up about 120% if you did take the conclusion of that strategic review as a buy signal. That's about nine months ago. This, again, is another... If I can be said to try anything, it's I like to preach that you can make market-beating returns in odd and weird places. You don't have to go for whatever is super hyped in the media at this time. You can find it in Home Depot, as we talked about. You can find it in people who sell stuff to Home Depot, like Griffin Corp. So I thought it was an interesting story that most, probably most

I'm only full of money listeners probably haven't heard of. Well, I think we just hit the SMCI story with that as well. So we're about out of time, Jim Gillies. As always, appreciate your time and your insight. Thank you. You just found out that your sales team

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But Valentine's Day is over, and it's time for a little heartbreak. This time, Jason and Bill share the ones that got away. Last week, Jason Moser and Bill Mann joined us in the studio to talk about the great loves of their life, by which we mean, of course, investing in stocks. But you know what? That was last week. And this week, it's time to talk about the heartbreak of investing. You guys ready? I have tissues nearby if you need them. Valentine's is over. Back to cynicism. Bomp, bomp! Here we go.

I'm going to power through. Here we go. Alright. So, our first question today is to talk about the one that got away, by which we mean a stock that you never got around to buying and wish you had. There are a lot that I can put on this list. My recency bias is going to bring Nvidia here front and center. I'll go with Nvidia because it's funny, one of my roles here, I'm the advisor for augmented reality and beyond service. When I started that service almost five years ago, Nvidia was one of the stocks I recommended there. It made a lot of sense at the time. I remember digging into the company thinking, wow, these guys are

coming around, they're doing a lot of cool stuff. This is a stock I really probably want to own. And as I mentioned before on the previous episode, we have internal trading guidelines that make it a little bit tricky sometimes for us just to be able to transact whenever we want. It was just never a stock that was open. It was never available for me to actually go in there and purchase. I didn't at the time. It sort of left my mind. I never thought about it. Five years later, it's up like 2,000%. Now, I'm thrilled that I've got it on the card for our members, because our members have clearly won big from Nvidia. That's one where I look back and I think, man, dang it, I should have just kept that on my radar, and I just

didn't. And I wish I did, because I feel like they still got a lot to do. I'll just add a little bit about the trading guidelines for people who are curious. And that is, once The Motley Fool has recommended or discussed the stock, we are, as employees, prevented from buying it for, I don't know what it is, 10 days or something like that. And then also, if you own it and you want to sell it, you have to check and see if we've mentioned it or recommended it. You can't sell it. So, it does limit a little bit of the investment flexibility of working here. All right, Bill. How about for you? What's the one that got away? So, I read this assignment as

something that I had recommended for members and had never gotten around to buying myself. and the answer was a company that I loved the moment that I recommended it and never went back and bought it. It was a company called Transdime, which since that point in time, and I looked this up and it was painful to do so, is up 4,500%. Transdime, what they do is they make basically all of the parts inside of an airplane tube. The tube itself is Boeing or Airbus, but all of the components inside are built by other companies. And by other companies, I basically mean Transdime. They did almost everything else inside Boeing planes. And it turns out when you sell those sorts of things, it works out really, really well. And I thought it was going to work out

really, really well. And it has worked out really, really well for a lot of people who are not me, because I didn't buy it. Do you feel it's too late to ask them out? You know, it's water under the bridge at this point. It's felt expensive for the entire time, and for the entire time, that's been wrong. So, maybe. She's out of your league now, maybe? What about NVIDIA? Is it too late? Not too late as far as the business goes. Now, the valuation is one where I feel like, you know what, I'm going to be patient here. I'm going to be patient and let it come back to me. If she comes back to me... You're talking about the Taylor Swift of

stocks right now, my friend. She's moved on. She's on TV and you're not. Alright, next question. We actually kind of covered this a bit last week, but tell us about the one that broke your heart. By which I mean, a stock that you bought and it just went nowhere. This one's funny for me because it's one that really did well for a while until it just didn't. And that's Under Armour. Under Armour is one that had... I dated Under Armour, too! Brody. So much potential. And we saw that stretch of time where Kevin Plank really seemed to have

the answer for everything. And then they just hit a wall. And it was self-inflicted errors. I mean, He just made some strategic blunders, I think, that really sent the company into, not a death spiral, but certainly something that's been very difficult for them to recover from. Thankfully, it was a smaller position. It's not something that was terribly material to my portfolio. It was one where I was considering, hey, maybe this is one we need to keep building this out. This could be the next Nike-like story, until it became apparent that it probably wasn't going to be. To be clear, I still own those shares today. it's a small, meaningless position. But I was telling you before about, I kind of default to

not selling. And the funny thing is, I think Under Armour makes great stuff, right? I'm wearing Under Armour pants. I mean, I love them. They just can't get that business in order. It's really interesting to watch. And we've seen, I remember before, Bill, how we would talk about Lululemon versus Under Armour. I mean, all of these... Nobody's talking about that anymore. Yeah, it's fascinating to see how well Lululemon has performed while watching Under Armour just completely flounder. It's been a real lesson. What's been the difference, do you think? Well, I think certainly just vision and leadership, right? Leadership with Under Armour,

they've just never had any kind of consistent vision as to what they wanted to do with the business in recovering from those strategic blunders that Plank made long ago. And most that was in regard to supply chain management. Yeah, it's just been a difficult road to hoe for them. I'm still completely distracted by the fact that you used the word grody. To the max, even. To the max. Yeah, I think it's meaningful that you, off the top of your head, know exactly the name of the founder of Under Armour and don't know the founder of Lululemon. They have a much more professional management team.

Was that Chip Wilson? Yeah. Now, Wilson's out of the picture. Wilson was a bit problematic. Yeah, argued a little bit out there. I don't know that much about him. But it was very clear that they were like, look, we have to part ways and get this thing back on track. Under Armour has not had that luxury because Planck is still a majority owner of the business. Split those shares out. He's controlling the whole thing. I think we could argue that's a bad move. Clearly, investors have lost from that. I'm not suggesting that Wilson was the one that got away, by the way.

I am simply saying that they had a professional management team and structure in place, whereas with Under Armour, Kevin Plank's basically up there Napoleon-style pointing, here, we go there, and you know, if you're going to be a Napoleon, you'd better bring it. And he hasn't. Hmm. All right. What's the stock that broke your heart, Bill? Bill Mann. Mine's Kahoot. Kahoot? You know Kahoot. You know, the little kahoots, the quizzes that basically got your kids, you know, 80% of the learning they did during the pandemic.

Yeah, little quizzes. Yes. It was a great little company, and we recommended it almost when it was pre-revenue. So, they were building up their business. Didn't even have a marketing team. It was all word of mouth and just exploding. And it was one of those companies that simply, and, you know, I wouldn't take the other side of this, by the way. I wouldn't want the other experience. But it was one of those companies that really took hold during the pandemic and then lost its grip on the other side, right? And again, I don't wish we were still in the pandemic so that Kahoot! would be doing well. It's such a company with a purpose that I really, really wanted it to financially succeed more than it has. Alright. Our last question is for you

all. Now, this was the one that got Jason squirming in his seat, so we'll see if it's true. The one time you cheated, by which we mean an investment that generally goes against your principles or what you've recommended to readers and listeners here. Yeah, well, I think the reason why I squirm is because I look at these tickers and I'm like, yep, they're not working out, and yet I still own them, and I don't know why. Oftentimes, I own them because I either am holding out hope that things will turn around or they serve as living lessons and reminders. I think in this case, these are reminders.

One of the rules I tend to espouse, and I follow it for the most part, but every once in a while I stray, is to just not buy into IPOs. Give it some time. I like to see four quarters of reporting. I want to understand how this management team works, what they're focused on, how they report metrics, yada, yada, yada. Every once in a while, I do stray. Two that stand out, I'll give you two here, Eventbrite and Unity Software, a couple of companies that I bought into early, early on in their public lives. They just struck me as interesting businesses with a lot of potential. I didn't worry so

much about the valuations and the enthusiasm behind this stuff. With IPOs, that can often be a drawback, is the enthusiasm that pushes those valuations up a little bit irrationally, especially in the case of Unity Software, given the time that it went public. But Eventbrite and Unity stand out to me as two where I should have listened to myself, I didn't. Maybe things will get better for them. But, you know, I'm not terribly optimistic at this point. All right, Bill, how about you? I have a basic rule, and it is this. Don't leave your money at risk of dictators. We're getting back to Napoleon again. We're getting back to Napoleon. I have a second rule, and it is,

if the person who is running a company seems like a bad person, they're probably a bad person. So, I had recommended a company called JD.com, which is a Chinese company. It's a very interesting company, kind of a clone of Amazon. And their CEO got in trouble with the law in a very bad way in Minnesota in, I think, 2019. What was he doing in Minnesota? Getting in trouble? You can get in that much trouble in Minnesota? Oh, yeah.

I went to a seminary in Minnesota and had to story. I don't know how to respond. Like, go on. We'll save that for another episode. You've left him speechless. Yeah. Was arrested for messing around with a woman who was not his wife. And you know what I mean?

And I found myself a little bit frozen by what do I do? Because we as analysts are supposed to focus on a business, right? You don't want to overreact to things, but you don't want to underreact to them either. In this case, given everything else about what was happening in China, the fact that it's not a particularly friendly environment to foreign capital, I should have just pulled the plug and just got out and said, OK, listen, this is not a place where we need to risk our money. We have thousands of companies that we can invest in.

why would we remain exposed to this one? Let's close on a more optimistic note. Thank you! I really didn't want that to be the end. No, we're going to close on an optimistic note here. So, Moser and Bill, is there any stock right now that you're maybe slipping notes to in class, saying, do you like me? Yes, no, maybe? Maybe a stock on your radar? Wow! Of course, if you talk about it, then you can't buy it. Yeah, that's right. What have I already mentioned? Well, yes. I've recommended it in my next-gen supercycle service. It's performed

very, very well in a very short period of time. It's a company called Samsara. Ultimately, in connected cloud operations, helping businesses connect all of their devices and vehicles and buildings and stuff like that. Samsara builds that technology, runs all the software behind it. The ticker is IOT, which is clever because of Internet of Things and all of that stuff. So, it's an Internet of Things kind of play. Speaking of valuation, the stock has taken off. The valuation is one where I'm like, OK, it needs to come back to me before I can really start getting serious about those love letters. We're going from notes to love letters. That's what I'm hoping. But yeah, that's one that I continue to really be interested in.

Alright, IoT. Alright, Bill, how about you? Jason talks about all this technology. I'd like to talk shoes for a minute. We all got to wear shoes. Well, I guess we don't all have to, but we all do. We're all requested to wear shoes lots of times. Not that long ago, I was in Japan and was walking in a very fashionable part of Tokyo. There were all these little boutiques, and one had a line going around the block. As an investor, that's the kind of thing that makes me go, huh? And the company was On. On Holdings, the running shoe company. No, they call themselves a movement company. O-N? Yeah. On. The people will have heard of this,

even if you have not. And it is a Swiss company co-invested by Roger Federer. And the guy who founded it was a former triathlete who noticed that other triathletes were suffering from the same exact injuries and decided to try and develop a shoe that would be safer for people. And they're fantastically comfortable. They very fetchingly call their technology cloud technology, which is a great sounding thing for your feet. And they're selling like wildfire. So, a little bit of a challenging valuation, but in the very same way that Lululemon has always had a challenging valuation, this is a company that I am making goo-goo faces at and the like just to see what happens next.

Eyebrows, eyebrows. Exactly. As always, people on the program may have interests in the stocks they talk about, 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.