Motley Fool Hidden Gems Investing - Compounders Past vs Present

Starting point is 00:00:00 Emily Flippen Earnings from four companies that have the market beat by triple digits. But are they still growing fast enough for investors? Find out today on Motley Fool Money. I'm Emily Flippen, and today I'm joined by analysts Sanmeet Deo and Jason Hall to talk about capital compounders. They're businesses that have reinvested for growth so rapidly that earnings and their market values have just snowballed over time. We have earnings out from two of these new school compounders that we'll discuss. But first, let's talk about some of the old school compounders that reported last night, both of which that have been defying that overvalued label for years. A quintessential

Starting point is 00:00:47 element of being a rule breaker investment is being called overvalued. Send me, let's start with Axon. Axon Enterprises just posted its 29% revenue growth with over $1.2 billion in annualized recurring revenue. They have contracted bookings growth of 43% year over year. Management also, once again, raised guidance. Now, when I rewind to August 2020, I find a Seeking Alpha article that claimed despite the strong unit economics of Axon, the stock was too expensive at around $80 a share, and that its intrinsic value is closer to 74, quote, at best. Today, Axon, after earnings, trades for over $800 a share. What are your takeaways here? Yeah, you know, this stock over a five-year period has grown 704%. And that is really

Starting point is 00:01:37 because of a consistent, strong execution and a powerful business model that's almost like a razor razor blade model where they're selling hardware and offering high margin subscription software, cloud software to compliment that hardware. And they have just continued to consistently over really that whole five year period generate double digit revenue growth. And, you know, this quarter was no different. You know, they, they had, they beaten raise on earnings and revenues, continued strong revenue growth,

Starting point is 00:02:08 software services, you know, providing that high margin growth. I mean, I mean, it's almost like, when is this company not going to perform? And that's kind of the worry. And really, the only concern of this company right now is its valuation and that it's stretched. But with numbers like these, that kind of valuation is justified for a growth company. Yeah. It's so funny to go back and find articles that compare a mere $6 in price difference. At the time when that article was written, $80 versus $74 probably felt like a lot. When you look at it where it is today, it's almost like splitting hairs. But I do have to ask, this is the definition of what it means to be a compounder. And a quintessential definition

Starting point is 00:02:50 of a world-breaking stock is that they always somehow look overvalued, but in order to compound, you just continue to grow and grow much faster than the market expects. In your opinion, does Axon have what it takes to continue to compound? Or is this truly overvalued? Because there are moments where stocks truly are overvalued for the growth that they put forward. Well, really it's overvalued and it's still a great investment compounding because growth are like muscles. They always need fuel. Growth is always needed with fuel. Axon has proven that their products and services right now are growing. There'll be a limit to that, but growth investors are always looking for what's that next leg of growth. What is that other

Starting point is 00:03:35 opportunity that can cause this company to continue to grow and continue to justify that premium valuation axon has international markets that can continue to grow in it's looking to also possibly get into more of the federal um enforcement agencies um that's a little tougher not to crack but that's something they're doing and like we all hear from most most other companies ai one cool thing that they're using with ai is their ai power software you know they collect a lot of data from their body cameras and and their hardwares gathering all that data and something as simple as just making paperwork easier for officers. That in itself could be a huge leg of growth. You think, oh, it's just paperwork. Paperwork takes a lot of time and takes a lot of

Starting point is 00:04:20 effort away from doing the actual work that officers need to do is being out there in the field. So things like that. And then now they bought a drone company called Skidio, working to do something called drone as a first responder, where they can send out drones to kind of monitor what's happening in the real world and maybe triaging whether the officer can really go in there. So lots of great opportunities, but they got to execute to justify the valuation. Another business that has to execute to arguably justify its valuation, although it's looking arguably a little bit cheaper today, is MercadoLibre. Now in their quarter, they just topped 90 million unique active buyers, 68 million fintech users with an FX

Starting point is 00:05:05 neutral top line growth of over 50%. Now, I rewind even further with MercadoLibre back to 2014. There's a Forbes article. They asserted that MercadoLibre was significantly overvalued at $87 a share since that valuation implied a 17% compounded annual growth in operating profit for the next decade. Certainly a high bar, but I'll tell you what, it's been a decade, Jason. MercadoLibre posted net operating profit CAGR of over 40% for the past 10 years and its share price now sitting at just under $2,300 a share. What did you make of this report? Yeah, it's, it's exactly what you talked about with, uh, when you and Sammy were talking about, um, uh, Axon it's, you know, two things can be true at the same time, right? So you, and they might seem diametrically opposing

Starting point is 00:05:51 where a stock can be overpriced, but the growth stories that can drive the results and it's still a winning stock can still be there. The key with Axon is, the growth opportunity has to be very, very large. The company has to be led by people who can execute on a vision that many others just really don't see. In the case of MercadoLibre, you go back a decade ago, and this was just a company trying to build e-commerce in Latin America. What it's actually done is build the financial tools for buyers. This past quarter, we saw the dual flywheels of the e-commerce business and payments continue to drive that growth. Since MercadoLibre operates in about a dozen and a half countries with different currencies, it doesn't really move

Starting point is 00:06:40 a lot of money around across those borders. The numbers that I'm talking about, they are currency neutral. Gross merchandise volume, that's the sum of all the transactions on the e-commerce platform. It was up 37% in the quarter. Here's the big one. Total payment volume. This is the value of all the transactions on its fintech platform. We're up 61%. Here's a giant number. Total payment volume, almost $65 billion versus $15.3 billion in gross merchandise volume. That's a ton of money that's flowing through MercadoLibre that's going to other merchants and going to other payments. And it's a massive amount of valuable data. So, now let's look at the bottom line a little bit. Because of all the currency adjustments,

Starting point is 00:07:27 MercadoLibre reports in U.S. dollars, but essentially does no business in U.S. dollars. So, we really have to adjust that. Net income was down, largely because of those foreign exchange adjustments. But adjusted free cash flow, very, very strong, even as it continues to spend a lot of money to build out its technology infrastructure and logistics infrastructure, the actual warehouse and distribution, and put a lot of capital to lending to consumers and merchants alike. Yeah, it's really hard to understate just how important that fintech business is also for the bottom line in terms of driving operating profits. But that's the optionality that comes with a business like this. A decade ago, you didn't know about the fintech

Starting point is 00:08:06 offerings. So same question to you, Jason. When you look out, this is an old compounder. Does it have the ability to keep compounding for the next decade? Yeah, just as with Axom, which used to be called Taser International, got into the body cam business, got into the SaaS businesses that started collecting all of that data, we're seeing a lot of the same thing that's driving the future for MercadoLibre, because it's really that data that it's gaining through its payments business about the spending patterns and habits of its consumers, and all of the data about its merchants that it's using to inform making good credit decisions.

Starting point is 00:08:41 I don't think we need any new transformative businesses like Mercado Pago, but it's starting to reach into that Amazon playbook. It's building an ad business, so there's an incremental thing there. You look at those growth rates and you think, these are crazy, they're unsustainable. Sure, they're going to come down over time, but I think we have to acknowledge how massive the market is. E-commerce, if we look at those 18 countries or so that it does business in, E-commerce is a fraction of total consumer spending in those countries. Banking services, credit card usage, even smaller penetration than we see in developed economies. Now, here's the key. Move fast and break things is great in tech, but not if you're lending money.

Starting point is 00:09:26 We saw a blip on the radar last year with the credit businesses. Default rates started to creep up. But what we've seen since then is that management is doing a good job so far of managing that risk. If it can keep being a good originator of debt, that's a very different operational skill set than the things that it's built its foundation on, and just ride the massive secular tailwinds of commerce and finance in Latin America, absolutely MercadoLibre could remain a winning investment. Yeah. And one thing I love about both those companies is that when you rewind time, it's really hard to find an analyst that didn't call them overhyped or expensive. Even amongst people who are fans of the investments, they

Starting point is 00:10:02 always looked expensive, but that execution just kept compounding. And it's like a playbook that just seems to work time and time again. So coming up next, we'll have two new school compounders that are trying to run the same play. This is Motley Fool Money. Stop wasting your nights on a mattress that doesn't get you. Experience the most comfortable mattress in the world. The Sleep Number Smart Bed. At the touch of a button, you can personalize your comfort. Choose firmer or softer. Adjust cooler to warmer. And right now, save up to $2,500 during our massive Labor Day event. Hurry into your local Sleep Number store today because we have your number. One of the great things about history is that while it might not repeat, it does rhyme.

Starting point is 00:10:52 Reinvestors keep finding great ways to grow an analyst, sometimes rightfully, sometimes regretfully. Keep calling them overvalued. So let's dive into two companies that are proving The history of compounders isn't changing yet today. Both HIMSS and HERS and Palantir, they both reported earnings. Both still have their fair number of skeptics. But Jason, let's start with HIMSS and HERS. This is a telehealth platform that's known for compounding more than just returns in terms of its popular compounded drug offerings. Their revenue growth has risen at triple digits in recent years, and the business is converting new customers left and right. But at the same time, there was a Seeking Alpha article posted last month that claimed HIMS

Starting point is 00:11:31 was potentially, quote, too late to buy after shares have doubled with a fair value closer to $40 per share. Based on what you're seeing in the most recent report, Jason, do you agree it's too late for investors to jump in on this bandwagon? First of all, it's a good thing that I'm talking about HIMS and HERS and not Palantir, considering that I'm using options to short it. And we'd get a lot of emails about that, so I'm not going to even talk about Palantir. But when you look at what's going on with HIMS and HERS. I think it's less about whether it's an overpriced stock and whether its future is going to be more like MercadoLibre and less like some overhyped pass flyer that came down to Earth. What that's going to work out to is the extremely large

Starting point is 00:12:10 market opportunities that are in front of it. In this case, we're talking about healthcare spending. Now, here's the thing. The core of HIMS and HERS today is, it's really about prescribing medications, and ideally ones that it can compound in its own pharmacies, where it can earn the bulk of the profits that otherwise are shared more with pharma. Just for example, it has about 2.4 million subscribers. Massive growth in subscribers. Continues year over year, quarter over quarter. Of that 2.4 million, 1.5 million are on what it calls a personalized treatment plan. That generally means that it's compounding a special dose, or it's combining multiple medications into a single deliverable, like a gummy, something that's not commercially available.

Starting point is 00:12:54 The question about this business model is, how large can it become? What percentage of the actual spend for pharmaceuticals can that actually be? And then it also ties to its incentive structure for physicians, which is heavily tied to writing a prescription. Can that remain viable? I think we've all read the reports of customers being written a prescription with less than a couple of minutes of interaction with a physician. So, up next is expansion and more vertical integration. We're seeing they're spending a ton of money to increase their lab testing capabilities and then start delivering even more personalized medical services. So, the bottom line here is the healthcare industry is worth trillions of dollars, and some disruption to the status quo

Starting point is 00:13:37 in this extremely regulated space is probably a really, really good thing. But hims and hers having a future that looks more like MercadoLibre or Axon is going to require it to do more than just being a compounding prescription factory. It needs to become a vertically integrated healthcare business that beats those entrenched players at their own game by some degree, kind of reinventing how that game is played too. And the only thing that I'll say about HIMSS is it's still very early in its growth, high risk, high opportunity. It's developing a healthcare platform unlike we've probably seen, Unlike we probably can even imagine, it's going to be hard. It's going to take a lot of work,

Starting point is 00:14:16 but there's a lot of growth areas that it can grow into. And it's just going to take a lot of time for it to cook. Exactly. It's an execution play, not evaluation play. That's beautifully said. And I think we spent a fair bit of time on Motley Fool Money talking about HIMS. And in hindsight, it might be one of those companies that flames out. We don't talk about it a decade from now. Or it could be the MercadoLibre, where a decade from now, the opportunity seems so obvious that we wonder why we didn't spend more time discussing it. It's kind of binary in that regards, but I'm really excited to see where it takes us. But Jason, as you alluded to, I'm really excited to talk about Palantir here. I'll spare you. You

Starting point is 00:14:53 are obviously a bear on Palantir. Maybe we'll have to have you on at some point in the future to give us some more context behind that thought. But so I mean, I want to go to you. I mean, this is a really lucrative business, but one that has all these like secretive government contracts and that has created an incredible opportunity for high rates of return on its capital. But not everyone is sold. One analyst claimed the stock is both overhyped and overpriced, given the fact that it trades at a forward price-to-sales ratio north of 70 times. I have to admit, that does sound pretty expensive. What are you seeing here? Oh, yeah. This is the most expensive stock on the market, probably. But this is a classic

Starting point is 00:15:30 rule breaker in so many senses of the of the term that um intuitively it just feels and i will say here now and i've said it before on some of our other shows i think it will be a trillion dollar company at some point um it will hit its it will hit its slide growth will slow it will um you know take a correction as all rule breakers have but the the growth that they're doing right now it's such a high margin expanding from the government to the commercial side of the business and basically becoming the operating system of AI. Short-term, it could be a great short. Long-term, I think it's going to be a fantastic compounder that I think we'll be talking about as one of the premier software companies. Well, I can't wait to have you both on at some point in the future to have

Starting point is 00:16:13 the two opinions here between the actively buying puts and the belief that Palantir could be a trillion-dollar company, too. That is what makes a market, two entirely separate opinions. I think both of those could be true, though. We're going to see. When we get back from this break, we'll be doing tariff math in a minute. Stick with us. Policy shifts on tariffs are in motion. So as we wrap up here, let's do a little bit of tariff math that could go a long way for investors. For starters, let's take a look at hardware plus software business, Zebra. Zebra reported earnings this morning and management had to spell it out clearly for investors. There's a $30 million operating profit headwind just from

Starting point is 00:16:52 import tariffs alone, which reduced their EBITDA margin by nearly a full percentage point. Doesn't sound like a lot, but when you're Zebra, that's a lot of cash. And in other pure hardware companies, they're expected to be impacted even more. Caterpillar saw its operating profit fall 18% this quarter, again, largely due to tariffs. Now, I know exact math is impossible here, but when you look at businesses that can mitigate the impact of tariffs that have decent pricing power. Jason and Samit, I want to go quick round robin. Where, if anywhere, is pricing power strong enough that the cost can be passed along enough to mitigate the cost of tariffs? I think that On Holdings is a great company with tons of pricing power. They have premium brands that are,

Starting point is 00:17:37 you know, shoes are priced very highly, $150 and up. They have very high 50% and above gross profit margin, which indicates pricing power. They're willing to raise prices and they have, um, you know, just a very significant channel to, to do it with their direct consumers. So I, I believe they have pretty strong price pricing power. Yeah. I think, I think you pretty much are going to see it in, in consumer brands. Largely that's where you see it. You look at Coca-Cola is a good example. One of the reasons that Warren Buffett has loved the company for as long as he has is because their ability to raise prices, even as volumes of like Coke and diet Coke in the U S have declined, they've raised prices enough to more than offset the loss of the volume.

Starting point is 00:18:17 That's a good example. Even that company, though, has been a loser to the market over the long term. Pricing power is still no guarantee of returns. Ferrari, I think, is a primo example of a company in an industry that you don't associate pricing power. Automakers are price takers. They're heavily competitive. But when you control the market, yeah, there's plenty of hypercars out there, but there's only one Ferrari. And your motto is to provide the market with one less than it demands every year. You have pricing power. Yeah. What's 251,000 versus 250,000, right? No big deal. There you go. Exactly. I was, I was going to say Lululemon. Now they haven't historically been able, at least since this tariffs have been in place over the course of

Starting point is 00:18:59 2025, been able to pass those prices along. But I do think they had the type of audience and consumers as well as the pricing power to at least mitigate the majority of tariff impacts. But Sunmeet, actually, in hindsight, I agree. I think On Holdings is probably where it's at. They're expanding into apparel as well. So despite the fact that I think Lululemon looks scarily cheap right now and pretty balanced risk-reward investment, I do think On is, to your point, probably in a better position there. But I guess time will tell both for tariffs as well as future compounders. Really looking forward to where these companies are a decade from now. Sanmeet and Jason, thank you both so much for joining. As always, people in

Starting point is 00:19:35 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. All personal finance content follows The 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. For Sanmeet Deo, Jason Hall, and the entire Motley Fool Money team. I'm Emily Flippen. We'll see you tomorrow.

Motley Fool Hidden Gems Investing - Compounders Past vs Present

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