Motley Fool Hidden Gems Investing - Good Businesses in Bad Times

Episode Date: February 26, 2022

If you want to do well as an investor, you have to get comfortable with the idea of holding great companies through difficult times. (Like the one we're in right now. Motley Fool senior analysts John Rotonti, Maria Gallagher, and Ron Gross take a look at how strong companies bounced back from difficult times, and how investors can apply those lessons today. They discuss: - The tough decisions from management at Domino’s and Apple that ultimately rewarded shareholders - How Disney found strength in its intellectual property - Key takeaways from investing through the Great Recession - Best Buy rebounding from being "Amazon’s showroom" Stocks discussed: DPZ, DIS, AAPL, BBY, AMZN, AMD, SBUX, PTON Host: John Rotonti Guests: Ron Gross, Maria Gallagher Producer: Ricky Mulvey Engineer: Rick Engdahl, Austin Morgan Learn more about your ad choices. Visit megaphone.fm/adchoices

Here's one example where perhaps they didn't have that balance sheet that we would love to see all resilient companies have. But what did they do? They laid off 3,000 employees, they discontinued about 70% of Apple's products, and they got back to business of innovating. And it's almost a $3 trillion company today. So again, management's willing to pivot to make tough decisions. If they've got the financials backing them, even better. But it really comes down very, very often to really strong operators and managers. I'm Chris Hill, and that was Motley Fool senior analyst Ron Gross. Do you want to do well as an investor? Then you have to get comfortable with the idea of holding great companies through some turmoil. And yes, that includes what's going

on in the market right now. In this Saturday Classroom, we've got two more Motley Fool Senior Analysts, Maria Gallagher and John Rotonti, joining Ron to look at how strong companies bounced back from difficult times and how investors like us can apply those lessons today. Hi, Fools. I'm John Rotonti and I'm joined by Maria Gallagher and Ron Gross, and this is what bad times teach us about good business. This feels particularly appropriate right now because more than 40% of the stocks in NASDAQ have fallen at least 50% from their highs. Tech stocks are getting cut in half as the market is repricing or re-rating these stocks down, meaning that at this time, the market is willing

to pay much lower multiples for some of our favorite growth businesses. These are tough times and we feel it too. We're invested in many of these businesses and are suffering paper losses right alongside of you and it hurts in the moment it creates lots of fear and anxiety and ron and maria are going to try to help us get through this difficult time by sharing some lessons they've learned from businesses that have faced tough times in the past so ron and maria welcome thanks uh who wants to go first i could jump in john a few thoughts uh first is from a portfolio perspective, a portfolio management perspective. I think we want to make sure we're diversified. We talk about that a lot at The Fool. We say 25 stocks or more is a nice level to spread your risk.

We want to maintain a long-term outlook. We don't want to think in terms of how is a stock going to perform over the next year or perhaps even two years. We like to hold our stocks for five years or more. And just those two relatively simple things can help really mitigate the damage from a portfolio perspective. When we look at individual companies, so every situation or company is unique, but I think there are some common characteristics that many resilient companies possess. And I love to see companies with as many of these characteristics as possible. I'll name a few. there are more, I'm sure. The first is a product or a service that people love, right? If you have a business that is founded on the concept of a mediocre product or a mediocre service,

you're really fighting an uphill battle. So something that people really love and would miss if they didn't have. Strong management, obviously a foolish tenant, would love to see strong management or management that was put in place later to correct a problem. A company's, a board of directors' willingness to make a shift if necessary to make the company live to fight another day. From a financial perspective, strong balance sheet, essential to invest during good times and weather the storm and potentially invest during bad times. Strong balance sheet, essential. Pricing power, meaning the ability of a company to raise prices if necessary. Love to see that. And then just a few more quickly. A company that's cash flow positive

during difficult times or businesses that are not yet profitable but are addressing a large and growing addressable market that should lead to significant profitability down the road. There's plenty of companies we love right now that have not yet reached profitability or even are cash flow positive yet, but that we believe in as long-term investors. Finally, a company's willingness to innovate and pivot when necessary. Sticking to your knitting isn't always the right course. You have to be willing to make changes and you have to be willing to make tough decisions, layoffs, divestitures, cutting dividends. Sometimes as a shareholder, you want to see a management team make those tough choices, even if they're painful in the near term.

Maria, that's a heck of a list. It's hard to think of something that Ron didn't just say, but I think what's really interesting is so thinking about both the broader scale problems. So if we're thinking about things like the great financial crisis, even 2020, understanding the external shocks to the system versus what's going on with an individual company. So understanding what expectations are baked into the stock price to then understand what you think is a reasonable growth rate for the company ahead. And then understanding, like Ron was talking about, all of those different competitive advantages. Things like that enduring brand awareness, enduring customer loyalty is also a huge one. Having that financial ability to withstand lower revenue for a period of time and restructuring costs, as well as understanding the difference between a popular brand and a brand that has a competitive advantage. So what's a brand people are going to pay up for?

A great example is always people pay up for that little blue box at Tiffany's and people aren't necessarily always going to pay up for their favorite brands, even if you love the brand. So kind of thinking about that customer mindset, the consumer mindset, and parsing it out into understanding that competitive advantage. John, you know, it's really interesting what Maria said about price and valuation. And it really brings back that idea of long term. So if you're looking for a one-year investment and you're hoping to make a 20% return and you bought it wrong, you bought the price perhaps when it was too high, That rate of return may not come to fruition. You might be very disappointed. But if you're going to hold the stock for five or 10 years and it's going to be up 500%, 600%,

it matters less where you bought the stock. So maybe you only made a 450% return instead of a 525% return. But you're still growing your wealth rather significantly over time. And that's where the long-term time horizon makes the entry point just a little less important. 100%. Yeah. So we just gave our members a great list there. Ron, you said a product that customers love, a product that is relevant and in demand, the right management in place, strong balance sheet, cash flows, or at least a company that can scale into having cash flows. Maria and you both mentioned customer loyalty.

customer service. You both mentioned pricing power and competitive advantages. Are there any companies that we can learn from the past that exemplified this sort of resilience that we're talking about? You know, the markets are littered with companies that have had difficulty but have rebounded. But the market is also littered with companies who permanently were impaired and went out of business, and the ones that were permanently impaired were the ones that didn't possess enough of the characteristics that we mentioned early. And again, there are unique circumstances, and you could always point to different things

that happened with companies, companies that survived because they filed bankruptcy. I wouldn't necessarily call them resilient, but they were bailed out to a certain extent and live to fight another day, during the financial crisis, government intervention, even now, quantitative easing and keeping interest rates low are all ways that the outside forces helped companies to be resilient. We'd love to see companies be resilient on their own. A non-tech company that always comes to mind for me when I think about resilience is Domino's, interestingly, DPZ. If you look back to around 2008, 2009, The stock was at $4 a share, and I think we're probably around $440 a share right now.

And Domino's needed to make some tough, tough decisions right there. First of all, competition is fierce, whether it's from mom and pops or the big boys like, you know, the other major delivery companies like Papa John's. But they recognized something and were honest about it. They said, you know what? Our pizza isn't that good and our menu isn't that inspiring. So we're going to make some changes, and we're going to be honest with you about it. So they've revamped the pizza recipe. They added food items to the menu.

They invested in marketing and digital. They have a very strong digital presence right now from an ordering perspective. They have a loyalty program. They bought back weak franchises to bring stronger operators into the fold. And here we are from $4 to $440 because the company both had the balance sheet to withstand the tough times, but the management team was smart enough to make some very tough decisions. They did, Ron. And by coming out and saying our pizza isn't that good, it was a brave and bold marketing

statement that I think earned them a lot of brand equity with their customers. And like you said, they use their strong cash flows to invest in digital, to invest in profitable delivery and do all of these other things. And now you have a multi-bagger stock. What about you, Maria? Domino's is such a great example and such a pizza that I think is always solid. No matter where you are in the world, Domino's pizza is always going to be pretty good, which I think is- And we're New Yorkers, both of us. And so we, and it comes a lot, uh, it means a lot coming from us. So one that I think about a lot is Disney. Um, so Disney, obviously everyone knows everyone kind of interacts with Disney on

a day by day basis. And what I think is really interesting and is a show of competitive advantage too, is the amount of patents and trademarks they have. So Disney has over 2,200 active patent families and 6,000 trademarks. So they have that strong IP. And what we've seen is they were able to scale that with Disney+. They have over 118 million users of Disney+, within two years, completely blowing expectations out of the water. And what's really interesting is you had a pretty strong long period of time from about 2014 to 2019, where the Disney stock wasn't doing very much. They weren't innovating in that way. And then you saw Disney+, you see kind of this revamp of excitement about Disney. They're, I think, a good example of a really big company, a really

well-known company who is able to be agile and still play with nostalgia so we have you see if there's a new cheaper by the dozen movie coming out the mandalorian there you see that you can watch shows from your childhood and they have all of these new franchises coming in especially with marvel and so i think that it's such an interesting example of a company that you know when you see companies get so big you want to see them also be able to be nimble at periods of time and really especially during 2020 all of the amusement parks all the theme parks were shut down and they were really able to scale up disney plus and and like i said they got to 118 million users which is far and away more than most people would expect of them so i think it's just a really strong

example of a company that has grown but can still continue to grow with that good management and that ip yeah i think that's a perfect example if we want to look at tech or even consumer tech We need look no further than iconic Apple. I'll take you back to 1997. Steve Jobs returns after 12 years. They've got products like the Newton message pad, a handheld device similar to the Palm Pilot. They were 90 days from being insolvent. So here's one example where perhaps they didn't have that balance sheet that we would love to see all resilient companies have.

But what did they do? They laid off 3000 employees. They discontinued about 70 percent of Apple's products and they got back to business of innovating. innovating. And it's almost a $3 trillion company today. So, again, management's willing to pivot to make tough decisions. If they've got the financials backing them, even better. But it really comes down very, very often to really strong operators and managers. In all of those examples, you know, Apple didn't have the balance sheet. But in all of those examples, what they did have was they put the right management in place, whether it was existing

management that pivoted or bringing in a different management team, and they were adaptable and they innovated. Even Domino's innovated in its menu and in the food that it served. It innovated by investing in digital and different delivery options. And so in every case, it was the right management in place, an iconic brand, a product that customers really loved and coveted, product relevance and demand, and then the right management team to innovate and adapt as needed. You know, John, it's interesting. We're looking back and saying, in hindsight, here are some examples of resilient companies. And I want to fully admit that it's not necessarily that easy to identify them in the moment. That's where that checklist comes in handy,

Because even if you're getting a little bit nervous and you're having trouble seeing the forest for the trees, you can say, how many of these characteristics do they have? But I think of a company like Best Buy, which I know you know well. I left it for dead. It was Amazon showroom. Nobody was buying anything there. They would go, check prices, then go home and buy it on Amazon. The company has done a phenomenal job investing in their customer experience, their loyalty program. It's rebounded.

it's thriving to a certain extent, really. And I would have never guessed that would have been the case. So it's not, you know, I can't get it right every time. None of us can. But again, you go through those checklists and you see what exists and who's leading the company. And do they have those things, those abilities to make the shift when necessary? It's interesting you bring up Best Buy, if for no other reason, once again, it was bringing in the right management team. When Best Buy was struggling, when Amazon was taking share from Best Buy, they brought in Herbert Jolly as the new CEO. And he recently retired, but like you said, he invested in loyalty, he invested in their showrooms, he invested in merchandising, he invested in getting the

best inventory in the stores. And he said, we're going to match any online price. And so people that wanted instant gratification, people that wanted to touch and feel the product and walk home with it that day went to Best Buy stores because they could get it as cheap as they could online. And Herbert Jolly bringing in the right management team was a winning scenario. In a lot of these sort of legacy companies strike back stories, like a Best Buy, like an Apple. Apple didn't bring in an entirely new CEO, but they brought back their founder. They brought back Steve Jobs. Best Buy brought in an entirely new CEO. If we look at tech again, AMD under Dr. Lisa Sue, one of the greatest turnarounds of all time. She took over the stock. Like Domino's,

it was a single-digit stock price. I don't know if it was six or seven or eight or nine, but now it is absolute monster multi-bagger because of the turnaround implemented by a new CEO, Dr. Lisa Sue. And AMB's products, whereas we as consumers don't buy them directly, trust me, they are relevant and in demand. They are powering many of the devices that we use every single day. So yeah. Maria, do you have another company before maybe we talk about some of these periods in history that have been tough? Yeah. I mean, not to beat a dead horse in terms of how important management is, but I think another great example is Starbucks. So Howard Schultz had left the CEO position, but the business was really struggling. There was increased competition from

Dunkin' Donuts, McDonald's, kind of the more niche coffee shops in those small baristas. People were saying there's no way people are going to keep spending $5 for a cup of coffee. They were kind of leaning into more music and more food. And Howard Schultz came back 2008. He narrowed Starbucks Focus, went back to coffee. It closed 600 stores, laid off 12,000 workers in 2008. But it has actually, you know, really obviously continued to do super well. they introduced the loyalty rewards program to keep people around so by the end of 2010 it was

really back on track and one thing with Starbucks that I think is really interesting is one just being able to see these companies over and over again you kind of can't go someplace without seeing the Starbucks there are over 32,660 around the world so it's really a loyal place you can go if you're traveling you know you can get wi-fi there you know that you can get a good cup of coffee. And so I think that's one of the things, as well as Starbucks is a really good example of a company that treats its stakeholders really well. It is known for treating its employees really well. It has good benefits for its part-time and hourly employees. It has college benefits for those employees as well. And so I think Starbucks is a really well-rounded example

of a company that had hard times, but has really revamped, has really shown that you can grow steadily over time continue to gain that market share and how important that good brand is that good loyalty program and having kind of the consistency that anywhere in the world if you see a Starbucks kind of similar to if you see a McDonald's you kind of know what you're going to get same with Domino's right you know what you're going to get and you're going to be pretty satisfied with it and I think that type of consistency is very very hard to build up and once you have it it's really important for those enduring brands that's another example I would think of. The market has sold off in the past, whether it was dot-com boom, whether it was a

global financial crisis in 2008 and 2009. Are there any parallels or any lessons we can learn from those times to what we are seeing today in this sort of sell-off and growth stocks that we're seeing today? For me, the lessons I've learned from investing through difficult times um are a to don't be afraid to buy when things are weak because you you get your best bargains and for long-term investors that should be something you are willing to do even though it can certainly be scary to to uh to step up when other people are running for the door um the other is is to buy strong companies it sounds it sounds simple but if your portfolio is filled with too much speculation, you're likely going to get hurt on a more permanent basis

rather than just a short-term correction because not all of your companies will survive. Hopefully, you're well diversified like we spoke about earlier and the strong companies will make up for those clunkers in your portfolio. But being well diversified, making sure you understand your risk tolerance. And I think people think they understand the risk tolerance. Like Mike Tyson said, everyone has a plan until you get punched in the face. Everyone has a plan right up until things go bad and then people start to freak out a little bit. So do a little soul searching ahead of time. So you know what you're going to do if things start to get weak. I mean, 2008, 2009 was really scary. We thought we were going into a depression.

You know, a year and a half ago, two years ago, we thought we were who knew what was going to happen with a global pandemic. Really scary times. So you have to understand yourself pretty well during those times. Understand the context, Maria, any last words? Yeah, I think it's all about also understanding expectations, like I said, a little bit at the beginning. So understanding Peloton's a great example, right? What are the expectations of an exercise bike business that's worth 50 billion dollars? What are those expectations for growth for this company and understanding what kind of makes sense, what you think is reasonable and then where I think where it might not be the correction that is abnormal, but it might be the run up that's abnormal and understanding those different aspects and thinking it through from both a macro sense and a micro sense, I think is really important to see what's the overall economy doing, what's the overall market doing and what are these specific companies doing and what can I learn from each of those things to kind of keep a keep a clear head. There you have it, Fools. Ron Gross and Maria Gallagher gave you a resilient company checklist.

Write those checks down. Use them to measure your own portfolio resilience. Keep the right mindset, and we'll see you next time. I'm John Rotonti, and from Maria Gallagher and Ron Gross, we thank you so much. Thank you. That's all for today, but coming up tomorrow, we've got a preview of the dropout, Hulu's upcoming series about Theranos founder, Elizabeth Holmes. As always, people on the program may have interests in the stocks they talk about, and The Motley Fool may have formal recommendations for or against, so don't buy or sell stocks based solely on what you hear. I'm Chris Hill, Thanks for listening. We'll see you tomorrow.

Thank you.