Motley Fool Hidden Gems Investing - Inflation Cools Down, Stocks Heat Up

Episode Date: November 14, 2023

Inflation is closer to the Federal Reserve’s target. Restaurant employment is back to pre-pandemic levels. Maybe the economy is landing softly. (00:21): Ricky Mulvey and Asit Sharma discuss:  - What lower inflation means for stock investors. - Sticky housing prices.  - Home Depot’s quarter and sales decline.  - What softer spend on big-ticket purchases means for Trex.  Plus, (13:32) Alison Southwick and Robert Brokamp air some economic grievances discounts, shrink, and dynamic pricing.  Companies discussed: HD, TREX, AAPL, COST  Stock Advisor discount: www.fool.com/mfmdiscount  Hosts: Ricky Mulvey, Alison Southwick  Guests: Asit Sharma, Robert Brokamp  Engineers: Dan Boyd, Rick Engdahl Learn more about your ad choices. Visit megaphone.fm/adchoices

From morning hockey with a cup of coffee, to Timbits and road trips, Tim's and Canadian Tire have always gone together. Now it's official. You can now earn Canadian Tire money at Tim's. Link your Triangle Rewards and Tim's Rewards accounts to earn twice with every Tim's run. Terms and conditions apply. Visit timhordens.ca slash triangle for details. Inflation cools, but stocks are heating up. You're listening to Motley Fool Money. I'm Ricky Mulvey, joined today by Asit Sharma. Asit, good to see you. Ricky, thank you for having me. Glad to be here. Of course. Thanks for being here. It'd be hard to do the show by myself,

so I appreciate you being here. The headline story today, I think the reason why stocks are having a good day. Not even, I think. I'm pretty darn sure about this. Consumer price index reported for October. Inflation rising at the coolest pace since 2021. Prices are up 3.2% year on year. We got to use a decimal for inflation. Apologies. That's 4%, though, if you strip out food and those volatile energy costs. Asit, why is the stock market so giddy about this news? Ricky, the stock market is so giddy because it's not just one person in a corner celebrating. It's not just the tech stocks that are up today. The action is very broad-based. The reason is, this economy for the longest time has felt like it wants to be in expansion mode.

That's why we never got that promised recession in 2023. That's why we got that big GDP report last quarter. But we have, on the other hand, news that maybe inflation is cooling. That means that the economy can expand without this inflationary pressure we've had for quarters upon quarters. There are so many sectors across the economy that can go ahead with their capital expenditures, can go ahead with projects. Everyone can benefit from this. You've got a lot of different sectors I'm seeing that haven't experienced any sudden stock price joy in a while up in green today. Yeah, I think one will only know what a soft landing looks like in the rear view mirror, and it's impossible to make broad-based macro predictions in my opinion. But this seems like

this might be what a soft landing feels like, looking at categories like airline fares, hotel rates, restaurant meals, all of those are back in pre-pandemic ranges. Anything else stand out in this report to you when you were digging through those numbers? Well, energy prices, and we've seen this at the gas pump, they are cooling. The discretionary categories also cooling caught my eye. But what stuck out to me is shelter pricing. That's just persistent. It's such a strong factor in the inflation we've seen over the last more than 18 months now. Hotel prices cooled last quarter, but home prices and rental rates, just really giving economists a headache staying strong. To recall the words of the

great Jimmy McMillan, the rent is still too damn high. On the other hand, housing supply is starting to pick up, so maybe that'll give some relief this year. Yeah, this wasn't from this particular CPI index, but I think it is meaningful. The last jobs report showed that employment at food services and bars, we'll call those restaurants and bars, that's back to pre-pandemic levels. That's got to be meaningful. I think so. The food service industry is an important pillar of our consumption-based economy. We've seen since the pandemic, restaurants having to innovate, cut costs, be more productive at the restaurant margin level, reimagine their service models. Doing all this,

just so they could attract back food service workers at more meaningful wages as gradually customers got back into the idea of eating outside the home and continue to order food to the house. I like that this level is back at its pre-COVID state and hope to see more energy in this sector coming into 2024. Let's move on. Speaking of a softer consumer, a little less spending, Home Depot reported this morning showing that sales declined by 3%. That's in line with guidance. Don't worry about it, investors. CEO Ted Decker calling out, quote, experienced pressure in certain big-ticket discretionary categories, end quote. Stock market didn't seem to mind falling in line with guidance, but what stood out to you about the

the quarter. Ricky, you and I talked about the deflationary trend in lumber earlier this year, right after Home Depot earnings report, I believe. This is something that's really hard for Home Depot after the pandemic, after supply chains have reoriented. That spike in lumber prices, which was so good to them, is moving the other way and it's been doing so for several quarters. Smaller lumber prices, you sell a lot of lumber, record less revenue on the books. That's one headwind that's still there for Home Depot. The thing that caught my eye in this report is just this continued emphasis in the report and management's comments on its pro-customers and the investments that Home Depot has taken

to fortify the side of the business. In a vulnerable macroeconomic climate, the do-it-yourself customer can pull back. You can drop down from a big purchase of appliances to maybe doing just a little touch-up on some windows that are old. You're going to decrease the scale of your spend. But the pro is out there running a business. He or she's got to find a way to sustain revenue. The technology, the price inducements that Home Depot is making are catching that very important customer. I'll note here, the construction labor market still remains very tight. Even though you hear that this total construction market isn't healthy, the contractors, they're a conduit to where the business is, and that's why Home

Depot keeps investing in them. One thing I'm a little worried about though with the quarter, especially as we look at these big projects slowing down, there's another full favorite stock in here, which is Trex. It's a composite decking company. Big project slowing down. Sounds like putting in a composite deck counts as a pretty big project. Seems like this might be a headwind for that company. Might be experiencing that same, quote, experience pressure. I don't know, Asit, what do you think? Ricky, maybe, maybe. Trex has a pretty good mix of residential and commercial business. I thought there was an interesting sort of clue in the last call that Trex conducted. CEO Brian Fairbanks reminded an analyst on the call that

contractors report only around 10% of residential decks are financed. So there's a clue in there the average Trex residential customer may be a little bit more well-heeled than the general population and thus a bit less immune to macro considerations. And then throw in this potentially soft landing we've been talking about, the fact that the market's always forward-looking, maybe it doesn't really affect Trex that much. I wouldn't worry too much if you are a long-term shareholder of Trex. I don't know, near-term volatility, but intact long-term. They know their customer. Trex isn't for kids. Over the last nine months, focusing back on Home Depot, something that a lot of investors love is it's a very

shareholder-friendly company, even with the return on invested capital declining. It's still in the high 30s for this quarter. The company also did about $12 billion in net earnings over the past nine months. However, Home Depot spent about $13 billion on dividends and buybacks. Billion Extra, does this signal anything to you about the business? If I didn't know the business, it would signal to me that it's probably a mature business. We can see that management is emphasizing shareholder value creation over economic replenishment, that is, reinvesting back in the business. Not to say that Home Depot doesn't invest in this business, but they're making some decisions about where they capitalize. Do you keep it on the books,

or do you send money out of the cash coffers to shareholders? They've obviously made their choice. The second thing is, we probably want to compare the cash flow that the company's generating to those dividends and buybacks. Although I'm with you, Ricky, I tend to look long-term at companies' earnings versus those cash outlays to customers, because over time, earnings and cash flow should converge. When you look at the cash flow picture, it's a little better. But again, they're at a deficit over the long-term and that's why you will see, if you look at Home Depot's books, a lot of debt on the balance sheet. They're financing this mechanism of sending so much money out to shareholders in excess of economic profits.

So, where's the trade-off? The trade-off is in a weaker balance sheet. Also, in a higher interest rate environment, you get a toll tax for doing this. Every quarter, Home Depot has a higher interest expense on its books, and that eats into earnings. So, lots of trade-offs here, but shareholders seem to like it, and the stock is up 6% as we tape. Something to keep an eye on with Home Depot. On Friday, Dylan, Andy, and Emily talked about Disney's earnings, but Disney also had a big story over the weekend, as Marvel had its lowest opening ever. The Marvels made a little under $50 million in the United States and Canada. The movie cost about $300 million to make. Asit, what do you make of this? Is

this superhero fatigue, the actor's strike, both? What's going on here? Asit Sharma Yeah, it's both, Ricky. It's also Disney's push to have so many Marvel Universe movies in order to create content for Disney+. Every good thing has to come to a hiccup at some point or another. This isn't the end of the Marvel franchise, but it does play into something that Disney management has on its mind anyway. Bob Iger has come back to Disney with a mandate from investors to right the ship, and he's doing that by cutting costs, increasing free cash flow, and has emphasized in many calls now the idea of quality over quantity when it comes to studio production. We see that

both with Disney Plus content and with the movie slate that Disney wants to architect over the next few years. I think this will play into those decisions rather than try to pummel fans with content. Let's get back to basics. I think the whole franchise is just straining for creative ideas as well. They output an incredible amount of pictures over the last several years. And Curious, you are much more adept in the movie industry than myself. What are your thoughts about this? Yeah, so it's not a poorly reviewed movie. I think it's got like an 80%. So by the critics, it's got like a 60% score on Rotten Tomatoes. Audience score is about 84%. I have not seen the movie, so I'm going to reserve judgments about

the movie itself. One thing that I hope is starting to break, and it sounds like it is, is this idea that you have to watch the TV show to see the movie, the movie you have to watch to understand the TV show. And that's been going on for a long, a long time at Marvel. I think for, for a long time, Marvel had this idea that for Disney, we're going to, we're going to tell you about all these movies that are coming out in the years to come with the idea that stock analysts can sort of pencil in these billion dollar hits into their financial models. After 32 movies, that's no longer reliable like this is by far the lowest opening the second was the ang lee's the incredible hulk in 2008 opening at 80 million dollars rest in peace rest in peace this

this is something comic books have always moved in boom and bust cycles and cycles always last longer than you would like them to so i my expectation and my hope is that marvel will start taking some some notes out of sony's playbook with phenomenal innovation in in the into the Spider-Verse franchise, moving away a little bit from that hyper-focused model of the Marvel Universe, or just the hyper-focused styling, so there can be more uniqueness, more creativity in what they offer, and hopefully a little bit of a lower frequency. But the question is, is it if Bob Iger gets it? And I don't know. I really don't know, Asit. Well, you and me will be in the theaters at some point next year,

testing out the proposition that he does or doesn't get it. Before we get to our next segment, first, a quick ad. The analysts you hear on the show, they have a whole other day job, providing premium coverage and recommendations for the Motley Fool's suite of stock investing services. We're giving our listeners a discount on the Motley Fool's flagship service. It's called Stock Advisor. If you're interested in more analysis from our team, two stock recommendations per month, and access to Stock Advisor's full scorecard of companies, visit fool.com slash MFM discount. I will also include a link in the show notes. All right, next up, Allison Southwick and Robert Brokamp. Well,

they have some financial grievances. I'm at a loss to intro what we're going to talk about today. So, maybe we embrace the whole decorative gourd season and call this a cornucopia of bad deals, sneaky tricks, and just stuff that gets my financial goat. How does that sound, bro? Sounds great. Let's do it. All right, let's do it. All right.

My first goat getter is sales that aren't actually sales. So, if you're like me, you might have a hard time resisting the siren song of a sale, but the public interest group, Consumer's Checkbook, found that many of the most popular retailers' discount claims were bogus. For their research, they looked at 24 retailers and tracked prices of items for 33 weeks. They discovered that most store sales prices, even those that advertise big savings or dishonest discounts, with retailers offering the same quote sales price more than half the time. Of the retailers they looked at, nine were usually misleading, including Amazon, Nordstrom, Gap, Dix, and Wayfair. 12 were often misleading, such as Best Buy, Home Depot, Macy's, and Walmart.

Now, the worst offenders were Foot Locker, where 98% of the time, the items Consumer's Checkbook tracked were listed as on sale. Old Navy came in at 96% of the time, and Wayfair at 87%. So, only two retailers offered legitimate sales. Bro, do you want to guess who? I'm going to say, yeah, I don't know. You tell me. no idea all right it was apple and costco oh nice all right yeah i know so maybe you're like okay who cares a price is a price and if you're willing to pay it then great but this is going to shock no one here these fake sales are designed by retailers to get you to spend more they're hoping that when you see a flashing sales ad you won't bother checking their math and see if the item really

is available for cheaper elsewhere it's also possible you'll buy more stuff with them because you think you scored a deal. Hey, you got money to spend. Treat yourself. So sneaky, yes. But Consumer's Checkbook argues it's also illegal. If you ask the FTC, the gist is they say that an item must have been listed at a higher price for a reasonable amount of time, whatever that means, before you can claim it's being offered at a discount. So there's definitely room for interpretation here. So concerns of illegality aside, Consumer's Checkbook says that the problem is getting worse. So, as we head into the holiday shopping season, what's the takeaway here?

Well, shop around. Check competitors to see if the price listed really is competitive, and don't assume that because you bought something on sale, that then gives you a hall pass to spend more on other things. I think the other aspect of the sale part is it creates urgency, right? You feel like you have to buy this now before the sale ends. And this just happened to my wife and me just this weekend. we were in the market to buy a new Christmas tree. We found one on sale for $200, but it was part of

a Veterans Day sale, which means it was ending on Saturday. It made it feel like, okay, we have to make a decision. We bought the tree I checked just this morning. It still has the same sale price, but now it's an early Black Friday sale. We could have waited, but the urgency definitely got us to buy. We still got a good price, but I do feel a little manipulated. Yeah. Well, bro, you know what really gets my goat? Let's move on. It's the unfortunately named epidemic of shrinkage. And by shrinkage, we mean the term retailers use to describe shoplifting, employee theft, or just generally stuff going missing. So it's been a common theme on quarterly calls with executives at Walmart, Target, Home Depot, Dix, and more, all pointing the finger

at shrinkage for why they may have missed targets. So how bad of a problem is it? Well, according to the National Retail Federation's annual survey of companies, shrink cost retailers about $112 billion in 2022 compared to $94.5 billion in 2021 and $90.8 billion in 2020. So it looks like it's going up. In response to the uptick in theft, Dollar Tree has said they're going to start putting some items behind locks and even stop selling certain high theft items. Best Buy is taking items off the shelves so you can't handle them. Walmart president and CEO Doug McMillan said in December 22 that stores would close and prices would rise if theft levels did not drop. And just this September, Target cited theft for the closure of nine stores.

Oh, geez, poor retailers. But some experts are skeptical that crying shrinkage is actually more of a scapegoat excuse to rationalize a company's poor performance or justify closing stores in underserved communities. Neil Saunders, managing director of the consultancy group Global Data, told the New York Times that, quote, the term has become so generic, you can almost sweep everything into it and avoid a little bit of scrutiny. So when you look at the impact of shrinkage by a sheer dollars lost, then it does look like a serious and growing problem. But when you look at the impact of shrinkage as a percentage of sales, Yahoo Finance says that the figure came out to be about 1.6% of sales, which is up slightly from 1.4% last year,

but it's still level with 2020 figures. So when you break out the cause of shrinkage, execs have blamed shoplifters. And you've perhaps seen videos of organized mobs smashing and grabbing stores. But external theft, including organized retail theft, was responsible for roughly a third of shrinkage in 2022. But when you add up internal factors, such as employee theft or mismanagement, those two add up to more than half of the shrink concerns. Also, there's a convenient unknown cause where you can sweep about 6% of your problems in there. Back in January, the Walgreens CFO even admitted in an earnings call that they had previously overstated the impact of shrinkage, and it is now back to manageable levels. It sounds like the reports

of shrinkage were potentially exaggerated here. If you're still seeing a retailer you're invested in blame an epidemic of shoplifters for their financial shortfalls, maybe take a moment to go deeper and see if that is really the case, or if they're just looking for a scapegoat. This is a goat-heavy episode, apparently. I will say that the whole theft part does bother me. I'm from the Tampa area. Recently, a preacher was arrested. Among his responsibilities was to run a halfway house for recovering addicts. Turns out that he was pressuring those addicts to go to Home Depots to steal merchandise that he would resell on eBay. $1.4 million worth of merchandise. I'm a Home Depot shareholder, so I don't like that very much.

But I think the bottom line here, the point that you made that is important to know, is that often we see executives of the companies we own give excuses for poor performance, and it certainly makes sense to dig into those, especially when they're blaming external forces. Okay, Bro, the last thing I want to talk about today that really gets my goat is the slowly boiling pot of water we're all stewing in that is called surge pricing. So surge or dynamic pricing is when the price of goods and services go up because of increased demand. You're probably used to seeing it when booking travel during peak times, flights and Airbnb or hotel rooms are more expensive during spring break, for example. And even local travel

is impacted by surge pricing when HOV lanes or Uber rides are more expensive during rush hour. Well, thanks, AI, because now more industries are able to put the laws of supply and demand on steroids because of surge pricing, including the retail and restaurant industries. So, for example, Britain's biggest pub firm, the Stonegate Group, which operates such places as The Slug and Lettuce, is instituting surge pricing at more than 800 locations, which will increase the price of a pint by 20p during busy periods such as evening, weekends, or during soccer matches. A 20p isn't a ton, but Bloomberg says that during the World Cup, the cost of a pint went up by a pound, which is about a 20% premium. Another example here in the U.S. is Noodles & Company

said in March that they're going to install digital boards at the restaurants that would allow the change to charge different prices for items at different times of day. And Amazon has long been using dynamic pricing. According to the book Swipe to Unlock, using AI, Amazon changes product prices 2.5 million times a day, meaning that an average product's cost will change about every 10 minutes. The authors say this practice has boosted Amazon's profits by about 25% in the past. That's because, according to a retail pricing expert talking to Spy Magazine, dynamic pricing is about figuring out the highest price we're willing to pay for something. So what's it costing you? Well, a 2016 study by Rajin Kalka and Andreas Kramer found that the price of a Nikon camera on

Amazon changed within hours from about $743 equivalent to about $1,800 equivalent. The difference of about $1,000. And Amazon will likely tell you it's to ensure their prices are competitive, but dynamic pricing can also lead to price discrimination because they can adjust their prices based on your location, browsing history, and purchase behavior, which annoys me personally because we live in a town where a lot of very well-paid people will eagerly throw money at their problems. You're in the DC area. I am being outspent. Amazon isn't alone. Other retailers like Walmart and Target also use dynamic pricing. According to Influencer Marketing Hub, even streaming companies like Netflix and Spotify adjust their prices based on what they know about

you. Okay. So how can you try to get a good deal amidst dynamic pricing? If you can avoid peak times, and this includes peak times for travel, but also peak times for when people are shopping for the same stuff. So if you're serious about saving money here, buy your swimsuits in September, but also since people do more shopping on the weekends and the evenings, you might get a better price outside of those times as well. I've never used it, but some experts recommend using the app honey for tacking prices over time and getting a notification when a price drops. Another online shopping trick is to try to abandon your cart. This might result in an offer to lure you back in. These are all just little fixes to a growing concern, because the truth is,

dynamic pricing is not going away. It's us versus the machines, bro. Yeah, I saw this last spring when I was buying tickets for our vacation in the summer. I checked prices, and I'd see a certain price, and then I'd check later, and the price kept going up, and then check, and the price kept going up. I was wondering whether my checking of the prices themselves was causing the prices to go up. I did a little bit of research, and the answer was basically yes. Again, I think they're trying to create urgency by saying, you better buy this ticket now because it just keeps going up. But from what I understood, they're also looking at your purchase history, looking at how much you've been willing to pay for tickets in the past

to determine how much you are going to pay for a ticket. And I have to say, I felt a little creeped out by all that. Yeah, you were right to feel creeped out by all that. I mean, ultimately, a retailer's job or anyone who's trying to sell you anything is trying to get the most money out of you that you can. So with a little bit of discipline, maybe a little bit of a long-term outlook, maybe with some patience. You can, if you care to, save more money in the face of robots and other innovations that are just coming for your wallet. They're coming for our wallets. As always, people on the program may own stocks mentioned, and The Motley Fool may have formal

recommendations for or against, 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.