Motley Fool Hidden Gems Investing - Is Streaming Profitable?

Episode Date: May 7, 2024

For anyone besides Netflix? First up, (00:21) Jason Moser and Ricky Mulvey break down earnings from Disney and Axon Enterprise. Then, (19:44) Alison Southwick and Robert Brokamp look at the 60/40 portfolio, and if it still holds up in 2024. Tickers discussed: DIS, AXON, NFLX, GLD Learn more about the Range Rover Sport at www.landroverusa.com Host: Ricky Mulvey Guests: Jason Moser, Robert Brokamp, Alison Southwick Engineers: Dan Boyd, Desiree Jones Learn more about your ad choices. Visit megaphone.fm/adchoices

we've got tasers we've got disney and yes those are separate topics you're listening to motley fool money i'm ricky mulvey joined today by jason moser jason thanks for being here happy to be here as always ricky thanks for having me so we got we got disney earnings today that's that's topic a are you are you a disney adult would you define yourself is how how much does disney mean to your being and personality you know no i i wouldn't call myself a disney adult i but i will say like i've been there several times throughout my life as a kid as a parent it's weird to say but it really actually was always more fun going as a parent and it's just you watching the fun that your kids have that's just priceless those are memories you just you can't you can't buy those

well i guess you can actually you literally can buy the memories and we're going to see that show up in the operating income the headline of the quarter for disney jmo is that parks might be slowing down a little bit but streaming is becoming profitable in one very specific metric that bob eiger highlighted what say you what's what's your big what's your big headline for this quarter To me, it feels like Disney's on the right path. I mean, they still have an Iger problem they need to figure out, because at some point or another, and we kind of saw this with Starbucks last week, right? I mean, Starbucks with a Schultz problem, Disney with an Iger problem.

At some point, they need to address this and figure out who is going to be the successor to take this company into the next decade and beyond. That question is still outstanding. But, I mean, the company, they reported encouraging results, right? I mean, adjusted earnings per share up 30% from a year ago. They actually raised full-year adjusted earnings per share growth to 25%. That's versus around 20% quoted last quarter. So, that's encouraging.

And, I mean, with Disney right now, I mean, the Disney we all know is the parks and stuff like that. But really, I mean, the story for investors has been streaming and entertainment. And it does feel like they're making a lot of progress right there. When you look at the Disney core subs, the Disney Plus core subs, that was up 6%. The subscribers were in ARPU, right? That average revenue per user metric was also up 6%, thanks in part to some modest price increases. And I thought, encouragingly, they ended the quarter with 22.5 million ad tier subscribers globally. We know that ad tier is going to be an important component to that strategy.

That's something that they need to continue to exploit, because the ad tier subscriber is a very profitable one. It's one where they can make a lot of money for that company. It feels like they're making the right moves, they're doing the right things. But this is clearly still a story. Disney loves stories. this is a story that is still being written and we just don't know the end yet and the the story that eiger wants to talk about right now is streaming uh not you know 12 mentions i think of streaming in his uh prepared remarks no mentions of succession but eiger expects you know the whole

unit to be profitable in the last quarter of this year right now the entertainment side is profitable but the sports side is not does the story change for disney if they follow through on this and streaming as a whole is a profitable business for Disney? I mean, I think it does. I mean, it certainly, success on that front shows that they've made the right strategic decisions. I mean, it's one of those things where they were just kind of late to the game in getting here, right? I mean, we saw sort of the signs of streaming and kind of where entertainment was headed many, many years back because Netflix basically blazed this trail. Better late than never, like they say. I'm glad

to see that Disney really made the focus or had the focus to make this pivot into going into the streaming realm. But it's very difficult. I think one of the problems that Disney is going to face, and this is a little bit different than what something like a Netflix might have to deal with, it's complicated because Disney has so many properties. When you're talking about Disney, the core Disney content, that Disney Plus sort of thing. But then you've got Hulu, you've got ESPN. There are a lot of pieces to this puzzle. Figuring out a way to put them together so that consumers understand what they're getting, that there's a value proposition there that I don't think they quite solved yet. That, to me, is one of the things to keep an eye on.

because we, we, we use a lot of, of their, their services here in our house. And I think a lot of people feel the same way. It's, it's difficult to figure out exactly how to access all of it, trying to figure out exactly what you're getting, you know, for your money. And that's something they need to really kind of focus on, I think. Well, how's this for ESPN? Cause I think there's going to be a lot of confusion around ESPN, which is going to have a standalone app in the fall of 2025 this is one that does not require a cable subscription you also have espn proper which you can watch on tv i have an espn app with espn plus i don't know how that works in espn is also going to get a streaming tile on disney plus and also you might have a sports bundle with espn included

with spot uh fox sports and maybe all of these other other companies you know this you'd like to see a little bit more of a straightforward strategy here i think i agree and i think that's a big point of focus that management really is going to have to harp in on there. It's something they're going to have to navigate. It's a confusing experience at this point. And I mean, we have ESPN as well, but I'm not exactly sure what ESPN we have or how we get it, right? I mean, for example, in our household, we subscribe to Hulu Live because we like to have all of the live TV stuff. It's kind of like a cable light offering. And we get ESPN through that. But then there's also an ESPN Plus feature to the app that we have. And we can access that.

But I'll tell you, signing in from the phone and then signing into your TV, it's not the most frictionless experience. I'll just put it that way. And when you look at ESPN As a whole, it's still a very powerful brand in sports, but the costs continue to weigh on the business. Paying for that content, that just gets more and more expensive. We're seeing this going through with the NBA deals they're trying to cut and trying to figure out exactly what kind of content they're going to have to offer their consumers going forward. I think at the end of the day, granted, it's a lot of properties and a lot of different ways to get them. It can be a a little bit confusing. And at the end of the day, I think that's what you want. You want

access to all of that stuff, but you need to think about how you're going to deliver it. Going back to Netflix, I think that's what has made Netflix so successful here in this space, is they kept it so simple. And I don't think you can say the same thing for Disney at this point. And so hopefully, that's going to be a big point of focus for them going forward, is how can we simplify this and make it obvious the value proposition that we're presenting to consumers? Because right now, it's just not so obvious. What do you think about the capital allocation story? Dividends coming back, and also in this quarter, Disney repurchased a billion dollars worth of stock, which is a lot. That's a lot of money. That is. It is a lot of money,

and it's a business they're projecting, I think, what they said, $8 billion in free cash flow here for the full year, which is encouraging. I like to see the fact that they're repurchasing shares, particularly because they used a lot of those shares to make some of these acquisitions. Fox! But I think that with Disney, reinstituting that dividend made a big difference. That was something I felt like they needed to do way earlier. But again, better late than never. Good to see they did it. But I think for a long time, a lot of investors just felt like this was one of those holdings that you could kind of tuck away in your portfolio, not worry too much. You know, there's some income coming in through the dividend stream that got cut off for a little

while. It's good to see that it's come back. I do believe that with this business, the size that it is and what they do, they would be well served to really focus on figuring out how to make sure to continue that narrative of returning value to shareholders. Share repurchases are fine. You You got to figure this is probably a company that's going to make some acquisitions again going forward as we see this entertainment space consolidate. Focusing on that dividend could be a real positive for them and for investors in the coming years. But again, I guess we're going to have to wait and see, because they're going to have

to invest a lot of money in this streaming endeavor for some time to come. The big part of the business that makes operating income, most of the operating income comes from the parks and it seems like that may be facing a headwind quote we are seeing some evidence of a global moderation from peak post-covid travel end quote but it's also got expansion plans moving forward at disneyland you know is is the growth story changing for disney is is fewer people want to put on those mouse ears and get to the parks or am i concerned trolling no i think that the parks business kind of ebbs and flows right it it kind of goes with the general economic conditions. And right now, I mean, we're seeing myriad signs that consumers are feeling stretched.

And we saw in the call there, I mean, at Disneyland, they said despite growing attendance and per capita spend, the results actually declined year over year due to what they said cost inflation, including higher labor expenses. So, I mean, the parks business is something that kind of ebbs and flows as economic conditions go. But the nice thing, the good thing, the positive for investors is that parks business is just so darn difficult to replicate. You can't go out there and just build what they've built. I think that's a tremendous installed base that will serve the company very well. Sometimes, you just have to take the bad with the good. Right now, it's probably going through a little bit of a tough stretch just because of where

the consumer is. But the good news is, when the consumer recovers and when things start to improve, those parks are still going to be there and will likely continue to just mint cash. Because once you get inside those gates, it seems like your brain just shuts off, and you're going to pay whatever you want, whatever you can, even whatever you can't, because you almost have a hard time justifying whether you'll ever even be able to go there again. And I think that's really the power in that parks business. and and that to me is a big part of the longer term uh investment thesis with this business

yeah i was gonna i'm going to la in a few weeks and i was looking at going to disneyland it's like it's gonna be 500 bucks about just to get in the door for two people and uh that magic i'll i'll say i'll let them save that magic for some other people and i will see you at knott's berry farm jason moser let's move on to axon let's do it so i don't think we need to intro disney that one's That one's fairly well known, but for some setup on Axon, the company does tasers, cloud services for the equipment and police slash security databases. They also do a mix of training solutions to think virtual reality for real life situations. But the real business growth for this story, for this company, is the cloud and services division, which hit 176 million

for the quarter. That is up more than 50% year over year. What's happening at Axon? I think this is a great example. This company is a great example of monetizing an installed hardware base with more services, software features, etc. Subscription bundles now account for 90% of the company's overall revenue. They have customer relationships with more than 17,000 public safety agencies globally. The nice thing about this business is that customer base is expanding well beyond just public safety agencies. I mean, you're talking about everything from emergency services to law firms that are seeing the benefits of using Axon services.

And so, I mean, when you think about this business just generally, I mean, the thesis is pretty clear, right? I mean, public safety is a need that societies around the world will continue to prioritize. and Axon really is at the forefront of innovative solutions in that regard. You have to respect the company's mission. The company's mission is to protect life. They're trying to figure out ways for public safety and their customers in the ancillary markets. They want to figure out ways for those customers to be able to protect themselves without necessarily costing life. I think a lot of people would feel very good about that.

With Axon, again, it goes back to, they built this tremendous hardware product in their cameras and their tasers. What that does, it builds this long-term relationship with their customers, where the customers that use that hardware continue to benefit from the software, And that software just continues to build more and more data, which allows those agencies to become smarter and make better decisions. And it's just kind of a virtuous cycle that keeps on going on. And the best part about it is, there's no real Pepsi to their Coke. I guess I probably should say today, there's no real Coke to their Pepsi, but there's no real competitor out there that's doing what they're doing. And I think for Axon, they just continue to do what they know

how to do best and it's working out for them. There's also a very specific AI story here, I would say. CEO Rick Smith saying, you know, officers spend about 40% of their time logging reports doing what is essentially data entry. We're going to minimize that so you can spend more time in the field. I mean, from the outside, this seems like the AI story you like to see, which is we have a very specific solution that we think we have an application for. Yeah, I think you hit the nail on the head there. This is one of those AI stories that is a bit more understandable and obvious. I think this is a really exciting development for the company. They've introduced this new product or this new service called DraftOne,

which is ultimately a software product that utilizes generative AI to draft what they call high-quality police reports based on the auto-transcribed body-worn camera audio. To me, I mean, we talk about AI and all the things that AI can do and whatnot. Some of it makes a lot of sense. A lot of it doesn't. A lot of it really kind of requires you to make this big leap into saying, OK, well, I see where maybe this could work out in the future. But with Axon, I can really see how this is working out well now. And it was really interesting to see in their shareholder letter for the quarter.

They had some quotes from from some of the police forces that have started utilizing this this this service draft one. And I mean, one of the quotes said, and I quote, with over 27 years of experience in law enforcement, I have seen technology come and go. But draft one is the most exciting innovations for law enforcement I have ever seen. Another quote said draft one is the next evolution in report writing as significant as when law enforcement moved from the typewriter to the word processor. So, I mean, this to me is something, it really does, it does feel like you understand the value proposition that AI can bring when the officers or the customers that are using this technology, it's saving them immense amounts of time to get on record the facts of the matter, right? And I think that's ultimately what boils down, this is really what it boils down to for Axon and what they try to do. they're trying to give us reality, trying to give us objective information. These are the facts of the matter. And for Axon, a product like DraftOne, this is a new offering. It's just getting started.

I really feel like this has a lot of room to run, particularly when you consider how strong this business is on that recurring revenue front. So, before we wrap up, Axon also announced it will acquire Ddrone, or drones as a first responder. This is a company that's showing a lot of growth, but investors expect a lot of growth out of Axon. We don't know the price tag for Ddrone. I guess they're still in talks for it, maybe. I don't know why they did that. But are you buying that as a growth engine? I am. To me, I love Axon. I've recommended it a number of times in multiple services. I own the stock personally. I think there's a tremendous future for this business. I'm happy to see them doing things like this.

They do have a history of little bolt-on acquisitions in order to expand their market opportunity. I think the question really is, with this business, do they need to keep making these little acquisitions in order to expand that market opportunity? At some point, that market opportunity caps out. But when you consider the acquisition of DDrone today, they say AXON says this is going to expand their total addressable market from $50 billion to $77 billion. Now, when you put that in the context of a business like AXON, which is bringing in $2 billion a year in revenue right now, that's very meaningful. It shows you all of the opportunity there. But it's a little bit of a pivot away from what they do in regard to things like tasers and

in working with police forces directly in regard to the software and things like draft one and whatnot uh but you know where it's a new day and age right technology moves fast and drones are not going away and so the d drone acquisition is a focus on that counter drone market opportunity right drones being used for the purpose of bad right axon wants to figure out a way to help police that. And so to me, it, we don't know the terms of the deal. Of course, I can't imagine they paid, you know, more than it was really worth. I mean, Axon has a good history of making smart acquisitions. I'd like to believe this will be another one of those, but that's definitely something to keep an eye on. Jason Moser, appreciate your time and your insight. Thank you.

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important decisions you make about your portfolio over the years some guidelines have emerged to help such as don't put any money you need in the next few years in stocks or 100 minus your age is the percentage you should invest in stocks but there's one asset allocation that is not only a rule of thumb, but also the basis for how hundreds of billions of dollars are invested, and that is the 60-40 portfolio. It's the Reese's Peanut Butter Cup of portfolio management, a mix of two popular investments that taste great together or at least has stood the test of time. That said, though, it's been a rough few years for the 60-40, which has led investors to question whether the correct ratio of chocolate to peanut butter. I mean, stocks to bonds. Well, anyway, bro,

let's get started by giving the basics of the 60-40 portfolio. Yes, Alison. The basic version is that it's 60% stocks, 40% bonds. And it's essentially a balanced portfolio of offense and defense with a tilt toward the more aggressive investments. In fact, mutual funds that invest along these lines have come to be known as balanced funds. Now, when you take a look at these funds or anyone else who's closely trying to file this type of portfolio, you'll find that some are 50% to 55% stocks, others are 65% to 70% stocks, so it's often not exactly 60-40%. But there will be some regular rebalancing so the portfolio doesn't become too overweighted

in one single type of investment, and you'll find there's a lot of diversification within the stock side as well as the bond side, so you won't find a balanced fund that's just invested in tech stocks. And that 40% allocation to bonds usually has all kinds of bonds and usually involves some cash. So, the foundation of the 60-40 is diversification, usually with a nod to the fact that stocks have outperformed bonds over the long term. So, the 60-40 portfolio has been around for decades. Do we know where it came from? If you try to research the origins of the 60-40 portfolio, you'll find all kinds of theories about who came up with it. But the truth is, no one really knows, which I think is kind of funny,

given how important it's become. Dr. Steve Forster, who is a professor at the Ivy Business School in Ontario and the co-author of In Pursuit of the Perfect Portfolio, published a very thorough article on Medium, chronicling his quest for the origins of the 60-40. And he tracked down anything he could find. He looked through old publications, and he spoke with several people, including luminaries like Nobel Prize winner Bill Sharp. And he basically included that if you look back as far as the 1930s, diversified portfolios managed by big institutions had more of a 50-50 split. But then came the 1950s, which was an excellent decade for stocks with U.S. large caps earning almost 20% a year on average. And that led more investors to tend to overweight stocks

from then on. As Forster wrote, quote, based on my quest, I can say with a high degree of confidence that the 60-40 portfolio most likely originated in the early 1960s. It wasn't based on a magical optimizer formula, but it made intuitive sense. All right. So, it's been around since maybe the 1960s, which was a while ago. So, the returns must be pretty good, right? Well, first of all, I was born in the 1960s. And I know what I said. I know what I was saying. I was alive for only like five months in the 1960s. But anyways, yeah. So, let's look at the returns here. And we're going to turn to Dr. Forster's article for the returns from 1960 to 2022. If we included 2023, they'd be a little higher because that was actually a good year for

the 60-40. But let's go with the numbers in his article. And over that period, the S&P 500 returned 10.1% on average each year. So that's right in line with what we've always heard, right? Stocks 10% over the long term. How much does that return drop if you move to 60% S&P 500 and 40% in a mix of 10-year treasuries and corporate bonds. It goes from 10.1% to just 9% a year on average. But what you get is a portfolio that is only about 60% as volatile as an all-stock portfolio, as measured by standard deviation. If you look at the returns of stocks and bonds since 1960, there have been 14 down years for the S&P 500. But in nine of those years, bonds made money. They counterbalanced the loss. In five, they declined, bonds declined, along with stocks,

but most of the years, it was just 1% to 3%. On the whole, an impressive risk-reward trade-off. The issue nowadays is that bonds are on a historically bad run. Interest rates were driven very low after the Great Recession of 2007-2009, and then even lower during the pandemic. The best predictor of future bond returns is current rates. Sure enough, the returns on bonds over the past several years have just been really bad. In 2022, bonds lost around 15%. By some measures, that was the worst year for U.S. bonds in history. Of course, stocks also plummeted that year, making 2022 the worst year for the 60-40 in decades. In fact, you have to go back to the 1930s to find a time when the 60-40 did worse than it did in 2022.

It makes sense that people have been questioning whether the 60-40 portfolio really works anymore. A debate that's been going on for actually several years now. Here are some headlines from the past couple of years. From Goldman Sachs, is the 60-40 dead? From Investopedia, why a 60-40 portfolio is no longer good enough? And from Kiplinger's, the 60-40 portfolio is dead, long live, 33-33-33. It sounds like people think we can do better than 60-40. Yeah. The disappointment over the last few years really does come from being burned by bonds. They lost money in 2018, 2021, 2022, and they're down so far this year.

What critics point out is that both stocks and bonds can struggle during times of rising inflation and rising interest rates, so you may not be getting as much diversification as you think you're getting. Some will also point out that except for 2022, the 60-40 actually did pretty well in the recent past, but mostly thanks to outstanding stock returns. But these high returns have led to high valuations, which suggests lower future returns. In January, I took a look at the predictions for various asset classes from 12 big-name firms, such as Fidelity, Schwab, Vanguard, and so on, and none expect U.S. stocks to return 10% a year over the next decade or so. The predictions range from essentially zero return to 7% a year, with the average being around 5%.

Of course, no one really knows how the stock market will perform, but if you place current conditions in a historical context, it definitely suggests that below-average returns are likely over the next several years. So, you put pricey stocks with struggling bonds, and you can see why some experts believe investors should move beyond the 60-40 by putting some portion of that portfolio in something else. So, on a recent episode, Lawrence McDonald, he's the author of How to Listen When Markets speak, made the case that investors should adjust for a sustained period of high inflation.

And that looks like 40% stocks, 40% bonds, and 20% commodities. The idea is that the long period of low inflation and low interest rates favored gross stocks, while commodities and commodity stocks often do well during previous periods of high inflation. Yeah, these days, you could read about many proposed tweaks to the 60-40 that entail allocations to what I think would be broadly considered alternatives. That can include commodities, private equity, hedge funds, directly owned real estate, and other investments not commonly held by the individual investor. There might be some merit in these arguments, but the challenge is that many of these asset classes are difficult and or expensive for the typical working class

American to invest in. The cream of the crop is usually only available to big institutions or really wealthy individuals. Plus, these investments are often very illiquid, so you have to hold on for many years to realize the payoff. The one that is most interesting to me is commodities-based companies, such as energy companies, materials companies, maybe even real estate in the right location and uses. Certainly worth investigating if you think inflation is going to be a persistent problem. I'm less excited about individual commodities themselves, because they can be very volatile. Most investors own them through ETFs that invest in commodities futures and not the commodities themselves, which adds an extra layer of complexity. That said, I do own a bit

of gold via the Spider Gold Shares ETF, ticker GLD, which is now trading near all-times highs of around $188. I think it's fine to own some commodities if you've done the research and you understand the investment. But I will point out that the gold ETF was trading a hair under $180, so just a little below where it is today, back in 2011. So, it's not a great long-term investment yet. And unlike many commodities-based companies, gold and other commodities don't pay a dividend while you're waiting for the stock price to eventually go up. All right, then, Judge Breaux, what's your final verdict here? Does the 60-40 portfolio still make sense, or is it time to look beyond the Reese's Peanut Butter Cup? Maybe add some

Rice Krispies, some caramel. I don't know. That sounds good. I think it might be a little too sweet. Anyway, conceptually, I think it makes sense for everyone to be thinking in terms of playing mostly offense in their portfolios, but also some defense. The right mix of offense and defense is going to vary from person to person. From people who are far from retirement, I think 60-40 is likely playing it too safe. Early this year, I looked at the average allocations of target date funds from the biggest providers. Target date funds, again, are these asset allocations that are based on when you will retire. The year is usually in the name of the fund. For people farther

in retirement, it's very aggressive, but they gradually get more conservative as you get closer to the date. The 2050 funds, on average, had more than 90% of their assets in stocks, and the 2040 funds had more than 80% in stocks. It was the 2030 funds that, on average, had that classic 60-40 allocation. The funds for those near or in retirement had just 40% to 50% in stocks, which might be a little low for my tastes. But rather than close with what I think, let's turn to someone who has been erroneously credited with creating the 60-40 portfolio. And that person is William Bangan, the father of the original research that established 4% as a safe withdrawal rate in retirement, though he nudged that up over the following years after doing additional research, closer to maybe 4.5% nowadays.

The recent addition of Jeremy Siegel's stocks for the long run said that the 60-40 portfolio could be attributed to Bangan's research. So I reached out to Mr. Bangan and asked him if he considered himself to be the father of the 60-40. And he said, you can't claim credit for it, but it does line up pretty closely with his current research, which indicates that a 55% to 60% allocation to stocks with regularly balancing is ideal. So, that's good enough for me to conclude that, at least for retirees, the 60-40 portfolio is still a good starting point. 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