Motley Fool Hidden Gems Investing - Peloton's Turning Point?

Episode Date: February 1, 2023

It's been a rough 12 months for Peloton, but the fitness company just offered shareholders a glimmer of hope. (0:21) Asit Sharma discusses: - Peloton's 2nd-quarter revenue surprising to the upside - A sluggish digital ad market hurting Snap's 4th-quarter results - How Snapchat+ could be a potential lever for management to pull  (11:00) Jason Moser and Matt Frankel discuss the 30th anniversary of exchange-traded funds and how stock investors use ETFs today. Stocks discussed: PTON, SNAP, GOOG, GOOGL, SPY, VNQ, RSP, CIBR Host: Chris Hill Guest: Asit Sharma, Jason Moser, Matt Frankel Producer: Ricky Mulvey Engineer: Rick Engdahl Learn more about your ad choices. Visit megaphone.fm/adchoices

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I'm Chris Hill. Joining me today, Motley Fool Senior Analyst Asit Sharma. Thanks for being here. Chris, I appreciate you having me on. Once again, we are in the position of recording before the Federal Reserve makes its announcements regarding the rate hike. And people are listening to this after that news has broken. So we're going to talk about the Fed and interest rates later in the week on this show. And you and I are just going to focus on earnings results. And let's start with Peloton because shares are up nearly 20% because second quarter revenue came in higher than expected. Next week marks the one-year anniversary of Barry McCarthy, being appointed CEO, he called these results a possible turning point. I'm

not a shareholder, but I hope he's right. It could be a turning point, Chris. Here we see a company that's cut its cash burn down tremendously. Just two quarters ago, Peloton burned $547 million in cash, so that's negative free cash flow. This quarter, came in at negative $94 million. McCarthy has done, I think, a lot of your basic turnaround playbook in pretty convincing fashion. He has changed the go-to-market strategy, so forming relationships with companies like Amazon.com and Dick's Sporting Goods. He's focused on reducing the inventory that was so bloated and has emphasized that subscription revenue. Subscription revenue this quarter came in at $411 million. That's more revenue

than they took in from selling equipment at $380 million. Why that's important? Well, number one, it's a trend for the last couple of quarters. But number two, they actually make money on subscriptions. We have positive subscription gross profit of $278 million. You have a cash burn in gross profit on the equipment side, the connected fitness product side of $43 million. If this trend continues, then conceivably, that subscription gross profit can make this a positive business. McCarthy said today, if you strip away some of the extraneous cash flow items, we really were breakeven on cash flow or slightly positive. If you adjust any number enough, of course, you can get positive, as we both know, Chris.

he's got a point there. Yes, this potentially is a floor in all the bleeding we've seen in Peloton over the past several quarters. I went back and looked at my notes from a year ago when McCarthy was an appointed CEO. Bill Ma'am was on the show at the time. One of the questions I posed to him was, hey, do you think they brought this guy in just to sell the company?" In summary, Bill said, no, I don't think so. You look at McCarthy's experience at Netflix and at Spotify, he's someone who's been brought in to try and turn the business around. Again, I'm not a shareholder, but I'm glad the results turned out the way they did and the stock is reacting the way it did, in part because even with the pop

today, shares are basically trading at half of where they were when McCarthy came in as CEO. I think if they didn't have this glimmer of light in their quarterly results, I think we would be talking about, okay, McCarthy has been on the job for a year, he's done what he can, but it might be time to sell this company to someone else. I think some large companies are still interested, at least sniffing around at Peloton, it. He really is managing this company not just to present it for sale, but to make something of this business. Peloton is still a market leader in the connected fitness industry. It's still a really strong brand among consumers. There's no reason that this couldn't be a

successful business. Whether the stock ever fulfills the promise that it had when it IPO'd, I don't know, but there's a bigger point here in that every manufacturing business, which this is, has to find its equilibrium point, has to find that profitable equation. It looks like Peloton 2.0 is going to do it by not bleeding so much cash on the equipment and finding a way to keep pushing those subscriptions. They still have a pretty decent base of connected Fitness subscribers. Subscriptions are over 3 million unique subscribers. There you go, Chris. Like I say, I think there's something here in this business. I think McCarthy, as you point out, isn't in the hottest seat now. The seat's cooled down some. Let's see if he can continue this

performance over another year. Absolutely. Three months from now, it's going to be interesting to see if this is a trend or if this was the positive version of a speed bump. Speaking of speed bumps, let's move on to Snap. Shares are down 13% because fourth quarter revenue was a little lower than expected. Average revenue per user was lower than expected. Probably not a surprise given what we've seen over the last few months in the digital ad space from companies like Google that are a lot bigger than Snap. Snap, I can't be the first analyst to have said that. But you have a point, Chris. There's a really pronounced pullback among middle market companies, among enterprise

companies to rein in their advertising, and that directly affects companies like Snap. Snap itself is more of a targeting advertising company. When you have this double whammy of Apple instituting its privacy changes, and companies just not wanting to spend as much on targeted advertising, I think Snap finds itself in this uncomfortable position. They're already burning cash. Their business model has never yet realized its potential to be this hugely positive operating model. What we have here is a company whose balance sheet is getting slimmer. You look at its working capital versus its convertible debt, and there's not much breathing room. You also have a company, on the other hand, which keeps

increasing its daily active users. Those increased 17% year-over-year in the fourth quarter. they still dominate a certain demographic. They are starting to compete with TikTok. They have an alternative offering, and they also have a burgeoning AR business, which some think could be a revenue generator in the future. I don't want to try to pull out too many silver linings here because there aren't a lot in this report, except to say Snap has the user base, it's got the engagement over time, maybe the numbers are a bit soft this quarter. The question is, how do you make this model profitable and cash flow generative on a per-user basis? We've seen this story before within

the Alphabet empire. For as strong as YouTube is, there's a very healthy stretch of time where that was the question around YouTube. People looking at it and say, how can YouTube be as dominant as it is as a video platform? It's still not really the profit machine that Google search is. You said there aren't a lot of silver linings to Snap. I agree with that. I would also add as one more thing that is not a silver lining is they're still not technically offering official guidance, but they are talking openly about what they refer to as their internal forecast. And that forecast is projecting a drop in revenue. Which can't be good for their cash flow. There are a few levers to pull. Let's just briefly talk about one. Snapchat does have a

subscription service. It's called Snapchat Plus. They now have 2 million paying subscribers. You mentioned YouTube, Chris. That's something that YouTube has done to increase the monetization of its business model. This is an area where potentially they can stabilize revenue a bit, but it's just not growing quickly enough to cover the shortfall. When you talk about a decline in revenue for a company that is barely generating free cash flow, that worries investors because, as I mentioned before, the balance sheet is a little thin. It's $3.7 billion of convertible debt on their books at the moment. Their working capital, which I referred to, has only an excess of about $300 million. What if the company is subject to this weak economy,

doesn't have that lift now that Apple's pulled back on its privacy changes, and at the same time, you can't grow the other parts of the business quick enough. You can't pull up the subscription base, you can't get enough monetization out of the VR venture. It's just hard to see where this business starts to gain its momentum unless and until the economy as a whole recovers. Then you can maybe see a little bit of breathing room here. Yeah, and maybe on some level, it doesn't make sense to talk openly about this, but perhaps privately, they're just crossing their fingers that TikTok just gets banned in the United States across the board. That seems like that would be a boost.

It would be a boon. I bet a lot of companies where TikTok is there, some kind of market share are hoping the same thing. Let's be clear, Snap is not the only business crossing at fingers that TikTok just gets banned in America. That's true. To the consternation and dread of millions upon millions of teenagers on up, and some people even our age, Chris. Asit Sharma, always great talking to you. Thanks for being here. So much fun. Thanks a lot, Chris. The first exchange-traded fund celebrated its 30th birthday this year. What started with just a few million dollars of capital is now a $10 trillion industry. Jason Moser

and Matt Frankel look back on the history of the ETF and how stock investors use them today. Hey, Matt, it's great to catch up with you again. We say a lot on these shows, but it's always worth reiterating, we're big fans of index funds. I know that seems maybe a little out of sorts given that we focus primarily on individual stocks here at The Motley Fool for the most part, but our ultimate goal is to help people achieve their financial freedom. Index funds are a great part of that overall strategy. Index funds, ETFs, exchange-traded funds, those are just great ways for investors to achieve that overall strategy. This year marks a special occasion for a special fund.

The SPDR, the SPDR, S&P 500 ETF, Exchange-Traded Fund Trust, just turned 30 years old this month, Matt. Now, I'm older than that fund. I think you are, too. But hey, listen, they grow up so fast. We thought it would be a good chance to dig a bit more into exchange-traded funds, ETFs, dig into the history, what they are, why they are often a great option for investors, both passive and active. To kick this conversation off, let's just start with the very basics. What is an ETF, and who started this? The first part, an ETF, it's a way for investors to buy a whole bunch of stocks with one single investment. If you buy an S&P 500 ETF, you're buying all 500 companies

that make up that index. They trade on major exchanges, just like shares of stock. That's the biggest difference between them and mutual funds. You mentioned index funds. Most ETFs are index funds, meaning that they just passively track an index. But they don't have to be. There's a lot of active ETFs out there as well. The Cathie Wood, the ARK Invest ETFs are a really good example of that. But yeah, they are a mutual fund alternative, if you will, that just trades a basic stock on the stock exchange. You said the word there that I think a lot of people are very familiar with, and that is mutual. Mutual funds. I grew up in the age of mutual funds, and I'm sure they were

very popular offering early on in your investing career as well. We've certainly seen a pivot here over the last several years away from mutual funds towards more index fund investing, exchange-traded fund investing. Let's talk a little bit about the advantages and the disadvantages. Let's go with the bad news first. What are the disadvantages to actually investing with exchange-traded funds? Or are there any disadvantages? First of all, mutual funds are still very popular. There are about three times as much assets invested in mutual funds as there are in ETFs even today. The big reason is, that's the main choice of retirement plans and things like that. Those are mostly in

mutual funds still. But there are some disadvantages as opposed to individual stocks. Most exchange-traded funds are just designed to match an index's performance, not beat it, which is the goal of investing in individual stocks. There's always some sort of expense or fee that comes with it. Now, with a lot of index funds, that's very small, but it's still more of a fee than you're going to pay to develop your own portfolio from scratch in a brokerage account. There are a few disadvantages. Another one is that most ETFs are weighted, meaning that they can be very top-heavy. The S&P 500 ETF that you mentioned has 20% of its assets in just seven companies. It can be very top-heavy. You're putting a lot more of your money in

the biggest positions in a given index fund. But those are minor disadvantages. For the most part, these are actually really great investment products. What are some of the advantages with them? It feels like you run across every day a new theme. As we see new themes develop in the investing world, I think a lot of that is dictated by technology. But it does seem as if we see new ETFs coming online every day that are following some sort of theme. at least one of the advantages to me, it strikes me at least that maybe there's a little bit more choice for investors in the thematic investing. You have a little bit more opportunity

to chase the things that you're really interested in, and that choice didn't really exist before. Is that a fair assessment? Yeah, that's definitely an advantage. The biggest advantage in my mind is that you don't have to worry about your investments as much as with individual stocks. This whole episode is about the history of ETFs, so I want to give a one-minute history lesson. ETFs, as you mentioned, started in 1993. They just turned 30. But they didn't really gain steam for the first decade or so. The reason that they ultimately wound up getting popular is because of the dot-com crash. Investors didn't want their money all invested in one or two or three individual stocks.

They wanted to buy the tech sector for a long-term investment. We went from having about 80 ETFs in 2000 to 2,700 ETFs today. That momentum really took off after the dot-com crash. It's because it has that benefit of you're not investing too heavily in any given stock. You're just trying to match the market or the sector's performance over time. After a big crash like that really showed its appeal. Yeah, no kidding. You mentioned earlier the expense side of things. I just want, real quick, for investors, if they're interested in looking more into the

expenses that are involved with something like this, how do you find out the expenses associated with investing in a mutual fund vs. an ETF? What is that called? Where do we look for that information? They're both pretty easy. there's two main ways to do it. No. 1 is, you could go to the ETF providers page. If I go to Vanguard's website and type in Vanguard S&P 500 ETF, it gives me a whole fact sheet. One of the top lines on there is the expense ratio. The alternative is, just log into your brokerage account, type in the ETF's ticker symbol or just look for it in the search tool, and you can find the expense ratio that way. It's usually, like I said, one of the top things

listed, just because it is a big differentiator between different funds and ETFs. Yeah. Well, at the start of the segment here, I did mention, we focus a lot on individual stocks right here at The Motley Fool. That's what we do for the most part. But by the same token, I would be willing to wager that all of us on the investing team, we like ETFs. I think most of us do. I think probably most, if not all of us actually own ETFs in some capacity, too. They're excellent tools. They're excellent parts of your overall portfolio. They give you that instant diversification and can help you sleep at night, which is what we often say. You want to own stuff that helps you sleep at night. But ultimately, do you feel like ETFs are

a better option than individual stocks, or do you need to have both? Every money should own them along with individual stocks. Is it one or the other, or should we really be focused on both? ETFs can be a great way to create a backbone to a portfolio. I feel more comfortable having money in individual stocks if a certain percentage of my assets are just in a S&P 500 index fund. But they're also better than individual stocks in certain senses. Specifically, to invest in things you're not necessarily comfortable with analyzing individual stocks in. A personal example is, I have no idea how to evaluate biotech companies, so I use an ETF to invest in that part of the market.

They could be better than individual stocks in that way, as opposed to going outside of your circle of competence and investing in things you're not comfortable with. I like them for that reason. Bonds, especially. Who wants to go buy individual bonds? The ETF route is actually better than the individuals in that respect. Yeah. I'm glad you brought that up. It reminds me of a recent piece of content I published in my next-gen SuperCycle service, the 5G service. I'll pull the curtain back a little bit here. I don't think I'm giving too much away. But we have a radar stock feature. Every other month, I introduce a radar stock feature. It's not a recommendation, but it's a stock that's

on my radar, something that I'm interested in. In this past month, I actually introduced an ETF as a radar stock that was focused on cybersecurity. The basic idea is, listen man, cybersecurity is tough. I am fully not an expert on it. Furthermore, it feels like that's a market that just is constantly changing as the threats constantly evolve and as tech constantly evolves. I saw that ETF as one way for investors to consider investing in cybersecurity without having to try to place all of their chips, so to speak, on one horse. It just seems like it's a very difficult space to pick one winner when you probably have a few that are going to help drive performance there. Again, I didn't recommend it, maybe

I will, but it did seem like an ETF in the cybersecurity space was perhaps one way for investors to consider getting some exposure there. Speaking of exposure, I guess before we leave today, I want to ask you, are there any recommendations out there? Do you have any recommendations for ETFs beyond the SPDR, beyond this S&P index fund that's celebrating its 30th birthday? Anything out there on your radar? I'm sure it's probably something real estate related, but I figured I'd check. I don't know why you would think that. No. I'll give you three. Two Vanguard funds in particular I like are the VYM, which is the high-dividend ETF. It's above-average

dividend payers. Companies like Exxon, like Microsoft, I think is one of them. Companies that pay above-average dividends, if you want yield plus growth potential, that's a good one to look at. The VNQ is the real estate one that you just mentioned that invests in the REIT index. It could be a great way to diversify your portfolio away from stocks, just because real estate and stocks don't really correlate too well. Third is a ticker symbol called RSP. It's an equal-weight S&P 500 ETF. The benefit of that is, I mentioned that a lot of ETFs can be very top-heavy. If you buy an S&P 500 ETF like the SPDR, 12% of the assets are in Apple and Microsoft alone.

What an equal-weight fund does, it takes your money and invests it equally in all 500 companies, eliminates the top-heaviness. That's one to look at if you don't like the concentrated nature of weighted ETFs. I love it. I'm not going to leave listeners hanging. Just so that we're clear, the radar ETF that I announced last month in the service is the Nasdaq First Trust CTA Cybersecurity Index. It's a mouthful. The ticker is CIBR. Again, not a recommendation, but certainly something I'm digging in a little bit more to as far as looking at the cybersecurity space. As always, people on 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. I'm Chris Hill, thanks for listening, we'll see you tomorrow.