Motley Fool Hidden Gems Investing - Pessimism High? Might Be Time To Buy

Episode Date: September 19, 2022

"The best time to buy is when pessimism is prevalent." (0:21) John Rotonti discusses: - Why the rise in investor pessimism gets him excited to go shopping for investments - What he's watching - A mind-blowing stat about how important it is to stay invested in the market (10:30) Tim Beyers talks with Tim White about which SaaS companies have sticky software (as opposed to skippable). Stocks mentioned: FDX, KKR, ADBE, SQSP, SHOP,  TEAM, HUBS, CRM Host: Chris Hill Guests: John Rotonti, Tim Beyers, Tim White Engineers: Dan Boyd, Rick Engdahl Learn more about your ad choices. Visit megaphone.fm/adchoices

This family is on the brink of civil war. On September 18th, Mobland, the hit original series, is back on Paramount+. We are the Hartigans. Don't know them yet? Then Google us. From the underworld of Guy Ritchie. Do you want to step up the ladder?

I want Comet dead. Starring Tom Hardy, Pierce Brosnan, and Helen Mirren. Do I have to do everything myself? You want more? I'll give you more! Mobland, new season hits September 18th Announcements from the Fed are like early season NFL games. You see a lot of overreacting out there. Motley Fool Money starts now. I'm Chris Hill. Joining me today Motley Fool

senior analyst, John Rotonti. Thanks for being here. John Rotonti. Thanks, Chris. Glad to be back on the show. I wanted to get your thoughts on a number of things, including just how you're feeling right now. Because I said on the show on Friday, I think I said this to Ron Gross, I feel like if pessimism were a stock, I would be buying it. Because the pessimism that's in the market right now is really high. And I understand why that is. But before we get into the Fed meeting later this week, just generally as an investor, how are you feeling right now? It's so funny that you said that quote to Ron, because I think it was Friday, I tweeted out that the time to buy is when pessimism is prevalent. And so I feel the pessimism right

now as well, but that's kind of when I get excited. I'm not saying stocks can't fall further, but there's that old Howard Marks quote, if it's cheap, I buy it. Then if the story doesn't change and it falls, I just buy more. I'm at this point where I think there are some very good buying opportunities. I think it's a good time to nibble, take some small positions. Then if they fall more and the story hasn't changed, just buy more of those assets. Regarding what I'm looking at, believe it or not, one-year and two-year U.S. Treasury yields right now give you a 4% yield. That's pretty incredible, Chris. After years of a zero interest rate policy or ZERP policy, you can get a one-year for 4%. Those are some of the highest yields that I'm aware of out there.

Now, 4% yield is not going to cover inflation when inflation is 8%, so the yield is still negative on a inflation-adjusted or real basis. But honestly, Chris, I don't think a lot of investors think on a real basis. I think they see yields and they think on a nominal basis. They say, what's a high dividend yield? What's a high treasury yield? I think these treasuries offering 4% short-term data, one year and two years, are going to offer some competition for stocks right now. In the very least, it's going to drive up the cost of capital that we use to value businesses and a higher cost of capital all else equal does mean some pressure on valuation. Stocks could fall further, but I do think even at these prices, there are some very attractive

buys out there. Are there categories of stocks that you are looking at or avoiding? Because a lot of the refrain I hear lately is just stay away from anything related to tech. Not that non-tech stocks aren't falling as well, but I'm just saying I'm hearing more of that lately. Yeah. So once again, being contrarian, when I hear that and I've heard the same thing, that's when I start looking at tech. And so I'm very interested in tech right now, more interested than I've been in a while. Believe it or not, last week I was interested in the railroads when there was the possible strike on the horizon. and some transportation railroad stocks were getting knocked around.

Obviously, they were going to work out some sort of agreement, some sort of bargain arrangement at some point. And I think the railroads are wide moat. They're still growing. They're indispensable to the U.S. economy. So, railroads, tech, and then anyone that follows me on Twitter or The Morning Show knows that I like the alternative asset managers right now? Like KKR, for example. Just as in the NFL, with the start of the season, there are wild overreactions to the first couple of games. Some teams are 2-0, and it's like, oh my goodness, I think this is going to be an amazing year for them, when there's still so much of the season left to be played. I feel like it's a pretty safe bet that whatever the Federal

Reserve announces later this week after their meeting, I feel like there's going to be an overreaction of some sort, whether they raise rates half a point, whatever it is, I'm just stealing myself for overreaction. Yeah, the markets are on edge right now. And I do think that the Federal Reserve has been doing a good job lately. They've been going on these communication campaigns where they speak at different conferences and different events. and they basically say, look, we're committed to the 2% target for inflation, and we're going to do whatever it takes to get us to 2%. And so there could be some pain in the short to intermediate term. And so they're doing a really good job of trying to prepare the market for it. But like you

said, I just think markets are on edge. And so we're ready for a surprise. You're right. We're ready for a surprise, and yet it's probably not the way to bet, just because so much of the mentality right now is almost like if you go to a big family event or something with your friends and you're not really excited about it, and a couple other people are. Your mentality is, let's just get through this. We have to go to this thing, let's just get through this. It seems like that's where we are for a lot of investors because earnings season is going to start next month. You don't really hear a lot of people thinking it's going to be great. It's almost like, hey, let's just get through the end of 2022

and maybe we'll start seeing some good stuff happening in early 2023. I think so, Chris. I think analysts, on average, were slow to lower their earnings estimates. Then FedEx came out, big surprise, last week, pulled their guidance for the year. Stock was down over 20% in a day. FedEx is seen as a bellwether. I don't know if it's as strong of a bellwether as it used to be, now that it doesn't have Amazon's business anymore. But, you know, it is a global logistics company. They move a lot of goods for a lot of different businesses. And I think that was a wake-up call for the market that some earnings estimates do have to come down. And so, I think in the third quarter, we could see analysts bring their

estimates down, which could put some pressure on stocks in the short term. You know, the thing that I keep going back to is, Chris, you've been doing this for a long time. I've been doing this for a long time. We always say this time is different, and it always is. But this time, for me, in the 20 years I've been investing, is truly unique. We've had 40 years of a bull market in bonds, of falling interest rates. We've had 30 years of benign inflation. And we had basically a decade coming out of the global financial crisis when money was pretty much free most of that time. And all of those things are reversing. In addition to that, the Fed is going to sell off $95 billion worth of its balance sheet, or let it run off, I'm sorry, let it run off of its

balance sheet every month. It's a $9 trillion balance sheet or thereabouts. We've never had this level of quantitative tightening, trying to unwind a $9 trillion balance sheet. So there's lots of unknowns right now. And there's lots of examples and reasons why this is new waters for a lot of investors. Should the mindset, having made the comment that I made about, let's just get through this, I should also say, I don't feel like that's necessarily a bad thing for investors to have that mentality, because an alternative to that is, I'm out. I'm just pulling my money out of the market altogether, and I'm going to try and time a bottom sometime in the future. One of my favorite pieces of advice to myself whenever I get anxious or pessimistic

is to zoom out. Zoom out. If you zoom out on the market, there's been a lot of scary times, whether it's pandemics, whether it's wars, whether it's global wars, market crashes, runs on banks, whatever it is. And over time, whenever the market falls from a high, it always, historically, always has recovered to a new high. And so, you know, if you zoom out enough, it's up and to the right is what the stock market looks like. And if you zoom out enough and you invest long enough, you get 9% to 10% on average over time, annualized over time. That's what the market has provided. And you don't want to get out of the market. If you miss, you know, JPMorgan Asset Management put out some research recently. If you miss the 10 best days, Chris,

over a 20-year period, the 10 best trading days over two decades, your returns got cut in half. So you don't, yeah, not a typo, not a misquote. Your returns got cut in half, 10 days over 20 years. Because most of the returns come on magical days. And believe it or not, most of those magical days come after really bad days, Chris. So it's like a really big down day and then a really huge up day. You don't want to get out of the market on those really scary days. You want to stay invested. Last thing I'll say is over time, and I mean going back 200 years, 100 years, 75 years, 50 years, 25 years, stocks have been the best hedge against inflation. Stocks have provided higher returns after inflation than corporate bonds, treasury bonds, junk bonds, gold,

and home prices. Stocks are the best hedge against inflation over a long period of time. The perfect place to end. John Rotonti, thanks so much for being here. Thank you, Chris. Software as a service is supposed to mean high margin recurring revenue for investors, but more companies are taking a close look at their budgets. Tim Byers caught up with Tim White to talk about why some software is sticky, and some is skippable. All right. Hey, fools. Tim Byers here with Tim White. You may know us from This Week in Tech.

Tim, we're going to talk some SaaS today, and we're going to talk about when SaaS isn't sticky, because usually it is. The overall argument for software as a service is that once you commit to it, it tends to stick around. It has a little bit of a Roach Motel type of reputation, where once you're in, you're not necessarily out. But sometimes, that's not really true. In fact, I think maybe the reputation is less true than the reality. Right. I think as companies are evaluating their costs going into tougher economic conditions, they're really looking at ways to save money. And those monthly recurring expenses they're spending on SaaS products are an easy target. Yeah. And they do get targeted a lot. So let's talk about some instances where SaaS is not so

sticky. I'll hit you with the first one here. Very often, it's not necessarily the software itself that is the issue. It's not like the software suddenly went bad, but it may be, and we were talking about this off air, when a free tier option comes up and you are looking to cut costs, Sometimes those free tier options are amazing and you decide, yep, I'm going to switch. Right. Many SaaS tools offer a free tier, meaning that you can use their product without cost up to a certain amount. So you might be able to use it for a few different users can have accounts or a few different hits per hour, hits per day that you can get for free. And a lot of these tools will have free tiers in order to get people in and try them. It's like a free trial. But those free tiers

typically persist, right? So that as long as you never go over that number, you can continue to use the tool free forever. And if a company that you have a product with is starting to ratchet up their prices and you're really not pleased with it, and another competitor has a free tier that really does everything you need, you're essentially cutting your costs from pretty expensive to zero and that makes it worth the pain of switching. Right. And, you know, there may be, if you have an ally inside the company who says, you know what? We're paying all of this money. You were talking about Adobe XD. You know, we're paying all this money, but I used Figment, my last company, and we can get that for free. You want to try it? I mean, that happens a lot.

Right. And I think Adobe in particular, because of their monthly subscription product pricing model really makes a lot of people question every single month, do I really need all of these Photoshop users? Do I need all of these users? And that questioning comes with just, okay, I can get rid of a few users to lower my costs, but then it starts to come, is there some other product I can get for a whole lot less? And I think that's part of why Adobe has decided to buy Figma. Yeah. Yeah. $20 billion purchase. All right. Number two, sometimes competitors who really want to make an inroads, and this is, I think it's more true with smaller competitors, Tim, or ones that are actually really large and trying to make a play to command the

market, they will come in and they will dramatically, dramatically lower prices. And sometimes a great product gets displaced because a salesperson comes in with the authority to say, cut costs by 50% or more. We've seen that here at The Fool. It does happen probably more than we'd like to admit. Right. And those bigger companies also come with armies of consultants that are ready to help you with all of your switching needs and move all of your data around. There is no SaaS product that's going to be competitive in the marketplace that isn't hiring consultants and engineers like crazy and building clear and easy pathways to convert from their competitors' products to their own. Right. That is one of the biggest hidden

advantages. It's one of the reasons I tend to like the consultants, the contractors of the digital era, they hold a lot of power. Contractors that have particular skill sets, there are companies that will invest quite a lot of money to train up consultants in their product because they know those consultants can recommend their product into different situations. I mean, it does happen quite a bit. Right. And in the case of a company like Atlassian, they use third-party consultants and system integrators to do things like even convert between their own products. If you currently have Trello and you want to switch to Jira, third-party integrators are there and waiting to take that business to make that conversion happen for you. Absolutely. Absolutely. All right, let's talk

about the third. This is probably the one that is, I think it's common, but it's also the one that if you are a SaaS company, and if you're an investor in SaaS companies, it may be the most frustrating, but it is the reality. This is where a company is bounded by its market, which is that you have a piece of software, but you've just outgrown it. You've just outgrown it, and now you need to start shopping for a different and better tool. Tim, I think you've probably been through... I don't even know how many migrations to, like, we had to graduate to a different tool you've been through, but I'm going to guess it's a lot. Sure. Let's just give a small business example, let's say you started with a tool like Squarespace or Wix for your website and you're

maybe selling a few PDFs or a few products that you're creating and you're really enjoying that and then you suddenly decide, okay, it's time to take the plunge and I want to sell a thousand products or 10,000 products. At that point, you might be looking at switching to a different, more capable sales provider that has the ability to have a lot more products and make that all much more simple. Yeah. Something that has a lot of history, maybe handling a lot of different SKUs. There's a huge difference between, say, a Squarespace and a Zuora, which has a lot of experience with a highly customizable product. It's designed to handle a lot of different SKUs. Somewhere in the middle might be a product like Shopify, which can handle lots and lots of SKUs,

much more customizable, maybe handles international a little bit better. But it's a little more complex to use than a Squarespace. So, I mean, this is one of those where, and if you're an investor, there is nothing inherently wrong with that. I just want to be clear about this. But this truism, Tim, about sometimes a product has to, you know, it only lives in a certain segment of the market. And so, a customer will say, like, I love this product, but I need to move on to something else. This is why, say, something like a HubSpot and a Salesforce can coexist because a Salesforce is for a much different type of customer that needs, say, customer engagement versus like a small business

customer like a HubSpot. It's not a problem that HubSpot doesn't necessarily serve a Salesforce customer and vice versa. Right. And especially small businesses that don't have big IT departments may prize that simplicity of a tool like HubSpot over the complexity of a tool like Salesforce, even if it doesn't have all those capabilities. They don't have the people who are technically experienced enough to take advantage of all those capabilities anyway. Right. So, three ways that SaaS can sometimes not be sticky. Sometimes, the free option is just so great that it's an easy way to save money. And that can be downgrading to the free option of the tool you already have, or it can be another free tool

that's a competitive free tool. Sometimes a competitor comes in and just dramatically lowers prices. They offer a deal that you, I mean, it's the godfather deal, the one you can't refuse. And then sometimes you just outgrow the tool. And in each of those cases, Tim, I would say that's not necessarily a knock on SaaS. These forces, I'm going to be clear about this. These forces existed long before there was such a thing as a SaaS model. Right. I think that business has essentially just caught up with things that were happening already in the old days of enterprise software and are now switching themselves to SaaS. Right. Because it is an interesting model that gives you a tax-advantaged way to adopt software and can really reduce your maintenance

costs, or at least the way we used to do maintenance back in the days when Tim was going to server rooms in the middle of the night. I'm sure you don't miss that, Tim. I certainly don't. All right. That's it for this segment on when SaaS isn't sticky. I'm Tim Byers for Tim White. Thanks for tuning in to Motley Fool Money.

We'll see you again soon. 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.