Motley Fool Hidden Gems Investing - Powell’s No-Action Streak

Episode Date: February 1, 2024

Prospects for a rapid string of rate cuts may be fading. That’s actually good news. (00:21) Bill Barker and Deidre Woollard discuss: - How fewer interest rate cuts may impact businesses. - Peloton���s path forward. - Ways streaks are valuable to businesses. (16:47) Mary Long and Matt Frankel discuss the buy now, pay later phenomenon and who it really benefits. Companies discussed: PTON, OKTA, AFRM, PYPL, SQ, WMT Claim your Epic Bundle discount here: www.fool.com/epic198 Host: Deidre Woollard Guests: Bill Barker, Matt Frankel, Mary Long Producers: Ricky Mulvey, Mary Long Engineers: Dan Boyd, Rick Engdahl Learn more about your ad choices. Visit megaphone.fm/adchoices

You've got to try breakfast at A&W. You've got to try breakfast at A&W. And what better way than with the delicious Pret Organic Coffee? Starting with just one dollar, all day, every day, now until December 31st. You've got to try breakfast at A&W. At participating A&W locations in Ontario. Rate cuts? We don't need rate cuts. Or do we? Motley Fool Money starts now. Welcome to Motley Fool Money. I'm Deidre Willard here with Motley Fool analyst Bill Barker. Bill,

how's your Thursday going? It's going great. Thanks for asking. Well, Bill, I'm here with you to talk a little macro today. Yesterday was a Powell day. We had Fed Chair Jerome Powell's conference yesterday. No interest rate change. That was expected, but we are now, I would call it, on cut watch. Powell has said he's prepared to keep the ship steady, keep things where they are for now. Market didn't love that. It's kind of shaking it off today. But should we have really been surprised? And why not just cut the rates? I think because you can't have your cake and eat it too. That's what the market wants and always wants, and that's what the rest of us all want too, is to have it all.

But you can't maybe have the GDP going along at above 4% growth, which it was on the second half of last year. The forecast on GDP now is not a lot of data yet in for Q1, but projected at above 4% by the Atlanta Fed, the Atlanta Fed's model anyway. The growth is fine. Inflation has come down, but is not at the target rate. The employment picture continues to be excellent. Why would you change what has been working? Which one of those things is the problem. The minor problem is that inflation is not yet at 2%, it's at about 3%. The reason to have had all the interest rate hikes was to address inflation, and the job is not quite done yet. Yeah. Powell has been very clear,

every time he says 2%, a lot. We know that's important to him. On the other side, before the beginning of the year, you know, everybody sits around and says, oh, we're going to have six cuts. We're going to have seven cuts. It's going to start in March. Well, it's starting to look like maybe it's not going to start in March. So if the forecast for interest rate cuts kind of shifts, everybody's models, everybody's forecast kind of shifts. And I'm wondering about some of the companies that were really kind of betting on that rate to go down so that they can restructure some debt. If the cuts don't happen until maybe June, how does that impact all of the companies that were really planning on it being March? Well, if they really need interest rates

to come down by 25 basis points or 50 basis points in the first half of this year, then they're not very good companies. The Fed has never indicated that there are going to be that many rate cuts. That's people hoping there'll be that many rate cuts. Why are they hoping? There has to be some element, I think, of a weakening and more rapidly weakening economic picture to get that many rate cuts. I don't know what the equation is that gets everything that you would want and six rate cuts. It's not going to happen. And the Fed's telling you it's not going to happen. Well, yeah, the Fed's telling you it's not going to happen. People still sort of say, well, it might happen. But if I think if it does happen, then we're in a position where

perhaps we don't want to be. And so you made a really good point there that I just want to sort of emphasize is that the companies that really, really need this to happen, those are probably the zombie companies that maybe have too much debt anyway. And so, you know, they've got a bigger problem than just waiting on Powell. Yeah. If you have in any way structured your company or your own finances in a way that requires interest rates to get back down to something approximating zero or very, very low rates, then you've got to rethink what you've done, because that was the anomaly of a 5% range for the Fed is not some sort of weird thing. It's much more historically repeated than this is a near zero rate level that we enjoyed. I get

everybody wants to enjoy borrowing money for free. I would love to do that too, but it's not going to happen. No, that was definitely an anomaly. So part of this is also the soft landing. I'm so sick of talking about the soft landing, but we have to do it. It's a delicate dance because you need this solid labor market, but not too solid because that's not so great either. And that can lead to inflation, which we're trying to get back down to that 2%. looking at the sort of hiring market bill, it was, it was a, it was a rough January. It seemed to me like not, not as rough as last year, according to one report that I saw, but it definitely, uh, it was the second highest layoff total, according to this report from challenger

gray and Christmas and lowest hiring outlook since 2009. So good for soft landing. But as I watch companies, big companies that I respect and invest in, do some deep cuts, I'm sort of thinking about what's happening here. So we had two just this morning. Okta's cutting 7% of their staff. Deutsche Bank is cutting about 3,500 jobs. When we see all these layoffs and we're looking at this soft landing, how do you kind of balance all of that? Well, those are headlines and those are real numbers and those are real tragedies for the people who are suffering the job cuts. But, on the other side, we don't see all the job hiring, which ends up producing these monthly numbers, which have been reasonably consistent at about 200,000 jobs added a month

over the most of last year. Now, the employment market has softly landed. 200,000 a month is roughly what we were tracking at pre-pandemic and for several years preceding that. It's really pretty close to that range. Of course, at the very beginning, 20-some million jobs were lost, and there were much higher monthly rates of people returning to work. The employment market was was having four or five, six, 700,000 jobs a month added. It's come down to 200,000, I would say it has softly landed. Whereas inflation has softly climbed down, it has not yet landed. 2% is the landing spot. It's announced, it precedes all of this, it hasn't changed after 2% is achieved, then maybe there's a time to revisit, hey, it doesn't need to be 2%,

is 2% to 2.5%, is 2.25% to 2.75%, all good. But until you've achieved 2%, you're not going to declare the landing achieved. I think we'll get new monthly employment numbers tomorrow, and those will not reflect these most recent announced job cuts, but it's expected to be a positive number again. If it isn't, if it's the first month since 2019 or late 2020 where there were jobs lost in a month, that will affect the probability of that interest rate cut happening a little bit quicker. And well, I think there's also another thing that I'm thinking about here is, you know, the last couple of years have been sort of like breathlessly watching each, each meeting of the transcripts are getting scrutinized. I'm hoping that if we, you know,

if there is less activity, uh, you know, maybe it takes a while for the cuts, maybe that maybe these, uh, maybe his conferences become a little more what they, what I feel they kind of should be, which is regular, steady as she goes, non-events. And if that happens, do you think that that sort of will tamp down that volatility that we have seen in the last couple of years every time he speaks, the market does these gyrations? Yeah. I mean, I think there are algorithms that are in part responsible for that. You see the market having recovered quite a bit today as we speak, compared to what it lost after the news came out. So, the volatility has been largely within 1% or 2% and quickly recovered, at least in this case, because almost everything

that you can look at for the economic picture is doing very well. And the ability of the narrative that the economy is in trouble or it's about to hit recession. Obviously, there are some political points that are trying to be gained by pushing that narrative, but it's not the case. It's not the case. Well, let's move away from the macro and into the specific. We've got big, big things to look forward to after market closed today with some earnings that I'm sure Dylan and the crew are going to talk about on tomorrow's show, but I want to take a look at one that reported this morning. It's Peloton. And listeners know me. I love to listen to an earnings call. Peloton call felt a little defeated. I mean, the numbers weren't bad. They're trimming

some losses. That's awesome. But you've got the CEO that came along to turn it around, Barry McCarthy, and the turn just isn't quite turning. The market doesn't like gloom. They responded poorly to that. Are you watching this one at all? What do you think? I'm not watching it because it's essentially a consumer electronics company, and that's a poor place to find good long-term returns. It's not a well-run company. It has not been. That's not McCarthy's fault. He came in and found this company that needed to downsize dramatically and reverse heavy losses. The heavy losses have been reversed, but it's not really making money. I don't want to stomp on a company that's already suffered 98% declines from the high in its stock.

So it's a consumer electronics company that doesn't have a differentiating factor that makes it interesting. I'm going to push back there because I'm not entirely sure it's a consumer electronics company because I feel like it's kind of a membership company. I mean, originally, yeah, totally consumer electronics and the instructors. But as time goes on, it's more of a, it's more of a membership. It's more of a, almost, that's not quite a social media, but it's a, or a streaming, but it's got a taste of that. I mean, they have that recent deal with, with TikTok. I mean, I feel like there's something here in terms of the membership, but I also see

that their churn rate is up over 7%. So I'm wondering about that, but is, is the future of it more as a, as a service than as a consumer electronics company? Well, let's say it's a membership company. It's got to take members from other similar offerings, gyms. And that doesn't dramatically grow. There was a vision, a belief during COVID that everybody's life was going to change and was to revolve around in-home athletic exercise, but that hasn't really been the case, at least as experienced by Peloton. It's not a value company because it's not earning money. It's not a growth company because it's still seeing declining revenue. It's a company that has an offering

that many people love, and the people who love it have probably largely found it by now. I don't know what's going to make a difference for all the people who haven't tried it or who tried it and left. I don't see what they have to offer that isn't largely available from many, many other places. Yeah. I think one of the things I'm going to watch with the Vision Pro is to see what Apple does with fitness. Because I mean, it's sort of an interesting thing because you had Lululemon tried to do that by buying the mirror. There's definitely companies are trying to figure out the future of virtual fitness and a lot of different swings are being taken. So it's interesting. But I want to talk to you about one other thing. And this is

something I'm sort of like puzzling around in my mind lately, which with Peloton, I knew a lot of people got super into it before the pandemic and during, and they talked about their Peloton streak all the time. And the word streak I hear everywhere lately. So people have Duolingo streaks, Snapchat, teenagers very worried about losing the streak. You've got people with Wordle streaks that, you know, sort of have this anxiety about that, but also love it. It's what drives, uh, the huge growth of the games at New York times. So everybody's kind of like a lot of businesses are banking on this streak trend, but every time I see a trend, I get like, Oh, when's this trend going to end? Are you a person who has any, do you have anything in your life that you have a

streak on? And do you feel like this is a trend that's continuing to grow? I don't know, waking up, eating, drinking coffee. I don't know what my streak is on drinking coffee, but I put it up against everybody, basically. I get it. You need a psychiatrist or a neurologist to explain why that is such an effective motivating factor in the psyche. But look, this is the most common New Year's resolution is to get started on exercising and maintain it, and it's the most easily dropped. Great for people who have any kind of healthy streak, including using Peloton, if they can leverage that to get people to lead healthier lives, great. But they're just one of many options for that. Yeah. Well, streaks can be positive and

negative. Thanks for your time today, Bill. Thank you. We talk about a lot of stocks on the show, but it's just a peek at the Motley Fool's investing universe. This year, we're rolling out a new offering. It's called Epic Bundle. The service includes seven stock recommendations every month, model portfolios, and stock rankings, all based on your investor type. We're offering Epic Bundle to Motley Fool money listeners at a reduced rate as a thanks for listening to the show. So, for more information, head to fool.com slash epic198. We'll also include a link in the show notes for you. Up next, Mary Long and Matt Frankel check in on some buy now, pay later companies

and what the rising use of the services means for the economy. If you buy stock in a buy now, pay later company now, will you actually get paid later? Here to check in on the status of buy now, pay later products is Motley Fool contributor Matt Frankel. Matt, thanks for joining me today. Hey, Mary. Thanks for having me. I'm glad to be here. Glad to have you. I was surprised to learn that BNPL lenders have actually been around for a decade. I think that surprise largely came from the fact that 2020 and 2021 really stick out in my mind as the peak moment for BNPL, yet we're in a different moment now. Klarna in 2021, which it's privately traded, but it was valued at $45.6 billion in 2021.

Now it's not at its lows, but it's still a far cry from that big number. Its most recent valuation placed the company at $7.85 billion. Affirm stock followed a similar story. It's risen above its 2023 lows, but it's still pretty distant from that 2021 high. Where are we in the BNPL hype cycle? The hype surrounding the stocks has certainly died down. But you could say that about pretty much every other fintech company, not just Buy Now, Pay Later. If you look at PayPal, Block, they're all trading at 80% and their all-time highs during the peak of the hype. But business-wise, I don't know if it's fair to call buy-now-pay-later hype, because more people than ever are using it.

Just looking at a firm's recent numbers, because they're publicly traded, it's really easy to get a read on the industry through them, almost 17 million active customers, 28% more merchandise volume in the fiscal first quarter than a year ago. Their revenue was up by 37%. Their margins are looking good. More people than ever are using this. Buy Now, Pay Later as a concept is clearly here to stay. Now, whether or not the stocks are going to reward that is another matter. Let's just hone in on Affirm because you mentioned that their biggest competitors aren't solely in the Buy Now, Pay Later space. Apple, PayPal, even Afterpay, which is owned by Block, they've all got their hands in different

products as well. Based on what you were just saying about Affirm and how it's growing over time, is Buy Now Pay Later viable as a standalone business, or is it most successful when it's offering other products as well? There's advantages to both, but I would actually make the argument that a standalone business is best for Buy Now Pay Later. I would use PayPal as an example there. When you think of PayPal, they're not the only company that was doing online checkout and payment processing and things like that, but they were the big peer play that was laser-focused on it. Now, there's a PayPal checkout button on every website you visit. It's a standalone payment processor, as opposed to some

of the other ones. That allowed it to really leverage its relationships, say, we're all in on this, and build a network. We're seeing that with Affirm. Affirm Checkout is now available on Amazon. It's on Walmart in the store, you can do a Affirm checkout in a lot of locations. I would argue that the standalone model is actually an advantage for Affirm, as opposed to some of those others that you mentioned. Affirm's self-stated goal is to, quote, deliver honest financial products that improve lives. What, outside of Buy Now, Pay Later, does Affirm, and even Klarna, for that matter, what else do they offer? Affirm's offering the Affirm Card now, which they call the future of the business.

It's essentially a credit card product that gives you certain options to pay overtime, pay in four installments, things like that. The four installments at 0% interest is the big differentiator, but you can treat it as a regular credit card. They want to offer a high-yield savings account, which I'm not totally sold on, if I'm being honest. But the Affirm Card is a really interesting product. It's a pretty small part of the business right now, but it's a higher margin product. 86% of its loans are interest-bearing, which is not the general makeup of a firm. It made up only 4% of its merchandise volume in the most recent quarter, but accounted for 7% of its revenue. As that grows, that could be really interesting.

Does it improve people's lives? It's a tough argument to make when you're talking about something that puts people into debt, but it can make financial lives easier. I'd bet that story. I think it's easy to focus on the dangers of buy now, pay later, this phantom debt and people not fully realizing the debt that they're in, the lack of regulation in the space, maybe compared to credit card companies. But Affirm CEO Max Levichen really seems to have a strong mission-driven vision for the company that hits on the making lives better piece. What is that vision? Do you find that compelling? Yes and no. Like I said, the savings account side of it, I really don't. But that's a crowded space already. And there are a lot

of fintechs that do it very well and have trouble gaining traction as it is. So, that part of the business, I'm not that sold on. The Affirm card does open up a lot of interesting possibilities. Just because when you think of what Affirm's normally used for, before we recorded this, I mentioned my wife used it to buy her Peloton. It's historically been used for big-ticket items like that. And this opens it up to certain verticals that were not part of its ecosystem before, say, restaurants, spending on groceries. If you have a big grocery purchase, say, you're hosting Thanksgiving dinner, you can split it into four payments. That's an area that wasn't historically part of the buy-now-pay-later landscape.

So, I do find that kind of compelling. I don't really focus as much on the dangers of debt, because the numbers tell us not to. The whole reason that Affirm and all the other ones tanked in 2022, 2023, was there was this fear that we were going to see this surge in delinquencies because of all this phantom debt and because their credit underwriting standards aren't as high as everyone else's and things like that. But what I think the market missed is that they underwrite based on a single purchase, not just a blanket credit line. It's a totally different ballgame to assess whether somebody is going to make the payments

on their Peloton bike than to just give them a $10,000 line of credit. And I think that's what the market got wrong, and the numbers are showing that. Not only have a firm's delinquency rates not exceeded pre-pandemic levels yet, they're below what we're seeing from most credit card companies. SoFi, which is known for having very affluent clients and high credit score and things like that, their loan delinquency rate is a full percentage point above a firm's. So, that's one thing that I found really interesting in the data, because it's turning out not to be like this terrifying type of debt, it's people are financing one purchase and then

paying for it. Affirm's been growing customers steadily, but you've mentioned at Walmart, at Amazon, there are different payment options available. Is there any real stickiness to Affirm in particular? Or if Klarna is also offered, what's stopping me from switching between the two? It's all about exclusive partnerships. I mentioned Peloton. Peloton can't offer Klarna as a checkout option because it's an Affirm customer. When I go to checkout online, I see a PayPal button. They have exclusive agreements with a lot of merchants. Affirm is doing a great job of leveraging that. The product itself is a commodity. Any type of

credit is a commodity. That's why Visa and MasterCard and American Express, they charge roughly the same swipe fees to merchants, and why Block and Adyen and all of them charge the same payment processing fees to merchants, because there's no real big differentiators. It's all about exclusive relationships and who gets the better exclusive relationships, because they offer the more compelling products and the best functionality and things like that. That's what a firm's been doing to differentiate itself, is really improving its functionality compared to peers. I can't tell you where I could go pay with Afterpay right now. I have absolutely no idea. But I could tell you 10 websites where I could go pay with a firm.

I want to get to Afterpay, too. But before we do that, let's stick on Affirm for one second. It's not yet profitable, but it did produce positive operating income for the first time for the last two quarters. The company reports earnings on February 8th. We're recording this on January 31st. What are you looking for? I'm watching the delinquency rate. I mentioned that the delinquency rate has reverted back to the pre-pandemic normals. Its 30-day delinquency rate is 3.2% right now. It was 3.3% in 2019. No sign of trouble yet. That could change. We're just coming off of the crucial holiday spending quarter. That tends to be a seasonally very busy time of year for a firm. If they

do get in over their heads in debt, it happens during the holidays. A lot of people could tell you that. I'm watching the delinquency rate really closely. But if they can keep that low, this will be a profitable business. It's a matter of time. But that's still a big if at this point. It hasn't really been tested in a recession or anything like that. You teased out Afterpay for a minute there. Block acquired the company in February 2022 for $29 billion. You hinted at this, but how has that turned out for Block so far? Well, just to clarify, because people are just listening to this, I did just roll my eyes when you said Afterpay and Block and the acquisition. They clearly overpaid for it.

The short answer is, the acquisitions turned out OK. It is a positive contributor to the company's numbers. They broke out the numbers in the third quarter, which is the most recent we have data for. Afterpay generated $129 million of revenue in the third quarter for Block. $94 million of that was gross profit, so a pretty strong margin there. That's about 5% of the total of the company. That didn't really justify that price tag. But to be fair, it was an all-stock deal. They paid for afterpay in stock, not cash, so they didn't actually pay $29 billion. If you look at Block's share price today, it was closer to $8 billion that they actually ended up paying in terms of the value of the stock. But they clearly overpaid

for what this business is bringing to the table. I think it makes their ecosystem stronger. Does it make it $8 billion stronger? No. Thinking about buy-now-pay-later companies and their competition maybe with credit cards, are there any pure-play BNPL companies that you see as being ripe for acquisition by a bigger player, perhaps a credit card company? I think Klarna would be the easiest, just because it's a private company. There's a lot more wiggle room there when it comes to a deal. Right now, a firm's market value is about $13 billion.

Realistically, someone would have to pay $17 billion to $20 billion to acquire it. I don't see it happening, but it's not out of the question. PayPal has been trying to break into buy now, pay later forever. They have $11.5 billion of cash on their balance sheet and the ability to borrow money pretty cheaply. A big tech company like Alphabet that has been trying to build out its fintech offerings could be a good fit for a firm if its numbers keep going in the right direction and if it really proves that this business model can survive no matter what the economy is doing. I want to say ripe for acquisition, just because I do think that's a steep price tag to pay. I think there is an afterpay effect in the market, if you will,

where companies are worried about how much it's actually going to contribute to their bottom line. But Affirm, I think people would be buying their relationships more than anything else. It would be very valuable, especially to a company that's struggling to figure out the next step like a PayPal. some of the bigger players in this space, the more diversified players, Apple, PayPal, they've been experimenting with this for a while. But if you're Visa or MasterCard, you're a massive company, are you threatened at all by these buy-now-pay-later companies, or do you think that they see this as technology that they themselves could

replicate if they really wanted to? It depends how much they end up leaning into the card products. To be able to use the Affirm card at any retailer, it has to be a Visa or MasterCard product. So, if the future of Affirm and the future of Buy Now Pay Later are card-based products, like Affirm's management seems to think, then they're a help to Visa and MasterCard, they're not a competitor. Right now, Buy Now Pay Later is sort of a competitor, because you're getting around the traditional credit card or anything like that system. But if the Affirm card really starts to gain traction and other similar card products start to gain traction, that's a net positive for Visa and

MasterCard, not a negative. Matt, thanks so much for taking the time to talk through this with me today. Really interesting space to keep an eye on. Yeah, of course. We could talk buy now, pay later for an hour. We did it in 13 minutes, so that's pretty awesome. 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 Deidre Willard. Thanks for listening. We'll see you tomorrow.