Motley Fool Hidden Gems Investing - Shopify’s Comeback Story

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Starting point is 00:00:22 Whatever lies ahead, don't change your morning. Let your morning change you. Discover Coffee Plus on Nespresso.com. we've got news on one stock you probably know and one you probably don't you're listening to motley fool money i'm ricky mulvey joined today by jim gillies jims how's everything in the great white north uh it's still relatively warm to be honest with you it's uh not bad but uh you look outside. You can see the frost coming. Before we get to the main event, the main event of today's show is the world's largest automotive safety supplier. Let's hit the small Canadian tech

Starting point is 00:01:07 company Shopify. And you know what, Jim? You always like these stocks that nobody has heard of because that's where you go find value. You know what? I'm pretty happy to own a stock that everybody's heard of today. Shopify up about 25% beat gross merchandise volume projections. The amount of stuff going through its system by about $2 billion. Total number for that, $70 billion. Revenue has grown 26%. We also got some commentary from Shopify president Harvey Finkelstein about just how the company is helping its merchants with taxes. How wonderful.

Starting point is 00:01:39 What are your highlights from the quarter? Well, sure. If I can reply to your mocking with my own mocking. You can do whatever you want. This is your time to speak. Well, you know, when I found Shopify, no one had ever heard of it, right? I remember Tom Gardner was up in Canada in the summer of 2016, and Ian Butler and I said, hey, let's introduce you to something. And we never would have expected it worked out this well.

Starting point is 00:02:05 But when I bought Shopify personally and we recommended it in the now-closed pro-Canada, we recommended it in Stock Advisor Canada, which is still going, our cost basis is under $4 Canadian a share. So it was a small cap when we recommended it. And I think there's a really interesting story to tell here from going from the unknown to the everybody tripping over themselves to own it to despair and rebirth kind of thing. So let's see if we can tell all of this. This was a great quarter. It's shocking how great this quarter, given if you look at where the world has been. And so basically, yeah, free cash flow margin, 19.5% this quarter. When we wrecked it originally, free cash flow was just a glimmer in Toby Lutke's eyes.

Starting point is 00:02:53 Even if you go back two years ago, free cash flow margin was humming along in the 5% to 6% range. Now on a four-quarters trailing basis, it's 17.4%. A year ago on a trailing four-quarter basis, it was 7.8%. And this is kind of always what we were expecting, not specific numbers, but when we recommended it, and it was not cheap when we recommended it. And I think we took out billboards in Central Park basically saying, look, the valuation is frothy, okay? It's trading at a, wait for it, ridiculous 10 times sales, ridiculous. And as you know, I hate price or enterprise value to sales multiples, because last I checked, most companies have some sort of expenses, and I much prefer an earnings or a free cash flow or other types of profitability metrics. But our thinking at the time was, look, these guys enable small and medium-sized businesses and a few large businesses to run their business online and present, and it's all kinds of little merchants and whatever, but large and small as well.

Starting point is 00:04:01 and the question really boiled down to how many small and medium-sized businesses can there be in the world looking for e-commerce? I submit to you the correct answer is more. There'll always be more. There's always opportunity. We kind of looked at the potential here, the growth potential and said, you know what? Sometimes I'm willing to pay up for growth because growth forgives a lot since. Now, again, that was roughly at 10 times sales. At its peak in 2021, it got to 70 times sales. There's no rational justification ever for something 70 times sales. People paying 50 to 100 times sales for certain companies today should probably take a look at the stock chart that Shopify threw up because even today, after this fantastic rebound and after, frankly, what's been

Starting point is 00:04:54 about two-and-a-half years of just steady grinding. Shopify in 2022 got back to 10-time sales, which is hilarious. We went from 10-time sales to 70, went back to 10. Now, you're at about 16-and-a-half after the earnings report last night or this morning. It's a very different company. They are printing cash. You already mentioned the growth in revenues, growth in gross merchandise volume. They're forecasting things that look pretty rosy, at least for the near term going forward. I think that it's okay. I'm going to shock a few people. I think it's okay to pay 10 to 15 times sales for this type of growth profile. You just have to say, I'm a long-term investor. The company still needs to perform because that's the other

Starting point is 00:05:50 look, if you paid 70 times sales at Shopify's peak in 2021, you are still down about 30%. But 30% is better than 90%, like a few other companies from that era I could mention, where investors seem to be willing to pay any price for stock and the growth did not emerge at the underlying company. Even though from the post-COVID bubble peak of 70X sales down to today, again, share price is only off by about 30%, but the multiple has contracted from 70% to, as I said, 16.5%. I think that when you're buying a growth story, you have to hope like hell that the growth does, in fact, emerge. And with Shopify, it did. They had a couple of little stumbles along the way, but so far, the last five to six quarters look pretty good. Cash flow,

Starting point is 00:06:53 like I said, is expanding. And the answer to how many businesses can they help enable online still remains more. And even on a discounted cash flow basis, which you can now value Shopify at, which you couldn't back in 2016 when we bought it the first time. I've got a reasonable DCF. It's overvalued today, but it's not as bad as you might think. I can make a reasonably conservative case for $75 to $80 a share, and it's what, at $112, I think, this morning. There are worse things to have than just be a long-term shareholder of Shopify. Again, know the ride you're signing up for if you bought your shares put them away look at them every couple of years but i think it's been pretty uh it's been pretty good so you just use price to

Starting point is 00:07:42 sales a lot for a company that's generating free cash flow oh i did well once the company i said discounted cash flow i said discount you said discounted cash flow and then you're talking about software companies with 70 times sales going to 16 times sales you talked about how much you hated the price to sales multiple and then you just still do like five times Now that this company is maturing, the cash flow for the quarter grew about 50%. That's what happens when you make your margins better. And that's what happens when you grow revenue. So how are you thinking about the company's valuation?

Starting point is 00:08:13 What should retail investors that are excited about the company, seeing what's going on, but maybe haven't socked away those shares for a three to five year period? What are the metrics they should be looking at for Shopify? Just is the growth continuing? always watch GMV and gross merchandise volume flowing through their system. Watch revenue, watch cash flow. It's not really any more complicated than that. Because again, this is an overvalued company today, but it's not that overvalued, to be honest with you. At least it's overvalued in my opinion, but it's not bad. And I could tweak a few growth metrics in my DCF

Starting point is 00:08:55 and probably get pretty close to today's share price. So I still think this is a company that you buy in thirds. I think you want to have some kind of a touchstone for it. When buying thirds, I just simply mean just buy a little bit and another opportunity shows up later, buy a little bit more, buy a little bit more. I think I bought it three or four times personally. There are fools who have probably bought it 10 times that many times than I have, and God bless. But just be aware just keep one eye on the valuation but when you do have a a truly long-term double-digit growth story i think you can afford to be a little less uh price sensitive than i usually am which is you know which i'm pretty yeah which is saying something yeah no but i mean like i

Starting point is 00:09:45 i'm not buying this one today but i i'm also not selling we'll put it that way let's move to auto live the main event of today's show. This is the leading supplier of seatbelts and airbags. Yesterday, the company announced that it would raise its dividend by 3% and extend its share repurchase program. So far, it's taken 11% of shares off the market since 2021. Jim, this is when we leave the listeners aside. If you're excited about a capital allocation story, you have my attention. This is a company that absolutely passes the David Gardner snap test, supplying 50% of vehicles with airbags. But tell me, why is this a capital allocation story that you're interested in for this company making seatbelts and airbags? Sure. So, I've owned this

Starting point is 00:10:30 one personally. I think I bought it the first time in 2006. I added significantly in 2008. You might have noticed something was going on in the world in late 2008, something about a global financial crisis or something. I don't know. And the stock had a weird near-death experience there. I'll explain why in a moment. So I had owned it before that. And the thesis is basically quality company making a decent amount of cash flow, using that cash flow intelligently in the service of shareholders. So dividends, buybacks, maintaining a reasonable leverage profile, probably going to do 10%, 15% annualized returns at that point. We run into 2008 and the stock dropped like a rock. I think it was $64 in the summer of 2008 and by Christmas of 2008, it was

Starting point is 00:11:28 $12. That's when I learned. I had a good learning from that environment and that is just because something says long-term debt on the balance sheet doesn't necessarily mean it's long-term debt. They had been financing themselves with some commercial paper facilities, which were long-term facilities, they had four or five years left to run on them, but you had to roll the commercial paper every six months, which effectively made them short-term debt. Given that the financial world was imploding at that time, it looked like they might not be able to refinance their short term, not long-term debt. So, they managed to do a new financing. It was expensive at the time, but it kept the company back on track. And that's when I added a significant amount.

Starting point is 00:12:14 Should have bought the preferred shares. They sold at that point in time that it sounds like they've been retired. That would have been a smarter play, but anyway. And I like to think they learned a little bit too. So, the near-death experience will not be repeated. The debt they have is reasonably good. And my look at this is, look, this is a company that is absolutely necessary. You talk about it passing the David G. Snap test. Absolutely. The auto world is in a bit of flux. We obviously have electric vehicles kicking around. We have plug-in hybrid electric vehicles, which I like to call a cheat code because they're fantastic, but a lot of people don't really know them or are a little skeptical of them. I have two,

Starting point is 00:12:51 so I'm not an unbiased audience. But even as the transition goes from ICE vehicles to PHEVs to BEVs whatever, they're all going to need airbags and they're all going to need seatbelts and that's what Autoliv does. As you say, they're basically 50% of the market. It has been a really good run since 2008. The stock is roughly a 10-bagger if you include a spinoff of the B&R subset, which is then taken out as well, I think by private equity and then it's carved up for parts subsequent to that. But you've got about $25 in change dividends since the credit crisis, well more than the share price you paid at that time. That's another reason I still hold it. I was dumb enough to buy it in a taxable account, so I'd get a hell of a tax bill if I sold it

Starting point is 00:13:36 today. Also, too, I look at Autoliv as a ballast-type stock. They're not going anywhere. This is a critically important company in the car space. I would hazard a guess that even if you ever got full self-driving vehicles or autonomous driving. And then by the way, the Viennese spinoff that they did in 2018, that was their autonomous driving sensor division and they sold it off. So that might tell you what they thought of the potential at that time. But even autonomous vehicles, I suspect are still going to have seatbelts. I suspect are still going to have airbags. Might be even more important to have airbags in those cars. So these guys are here for the long-term. I look at them and I call this ballast for my portfolio. I'm expecting a total

Starting point is 00:14:25 return, dividend plus share price appreciation from here in the 10% range. Some years will be more, some years will be less, but I'm willing to bet with my own money that 10 years from now, we'll come back and the annualized return from here will be 10% to 12%. That's fine. Not everything needs to be growth stock gladiatorial games, right? And it's still run by smart people who make a lot of cash, who are doing intelligent things with that cash. The only added difference from the credit crisis era is they don't have that ticking time bomb of short-term financing that's masquerading as long-term financing. And I like that. Do you think we're back in, as we close out here, maybe a little mindset thing. I just get the feeling we're back in a

Starting point is 00:15:11 little growth stock mania. Maybe not quite like late 2021, but it feels like we're getting back in a mania. And I remember asking you at the beginning of the year, are we in a mania? And is that meaningful for investors? And you're like, eh, there might be a little froth, but we're not in a mania. I'll ask you again in November. Are we in a mania? There's more froth. I'm still not sure I'd call it mania. I think there are pockets of mania. Certain companies trading north of 50 times sales that i would argue most people who own them have no idea what they do or how they make money i would consider that a mania but i mean like 2021 by the end of 2021 i was openly calling it tech bubble to electric boogaloo like i was just like if history has shown us anything

Starting point is 00:15:52 ricky it's that some people just have to learn a lesson they can learn no other way and i think that's kind of what 2021 did. But I think there's a lot of fairly richly priced companies out there right now, but I'm still finding lots of opportunity for adding different stocks in the services I run or contribute to. It's not as bad as 2021. When it is, I won't be shy about saying it. We'll put it that way. All right. Jim Gillies, thanks for being here. Appreciate your time and your insight. Thank you. All right. Up next, Alison Southwick and Robert Brokamp answer your questions about gifting to kids, ETFs, and allocation close to retirement. If you've got a question for the show, email us

Starting point is 00:16:44 at podcastsatfool.com. That is podcasts with an S at fool.com. new from Nespresso blend wellness into your coffee routine with a coffee plus range infused with functional benefits choose the coffee you love with added b vitamins like coffee plus b12 to help support immune function and coffee plus b6 to keep your day moving or go with the flow and choose ginseng delight our new double espresso with ginseng extract whatever lies ahead don't change your morning. Let your morning change you. Discover Coffee Plus on Nespresso.com. Our first question comes from Nick. My question deals with when to cash out my gains and not risk what I've made. I'm a firm believer that any stock I buy, I plan to keep for five to 10 years.

Starting point is 00:17:36 And I was lucky and bought 200 shares of Royal Caribbean for $39 a share during the pandemic. Now it is at $234 a share. I would be happy selling, but I also don't want to leave more gains on the table since their sales still appear strong. What general advice do you have on when to get out and take the win versus staying in too long and risking a drop? Well, Nick, congrats on making that very successful investment. And unfortunately, I don't have an opinion about Royal Caribbean stock, so I can't help you there. But there are plenty of ways to think about when to sell, so let's talk through them. First off, it always starts with your time frame, right? If you need this money in the next three to five

Starting point is 00:18:16 years, it makes sense to sell a good portion of that investment and keep it safe in cash or short-term bonds. Secondly, how does it fit into your overall allocation? Some general rules of thumb that we've talked about in the past is that once an investment becomes more than 10% of your portfolio or it's part of a sector or industry that is, say, maybe 30% of your portfolio, you might want to pare it back a bit. Those are just general guidelines, but they highlight when investment should perhaps bear a little bit more scrutiny. You also think in terms of how much a stock shares the same types of risks as others in your portfolio. Royal Caribbean is a company that is very sensitive to the overall economy.

Starting point is 00:18:53 If and when a recession occurs, fewer people take cruises. Is your portfolio full of stocks like that? Or do you have a good mix of companies that are consumer staples or others that hold up maybe a little bit better during downtimes? Then of course, there's your assessment of the company itself. It sounds like you think Royal Caribbean still has potential, that's but definitely do some more research. Look for opinions from other investors and analysts. See if there's anything you're missing, both good and bad. There's always the question of valuation. I would say among the analysts here at The Motley Fool, we have a range of opinions about how much valuation matters. Some include it as just a factor to consider,

Starting point is 00:19:29 others pretty much ignore it altogether. But Royal Caribbean stock has a PE in the high 20s, so I wouldn't say it's exactly cheap. Then as I often say, a good question to ask about every investment you own is, if you didn't already own it, would you buy it today? And if the answer is no, then maybe that suggests you should cut it back a bit, especially if it's in an IRA and there are no tax consequences. Which gets me to my final point. This isn't an either-or decision. You can take some profits, especially if there are other investments that you think are more promising, but still keep an investment in the company. This is what I often call the regret minimization strategy. By selling some shares while still

Starting point is 00:20:10 holding some, you'll feel partially good whatever happens. Our next question comes from Paul. Hi, Alison and Bro. You two rock. Well, Paul, you are a discerning man with excellent taste in people. All right. If only our political leaders would earn trust and approval ratings like yours, we'd live in a better world. Well, I don't know about that. Allison for president, that's all. Yeah, no, thank you. If I help pay off my kid student loans, are those considered gifts and subject to annual and lifetime limitations? If yes, is there a smart legal way to avoid such limitations? When the kids were in college and I paid much of their tuitions and fees, I never considered those payments as potential gifts. So Paul, the quick answer is yes,

Starting point is 00:20:57 it would be considered a gift and subject to the annual and lifetime limitations if you help them pay off their loans. And those limitations in 2024 are $18,000 from one person to another person. So if you're married, you could each give $18,000. And if you give more than that, you have to file form 709. But that doesn't mean you'll owe taxes. You'll just eat into your lifetime annual gift and estate exemption of $13.6 million per person. So twice that if you're married. That's this year. And by the way, those numbers are going up in 2025, they'll be $19,000 for the gift per person to recipient in 2025, and $13.99 million for the lifetime gift in estate exclusion. So basically, most people really don't have to worry about paying gift taxes.

Starting point is 00:21:43 Now, your payments for your kids' college tuition likely wasn't considered a gift. That's because there are no limits on the amount you can pay for the education or medical expenses on behalf of someone else as long as it's paid directly to the provider. So if you send a check to a college or to a hospital on behalf of someone else, you don't have to report it. But if you instead gave money to someone and then they sent that money to a college or hospital, it would be subject to all those aforementioned limitations. All right. Our next question comes from Marianne. What do you think of these ETFs that offer 100% downside risk protection? Yes, they limit your upside, but if you just want to make something

Starting point is 00:22:23 closer to a market return, and more than what bonds can typically offer, could these be a good option? These are a relatively new breed of ETFs, but the underlying strategy isn't new. What these ETFs do is they use options to create basically a limited range of possibilities that's basically dictated by the performance of an index, most commonly the S&P 500, but it's also you'll see them based on the Dow or the Nasdaq or the Russell 2000. For example, the issuer may say that if you buy this ETF, the return from, say, December 1st of this year to December 1st of next year will track the price return of the S&P 500, but you can't earn more than 8%. And if the market goes down over that period, you'll get a 100% buffer against any losses before fees. So in times

Starting point is 00:23:10 like now, when the S&P 500 is up over 30% over the past 12 months, you'd be earning a return that is just in the high single digits. Now, you can choose ETFs that have higher caps, but with lower buffers. So, you have higher potential upside, but you may actually lose some money if the market goes down, but generally not as much as the overall market. And I should point out that when the return of the index is calculated to determine the return of the ETFs, dividends are included. So, that knocks off about 2% from there. Now, to get these stated guarantees, you pretty much have to buy the ETF right after it's issued, and you have to hold it for the designated term, which can be anywhere from six months to a couple of years, though most of these are issued

Starting point is 00:23:51 with one-year terms. Those guarantees are before the fees, and the fees on these ETFs somewhere range between 0.7% to 0.9%, so a little under 1%. The issuers of these ETFs often provide information on their website, and that will let you know the range of returns you might get if you, say, bought one of these ETFs four months after it was issued. And then once the term ends, the ETF company will set new guarantees regarding the upside and downside limits, basically based on the pricing in the options market and interest rates at that time. And then you as an investor can decide to just roll it into the next term or cash out. The bottom line for me is that these actually are kind of intriguing. And I can see how

Starting point is 00:24:35 it could be appropriate for people who are near or in retirement and want, as they say, some of the upside of the stock market, but they want to limit the downside. But over the long term, they'll likely underperform the stock market, assuming the future looks mostly like the past. If you also find these intriguing, to learn more and see what's available, visit the websites of two of the biggest providers of these ETFs, First Trust and Innovator ETFs. Next question comes from just a fool. That's what they put. I'm not calling them names. I have a 401k, an unallocated IRA, and a brokerage account that is 99% in stocks. I want to allocate some of the IRA to ETFs and or dividend stocks. I'm six years from

Starting point is 00:25:18 official retirement. Are stock prices too high? Should I wait? Oh, bro, can you predict the future for us? Yes, that's exactly why I'm here. Yes. And I will tell you, 100% guaranteed that the stock market will either go up or down. How's that for you? It's about as much as I can hope for. Anyways, just a fool. At six years before retirement, you're pretty much in what they call the retirement red zone, which also includes the first several years of retirement. And the retirement red zone is a time when a significant bear market can have a huge impact on your retirement plans. If there's a bear market and you're 30 years from retirement, no big deal. But if it happens right before retirement or right after retirement, it can be a pretty big deal.

Starting point is 00:26:03 So if you're six years from retirement, it really is a time to be playing it safe with at least a portion of your portfolio, at the very least, building up the amount you have in cash and bonds to pay for your first five years' worth of portfolio-provided income in retirement, what we often call the income cushion. And maybe you've already begun doing that in your 401k. But if not, then I would factor that into how much you want to invest your IRA in the stock market. You said it's allocated. I assume that means it's in cash.

Starting point is 00:26:29 So, you know, if you haven't done that in your 401k, you might want to play it safe with your IRA. That said, if you enter retirement with different types of accounts, most analyses indicate that it's probably best to take withdrawals from your taxable brokerage account first and then tap your IRA or 401k. Just a general rule of thumb. everyone's situation is different, but you might want to start building up some cash in your brokerage account by not reinvesting dividends and perhaps strategically, gradually selling stocks

Starting point is 00:26:59 that you think have reached their peak potential. I do think that it makes sense for those who are near or in retirement to have a diversified collection of dividend-paying stocks or ETFs to focus on them because dividends are more consistent and predictable in stock prices. You know you're going to get cash every year, every quarter, and that allows you to gradually build up that stash of safer assets or give you money to spend in retirement. If you're looking for some ideas in terms of ETFs, here are three that I own, the Vanguard Dividend Appreciation ETF, ticker VIG, the Vanguard High Dividend Yield ETF, VYM, and the ProShares S&P 500 Dividend Aristocrats ETF, ticker NOBL. The aristocrats are basically companies that have grown their

Starting point is 00:27:39 dividends for at least 25 consecutive years. Finally, you asked whether stock prices are too high. I would just say they are definitely high. By some measures, the S&P 500 is trading at the highest valuation since the dot-com days of the early 2000s. For long-term investors, it's generally best to just keep holding on. The S&P 500 reached over 1,500 right before the dot-com crash, and today it's over 6,000. That doesn't even include all the dividends you received over those years. But for people who are in the retirement red zone, close to retirement, just retired, I would say it definitely makes sense to play it safe with the sizable portion of your portfolio. Our next question comes from Elena. I've heard you

Starting point is 00:28:19 recommend working with a financial advisor. Is it a good idea to hire a financial coach when you're just getting started budgeting, investing, and saving? Well, Elena, I see financial coaches as sort of like the personal trainers for your money, right? They can be very helpful with providing education, getting you set up, maybe building a budgeting system, introducing you to other financial tools. There are all kinds of financial tools out there. Maybe you don't know which one is best and a financial coach probably has some good opinions. They can also be basically accountability partners. They help you stay on track, maybe encourage you and troubleshoot issues if you come across any challenges, but it does depend on whether you have a good one. This is not a

Starting point is 00:28:59 regulated industry. Really, anyone can call themselves a financial coach. Fortunately, there is a certification offered by the Association for Financial Counseling and Planning education. You might want to look for someone with the accredited financial counselor designation as a start. Then be very clear what you're looking for and make sure that the service that this person provides is part of the deal. I would say definitely get it in writing or through some agreement, an engagement letter or something like that. I would say that a financial coach is best for someone looking for help with budgeting, more foundational money management, maybe paying down debt. Unless the coach has other certifications

Starting point is 00:29:36 licenses. They really shouldn't be providing detailed advice about investing, tax planning, estate planning, things like that. And while coaches are cheaper than your typical fee-only financial planner, they're not cheap. Coaches charge between $100 and $300 an hour. But if that sets you up on the path for better financial success, I think it'd be a really good investment. But before you spend the money, you might see what's already available to you through your employer. These days, many companies have financial wellness programs that offer some sort of coaching or an employee assistance program that have some sort of a financial component. Your 401k provider might also offer access to someone that they might call a financial counselor.

Starting point is 00:30:18 So you might be able to get some level of financial coaching. As always, people on the program may have interests 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. All personal finance content follows Motley Fool editorial standards and are not approved by advertisers. The Motley Fool only picks products that it would personally recommend to friends like you. I'm Ricky Mulvey. Thanks for listening. We'll be back tomorrow.

Motley Fool Hidden Gems Investing - Shopify’s Comeback Story

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