Motley Fool Hidden Gems Investing - The Ups And Ups Of The Stock Market

Episode Date: January 22, 2024

What’s behind this latest rally? (00:21) Jason Moser and Deidre Woollard discuss: - What could impact the recent rally? - The potential future for Macy’s. - Sports Illustrated and the value of legacy brands. (19:27) Deidre Woollard interviews Jamil Khan, Chief Strategy and Small Business Officer at H&R Block on where the tax-preparation company is headed next. Companies discussed: M, HRB, NYT, AMZN, GOOG, GOOGL, SEDG, SFIX Claim your Epic Bundle discount here: www.fool.com/epic198 Host: Deidre Woollard Guests: Jason Moser, Jamil Khan Producers: Mary Long, Ricky Mulvey Engineers: Dan Boyd, Kyle Carruthers 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. What goes up must go up. Motley Fool Money starts now. Welcome to Motley Fool Money. I'm Deidre Willard here with Motley Fool analyst Jason Moser. Jason,

how's your Monday going so far? Hey, Deidre, just great. How about yours? Well, pretty good and really good. I guess if you're watching the stock market, we hit an all-time high for the S&P 500 on Friday, and this morning it zoomed up again. Interesting, because the last all-time high was set in January of 2022. Not that long ago, but it feels like a long time. It does, doesn't it? It does.

What should we be thinking as we look at this rally? You know, I was saying, on Motley Fool Money on Friday, as well as the market performed in 2023, it just didn't quite feel like it. Maybe there were pockets about performance. To that point, we can't ignore the Magnificent Seven. I know a lot of people are probably sick of us saying this, but the fact of the matter is, while we've talked about the Magnificent seven for a while, their outsized impact cannot be ignored. When you look at these seven companies, and then you think that over the course of 2023, the laggard of the seven was Apple, which was still up like 50%, and essentially better than double the market's returns there.

We can just see that, clearly, those seven companies have had a big impact on the way the overall market has performed. Now, that doesn't mean that the rest of the market hasn't performed well or offered investors opportunity. Obviously, stocks on the whole are performing very well. I think a lot of that really is being driven by this idea that inflation really is now starting to come back down. The Fed's actions have made a difference. The conversation that comes with that is that now, we went through such a long stretch of pushing rates up, now it's a matter of, when will they start cutting rates? Maybe the question is, are they going to be cutting rates sooner rather than later, or

is this something that will be put off for a little while? It's that question of cutting rates because you can vs. cutting rates because you have to. And I think we're not quite there yet as to understanding exactly which scenario will play out. But, I mean, there's still a reason. I don't want to be a Debbie Downer. I mean, I want to be as glass-half-full as possible. But there are reasons at least to at least be sort of skeptical. I mean, you look at the holiday spending here, for example.

You look at credit card debt. I mean, credit card debt at a record high. delinquency rates have actually doubled over the past two years. If you look back during the pandemic, those delinquency rates were one thing. But if you look at delinquencies while they were at historic lows during the COVID-19 pandemic, the rate of people who've gone more than 30 days without paying their credit card bill has recently topped pre-pandemic levels. That's just all to say that we're comparing apples to apples. It's a bit more of a normal time vs. a normal time. Buy now, pay later.

That's something we talk about a lot on this show. That was a big contributor to holiday spending, boosted holiday spending about 14%, which is obviously a lot. We're starting to see some impacts there, some questions as to whether that is debt that's going to be paid back, or at least is it going to be paid back on time. student loan payments coming back into play. I feel like there's a lot of stuff we're going to see unfolding here over the course of the next couple of quarters that'll determine whether we hit that soft landing that I think a lot of optimists are hoping that we hit versus something like maybe a less-than-soft landing, should I just say.

Yeah, I think that's a concern. We're looking for interest rates, we're looking to see something there. That we'll probably know in a couple of months. But the other thing that I'm thinking about is, like you said, the Magnificent Seven, so much of this is the AI story. As we look forward to earnings, could that be a place where we get a little blip here of not a full-blown reckoning, but definitely a check-in? It's absolutely possible. AI has become the the headline du jour for a long time. I read a great article over the weekend by Christopher Mims in The Wall Street Journal that was talking about these technologies that have gotten so much attention over the last several years that maybe it's time we start pulling back

the expectations on them. Artificial intelligence clearly taking over, whereas all of these technologies we've been talking about in regard to things like blockchain and crypto or autonomous driving or even the metaverse. Those are the three points of the article. So much money has been invested in these spaces, and so much time has been spent on talking about the merits and the benefits of these spaces, but we haven't really seen that stuff materialize yet. Now, the conversation is moving on to AI. We're talking a little bit less about these other things, and that makes sense. The question is, will AI actually materialize into something, at least in the near term, that's a bit more tangible? It's not to say that things like

crypto and autonomous driving and whatnot, the metaverse, it's not to say they won't pay off, but it is to say that maybe it's going to take a little bit longer than perhaps a lot of people expected. I don't know that AI is necessarily going to fall under that bucket. I think we can really see a lot of the benefits that come from AI, but they may not necessarily be directly connected to us as investors. It feels like a lot of this is stuff, AI is really benefiting us behind the scenes, making our lives easier, but not necessarily as explicit of an opportunity for investors as we may hope. I guess time will tell. I think the other thing that I'm looking at is, we're seeing these results in aggregate,

but January has been a rough month in terms of layoffs. Some of the companies expected like Stitch Fix or even SolarEdge, but Amazon, Alphabet. I'm wondering if we're seeing signs from individual companies versus the aggregate rise up. Does that worry you at all? It worries me a little bit. I think that's fair. It's important to note that we're seeing these cuts across the spectrum. The companies that are doing well and companies that are not doing well are all cutting jobs. This is not something that's limited to one specific demographic of capitalism, so to speak. You look at a report published by Challenger Gray and Christmas, which is in the hiring space,

the pace of job cuts by U.S. employers in 2023, we saw that number surge 98% compared to the previous year. I mean, layoffs are a real thing, and they're happening across the board. I mean, the costs of employment are going up. We're seeing unions. Unions have been a big story over the last couple of years. Whether you're pro-union or anti-union, it doesn't matter to me, but they are taking advantage of this point in history, this advantage of the cycle. I think that's what makes sense. Unions have to take advantage, they have to strike while

the iron's hot, so they're doing that. What that does is, that changes the cost structure of some of these businesses. The cost of doing everything is going up, even with inflation coming back down. I think most people would agree, the cost of living is a lot higher. just tie this into your everyday life. I was looking at this the other day. The cost of auto insurance is up 20.3% in December from a year earlier. When you look at something like auto insurance, which is basically a requisite, everybody needs it. If you're going to be driving a car, and most people are, you're paying auto insurance in some form or another. When those costs jump like that, when they increase like that, that's something that

impacts everybody, from consumers to the places that those consumers shop. So, it's always something to keep in mind. Yeah. And I think this is just a reminder that a rally is great, a rally is exciting, but a rally is also, stock markets have cycles. We are going to go through cycles, and everything that goes down goes up, and things that go up, well, they go down at some point. Unfortunately. Let's talk about a company that has had some layoffs recently, the Macy's, that they announced layoffs on Friday, announced they're closing more stores. And then over the weekend, they confirmed what we knew in December, which is that they had received a takeover offer for $5.8 billion. They officially rejected it, but I felt like they left

the door open. And it's an interesting play because it's a brand, it's a great brand, a fading brand, in a vertical that is definitely seeing pressure. You've also got a nice bit of real estate, including that prime flagship store in Herald Square. We know private equity wants it. Do you think there's a public play here? There absolutely could be a public angle there. I would imagine this is more attractive from a private equity perspective. The reason why this deal didn't happen. There are concerns over financing and valuation. Valuation is obviously a bit more subjective. The financing piece, you're going to make that assessment and go forward. To me, though, when you look at Macy's, Macy's as a business, I think we all would agree,

this is a business that is challenged right now. Every metric tells you that this is a a challenged business. Revenue growth is not there. Cash flow, we're seeing cash burn. Margins on the decline. Every metric tells you this is a challenged business. From that perspective, it's probably nicer to be able to keep that stuff off of the public radar, so a private equity can get in there, buy this out, and then go in there and do their thing to try to fix the business. Now, the problem is, at the end of the day, If that happens, then at some point down the line, you probably see an IPO again, and they're just saddled with a ton of debt. That's happened before.

I don't know that that necessarily is the ideal long-term play. But to me, it feels like still, even though this deal didn't really work out, and it still may, you never know, they could come to a negotiation, but it does seem like the PE perspective is a bit more of an attractive one, as opposed to staying in the public eye. Yeah. And it's, I've been watching this too, because you've got a CEO who's been there for a while. He announced his retirement last year. It's supposed to be in, in February. He had no official date has been released yet, but you've got this new CEO, Tony Spring, who's the president of Bloomingdale's coming in with an idea of we're going to do smaller stores. We're going to get

off mall. If you were in charge of Macy's at this pivot point, what would you do? That is a big question. It's a fun one, though. Yeah, it is. There are a number of different ways to look at it. Assuming that you want to continue on as a retail concept, the key for retail operators, you want to keep growing your revenue and selling stuff. That ebbs and flows. You can't force people to buy stuff. Obviously, you can create a store with things that people want to buy. But I feel like I'd focus more, at least in the near term, on what I could control. In looking at the metrics, like I was talking about earlier, the metrics of this business

are in decline, focus on the cost structure of the business, focus on the inputs that go into making this business run. And if you just look at the operating margin alone for this business, you go back 10 years, Operating margin has been cut by more than half over the last 10 years. So, clearly, this is a business that is not operating as efficiently as it could. And that's exacerbated when you consider declining sales. And so, obviously, they need to figure the sales part out. But I think that the operating side is a bit more in their control in the near term.

So, I think I would really just be laser focused on that. And the other thing I keep coming back to, and I wonder if this is not something that we might not see at some point, because you hear folks talk about Macy's and the real estate dynamic right there, real estate being a big part of the investment thesis there. I wonder if there's not something where Macy's figures out a way to become a real estate investment trust, a REIT, or if they merge with a REIT or something like that to take advantage of the real estate side of that. of that argument, because I mean, it is, it is something worth keeping in mind. I mean, there is that dynamic to the business. Um, but yeah, I think near term, I'd be really

focused on just, uh, the costs that go into maintaining this, uh, this business. Yeah. You were just giving me flashbacks to, to Sarah Taj there with, uh, with what Sears did to try to spin, try to spin out that read aspect and, and, and get the value there at that, that, that did not work out. Although those properties definitely still have value. It's a really tough problem to solve. yeah absolutely well jason did you watch football this weekend i did i watched a lot of football this weekend how about did you i think a lot of people did i did and i'm thinking about the reason i'm asking is because it was a tough weekend for sports illustrated a bunch of their employees

were let go on friday and it's it's an interesting case because the brand used to be owned by meredith which publishes food and wine and a bunch of other things they sold it in 20 uh 2019 to Authentic Brands, which owns Reebok. It's got Brooks Brothers. It's got, I think, Dolce & Gabbana, as well as some sports figure licenses like Muhammad Ali. And so what happened was a greener group who'd been operating Sports Illustrated, they failed to make a payment. That agreement's terminated. I'm wondering, what do you think is the value of the Sports Illustrated brand now? I mean, this was the sports brand when I was growing up, but now you've got things like The Athletic. Does Sports Illustrated still have that cachet?

I don't think it does. It reminds me, watching the Sports Illustrated story play out over the last several decades, it was a big part of my childhood growing up. I remember it very well. Every week, the new Sports Illustrated came in. It was a big deal, right? It immediately just reminded me of the Warren Buffett quote, first come the innovators, Then come the imitators, then come the idiots. And I think for the longest time, Sports Illustrated was the innovator in the space. They were the ones that really were doing something special, something noteworthy, something different. And I think a lot of that was based on just the landscape at the time.

This is pre-internet, so distribution was a big deal in that regard. and Sports Illustrated had figured that out. Distribution was a big part of the equation. When you think about sports reporting on the whole, it really is, at the end of the day, it's a commodity business. Personalities, I think, play a bigger role today than probably ever before when it comes to sports reporting. I think you can look at the sports landscape now. You mentioned The Athletic. That's one of many names out there that really are out there competing in this space. Look at how quickly things like Barstool Sports are out-kicked. Look at personalities like Pat McAfee or Colin Cowher, Stephen A. Smith.

It's much more now than it used to be before. Distribution is what was once a competitive advantage. It's not really the advantage anymore. SI had to lock on that back in the day. It was how we got it. But as we've seen with so many businesses, the internet has brought those costs down to basically nothing, which brings a lot of new competitors into the space, the imitators. And, I mean, people may hear the word imitator and think poorly,

but honestly, I mean, that's where a lot of money is made there, folks that are kind of copying what you're doing. We've just got new ways of disseminating information, disseminating that content. I think it could be argued very effectively that SI has been completely asleep at the wheel when it comes to this stuff. Um, and so, yeah, it, it, it's a shame to see a brand that carried so much sway for so many years really kind of lose its status, but it has. And, and I don't know that the brand itself is even enough really to get it back. Yeah. Yeah. I think that's a really good point. You know,

it's, it's, it's interesting because I mean, we've seen so many brands go this way and there's, there's always the chance that, that Authentic finds someone else to manage it. But, but at this point, it's, you know, it's not, not the happiest way to, to see it go. No, it just, it requires constant attention. It requires reinvention. You can never take your audience for granted. It's just, it's, it's not something where you can rest on your laurels. And it feels to me like maybe SI for a while, really kind of, uh, perhaps is a little bit, a little bit guilty of, of maybe resting on its laurels. And I think that's kind of gotten where they are, where they are today. Yeah, yeah.

A brand is a living thing. Well, thanks for breaking it down with me today, Jason. Thank you. You just found out that your sales team is at risk of missing quota. Don't panic. Just ask Rippling AI. Since it's built on your real-time people and business data, Rippling AI can pull metrics from Rippling and Salesforce

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Sign up for exclusive access today, rippling.ai slash fool. 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. You may know H&R Block as a tax prep company, but that's just one part of its growth story. I caught up with the chief strategy and small business officer, Jamil Khan, for a conversation about how H&R Block is harnessing artificial intelligence and what he's seeing in the gig work economy. I think most people think of H&R Block simply as tax prep. We've all seen the commercials, but what would you like people to know about the company as a whole as we get started here?

Yeah, I'd agree that our core competency is tax prep. You know, we meet the needs of our clients by blending human expertise and cutting edge tech to maximize their tax outcomes. But I also share as a company, we do so much more than seasonal tax prep. You know, through our small business block advisor services and spruce, our mobile banking app, you know, we're meeting our customer needs throughout the year. And whether our clients are a single mom, a small business owner who's owned a plumbing business, or an Uber driver who has a a side hustle, you know, we're committed to maximizing their financial wellness and providing a human touch too. Interesting. I'm curious about Spruce because I don't think most people would

associate H&R Block with banking. Can you tell us a little bit more about that? Yeah, absolutely. It's not my area of expertise, but I'll give you a little kind of high level. You know, it's a mobile banking app. We launched it about a year ago. And really, it's providing checking accounts, savings accounts for clients. It's no fee. And it's really, you know, we've had some great feedback from our clients. We have both, you know, H&R Block tax clients who use it and also people who just use the app by themselves as well. Interesting. So, you joined the company in 2019. Of course, you'd heard of the company, probably seen it from afar. What surprised you once you got on the inside? Yeah, I think that's a great question. I mean, my biggest surprise

was just how big the growth opportunity was for us as a company. You know, we'd been flat for many years, and the reason I joined is I saw some growth. But, you know, once I got a little closer and a peek under the hood, so to speak, you know, I could just see the opportunity. So we had three lines of business, consumer tax, which we're really well known for, and that's how everyone thinks of us, small business, and financial products.

And we were best known for, you know, as I mentioned, consumer tax at the time. where I really didn't realize just how big the growth opportunity was for the other lines of business, which included small business, financial products. You know, they were meaningful, established businesses, but with a lot more upside. And over the last few years, we've realized some of that growth, and it's been a pretty exciting journey. I'm sure it has. And of course, last year, it probably got a lot more exciting with generative AI and the AI craze that I think has swept up every company. And, you know,

even from the outside, I can see some potential applications for H&R Block. As a chief strategy officer, this thing comes at you. You see everybody integrating AI. How did you start the process of thinking about how it would work with a company? You know, we tend to really think about the customer and start with the customer, because everything we do is for our customers. So, I'd say, you know, speaking to Block Advisors, which is the brand we go to market for with small businesses, we knew that small business owners feel pressure to make the best choices for their company. Entrepreneurs often want to know what should they be doing now, what should they be doing in the future to optimize their taxes. And these needs really inspired our AI tax assist

product, which we launched in the last month or so, which helps clients who choose to do their own taxes. So this product is an AI product. It helps them efficiently work through their tax preparation process, answer questions, as well as give it specific guidance on tax rules. We're still in the first innings. We're still learning a lot here. But, you know, that's really how we started thinking about this. Interesting. So, I'm assuming that you would have to sort of figure out a large language model of all of the rules and regulations across the entire country. Like, how did that even start? How did How did you even start that process?

Yeah. Think about it a couple of ways. So, firstly, we have a partnership with Microsoft and their OpenAI service that's helped us a lot. And we've really taken that partnership and their technology, and we've combined it with our own expertise. So we have an organization called the Tax Institute, which is also our internal think tank, which really helped us update those thousands of tax law changes that occur every

year at the state level, at the federal level, at the city level. And we're making sure our model works in conjunction with the LLNs we have. And really, it's kind of providing answers. And we've seen, you know, it's been running for about a month now. And we've seen it having an impact on our customers. I'm curious about the ways that people choose to interact with H&R Block, because you've got this AI, and I'm assuming that AI maybe doesn't necessarily connect with everybody. buddy. You know, some people really want to use AI driven tools. Some people really want to go

into an H&R Block office and talk face to face with someone. What are you noticing in terms of who wants to do what? Are there demographic differences? What do you see? Yeah, I'd say, you know, it's less so around demographics and more about kind of customer need and their want and where they are. So we think about our customers. We have customers who what we call do DIY tax. That's you're doing your own taxes. You do it online. And that's where our AI tax assist is really helping them now. I can share some examples of stories I've heard already. But then you have customers who want a human. They want a human. They want their tax professional to help them. And you can see them in a couple of ways. There's those who want human help but

never want to go into an office. They'll send their details. They'll work by phone. They'll work by email. It's how I get my taxes done with my tax pro for five years now. And I haven't yet met my tax pro and it's all done virtually it works really well but then i can tell you that most uh most americans live within a five mile drive of an hr block office and we have you know thousands of clients millions of clients who are coming in into an office they want to meet meet meet their tax professional shake their hand ask them questions and sit with them so we we have different options for how they want to interact and i'd say that they all cut across different demographics. It's really about the need for the client and what they're looking for.

Well, thinking about the small business aspect of things, one of the trends that I've been following, it just has to be the gig economy, the rise of entrepreneurship and side hustles. It seems to me that that gets even more complicated. What types of shifts are you seeing and what are people kind of asking for on that front? Yeah, that's another great question. First, I'll say, yes, we've seen huge growth in this space, in the gig space, side hustle, people use different words. And I'd say one of the biggest things we've learned and one of the biggest trends I've seen is that gig workers don't know what they don't know. And let me explain what I mean by that. The best example is many

of them don't realize that in the eyes of the US government that they're classified as a small business. And that comes with burdens and additional reporting needs, but also a ton of opportunity as well in terms of being able to deduct expenses, amortization, different tax things you can do. So that's been a real big trend and just showing, hey, you're considered a small business now and how we can help optimize you and your taxes is a big part of our business. How do you get the word out for people who may not know they're a small business? Yeah. So firstly, it's, you know, it's, you know, when people come and see us in person, you know, we have to explain to them. So like, you know, you're doing a Schedule C now,

you're considered a small business. I'd say a couple of things we're learning. One is when you tell someone you're considered a small business and they are doing selling on Etsy on the side, they're like, that's not me. Or they're driving for Uber. They don't see themselves as that. So what we'll often say is, hey, here is your, you know, here's your tax situation here the implications of that so i think you know using language they're comfortable like you know you're a gig worker or you work for uber and we'll talk to you in those terms as opposed to you know we've had some robust debates sometimes our clients say i'm not a small business i was like well you know this is just how your taxes play out and how we can optimize for you i'd also

say and i was going to say before the other thing we help you have a trend we see with gig workers as they get you know bigger and grow their lives get more sophisticated and more complicated and there's a ton of new regulations. So for example, I don't know if you've heard of it, but the new beneficial owner information guidelines that the U.S. government asked you to report, they started in the last month. We believe 32 million small businesses, which includes gig workers, are going to have to register their business. In fact, let me just do a redo on that. Not all gig workers, but some of them will need to do that. So I don't want to scare people off here. But they're going to register their business and we help them do that with new services we have. As they get even

bigger and they become more professional, they may need bookkeeping. They may even need payroll to pay others or pay themselves. And we see some people start as a gig side hustle and that can end up in a full-time job, which is just an amazing part of the American entrepreneurial experience. So what are you watching in general beyond tax prep as growth areas for H&R Block in general? Yeah. If I think of the small business area that I oversee, I'd expect there to be growth in all the areas. Let me say, if in small business tax, we'll benefit from the growth of gig and side hustle workers. As those businesses mature, we expect bookkeeping and payroll to grow as more people need that. As I mentioned to you, we're just getting started with the beneficial

ownership service that we have and I think that has a lot of potential and we're also helping our clients think through the implications of registering their business becoming an LLC or other forms of registration so I think all of those have you know a lot of headway you know our biggest share relative is in tax and we think there's a lot of upside in all the other areas so I'm pretty excited about the coming years and it's going to keep us all very very busy. 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. I'm Deidre Willard. Thanks for listening. We'll see you tomorrow.