Motley Fool Hidden Gems Investing - This Is When Amazing Companies Are Born

Episode Date: August 10, 2022

While some tech companies announce lay-offs, others are posting blowout earnings. (00:21) Deidre Woollard and Tim Beyers discuss: - How a decrease in consumer spending is hitting SaaS companies in unexpected ways. - Why The Trade Desk is thriving in a tough environment. - A “cautious” view on tech layoffs (and why we aren’t hitting the panic button). - Why Walmart might join the streaming wars. - A brilliant, tiny company that’s not getting enough attention from investors. Plus, (15:00) Jason Moser and Matt Argersinger look at how companies are managing their share count, and one homebuilder that’s outperformed Amazon for more than a decade. Stocks mentioned: DDOG, TTD, WMT, SNAP, GRPN, JAMF, META, NVR, LOW, NVDA, AMZN Host: Deidre Woollard Guests: Tim Beyers, Jason Moser, Matt Argersinger Producer: Ricky Mulvey Engineers: Dan Boyd, Rick Engdahl Learn more about your ad choices. Visit megaphone.fm/adchoices

D' The Trade Desk posts blow out earnings and will tell you about a homebuilder that's outperformed Amazon for more than a decade. You're listening to Motley Fool Money. Welcome to Motley Fool Money. Today, we are looking at those CPI numbers and the potential for more tech layoffs. I'm Deidre Willard, sitting in for Chris Hill, and I'm joined by Motley Fool Senior Analyst, Tim Beyers. Hey, Tim, how are you today? I'm well, Deidre. How about you? Doing well. A little hot here in the Alexandria area, but hanging in. Yeah, it's hot all around the world here. But, you know, I got my caffeine.

The wake-up juice is warm, which means I'm ready to go. Well, speaking of things that are warm, inflation. So, numbers came out and the annual rate of inflation, according to the Consumer Price Index, is holding tight at 8.5%. So, good news, unchanged from July, mostly because the gasoline index fell while the cost for food and shelter rose. So, it's kind of this mixed bag. But the thing that I keep coming back to is the high price of food. So, the food index has increased 10.9% over last year, which is the largest price increased since may 1979 tim do i need to stop eating i think we all need to stop eating didra yeah this is this is not great and i think we're gonna see more stories of people

really having a tough time here because these are essentials i said i think what we're seeing is that essentials are getting more expensive i've seen this recently i'll just give you a really a lame example but over the weekend i bought like a roast chicken and used to be able to go to the grocery store and you could get two roast chickens if you had like your grocery loyalty card you get two roast chickens for 10 bucks now it was one chicken for 8.99 it's like okay that's for real that's new yeah yeah i mean the thing that i'm thinking about with this too is because it's in our faces, we all go to the grocery store at least once a week. Is this going to start really impacting consumer discretionary? Because we've still been in that kind of revenge spending

mode, but I'm starting to wonder how fast is this really going to start impacting discretionary? There's no doubt it is. And it's certainly affecting guidance. I'll give you just one company that's talking about this. So in the most recent quarter when Datadog reported, Now, Datadog has nothing to do with consumer business. It is a cloud infrastructure provider, but it does have companies in the consumer discretionary sector that are just watching their spending. And so when Datadog issued guidance, they said, look, we have clients in the consumer discretionary spending. It looks like they're taking a look at all of their spend and their biggest buckets of spend. And Datadog has both a subscription product business model

with usage attached to it. And so there are ways for those consumer discretionary companies to dial down some spend. So Datadog just issued conservative guidance. It was still really strong, but they did call out the consumer discretionary sector and said, yeah, there's there's some caution there. We're going to be really conservative in our guidance. So, it is impacting, I think you're right to be thinking about this, Deidre, it's impacting companies across the sector, not just the consumer discretionary companies, but companies that are actually doing business with those companies and how they are generating revenue from those companies.

That is a really interesting point because you're absolutely right. We tend to think about retail, restaurants, grocery stores, the things that people are interacting with, but you're absolutely right, there's all of these other impacts that go all the way down the line. Which brings me to our next segment. Earnings have been a mixed bag, but one of them that was really good the last couple of days was the trade desk. People have been saying there's going to be this bumpy road for advertising, certainly tying into that consumer discretionary thing. We've seen Roku got walloped, Meta, not so great either. Trade Desk is forecasting 28% growth in Q3. What's the advantage for them here? Well, I think a couple of things.

They are focusing on an area that's really important, which is first-party data. Things have really shifted. In the case of the Trade Desk, where they're buy side for bid-level advertising. There is a real interest in figuring out how to work with customer data, first-party customer data directly, and build advertisements around that instead of things like cookies, which are going the way of the dinosaur here. So the trade desk, pardon me, has been pretty early on this in trying to figure this out. I think because of that, I think we're seeing the benefits of that. They're getting some more business here. They're becoming a provider of choice for a platform of choice, I think I would say here, but we're going to see a lot more of

this. Advertising spend will not go away, but I think two things will happen. The first is that it's probably going to be sharpened. So some budgets will be cut, but then the budget that remains, how do you get the most out of those dollars? And so you might get the most out of those dollars by looking at your existing customer base or cohorts like your existing customer base and putting advertisements in front of those cohorts because you've got more data about them. You're not really trying to guess, am I in the right demographics, figuring out, am I in the right space? I think I might be in the right space. The cookie data tells me this. Instead, I'm getting really focused using first-party data to get out in front of the customers,

where I think the chance of spend is much higher. I think it's targeted and interesting, and that's good for the trade desk. Is there any concern about the streaming consolidation and how that might impact Trade Desk? Because I was thinking about, we heard those rumors about Walmart making a Walmart Plus streaming service, and yet on the other side, you've got HBO Max and Discovery and that sort of consolidation. How is this all going to play out? I don't know, but I am strongly rooting for Walmart Plus streaming, if only because Walmart Plus is really interesting as an idea. It's cheaper than Amazon Prime. It has most of the things that Prime has, including free grocery delivery, but it doesn't have

the extras like the original programming. All of that to say that there are more platforms than ever for placing things like advertisements. I think the streaming boon or maybe the normalization of streaming versus linear TV is a real tailwind for first-party advertising where you're using first-party data to create relevant ads and put them in front of people. You want to make the ad tier on some of these streaming platforms relevant and profitable. They ought to be really good for the advertisers. And that requires a different level of engagement. And so using first-party data is going to be really important. So I think it's probably a net tailwind for the trade desk, but it's just too early to tell, Deidre. I mean, we're in the formative stages of this,

so calling it right now feels really presumptive, but it sure looks like a tailwind to me. Interesting. There's so much happening there that I find really fascinating. Another reason I want to talk to you today is because you and I are probably both studying tech layoffs from different angles. I'm studying it from this office space perspective. I'm watching my real estate investment trusts, especially in markets like New York City and San Francisco, and I'm watching what some of the big companies are doing and trying to figure it out. You're probably studying it more from this tech company perspective. I saw that Snap's doing another round of layoffs.

Groupon just laid out about 15% of the workforce. Should we be worried? I'm worried. Are you worried? I am cautious. I would not say worried. I'd say cautious. And the reason is because this does happen.

This goes in cycles. And unfortunately, Silicon Valley and the tech sector broadly has a habit of spending wildly and then you know cutting to the bone and those two extremes you know continue to exist through cycles and it really stinks so i think there's going to be more layoffs to come uh there's a tracker called uh layoffs.fyi which show a lot of you know they just kind of put in the latest layoffs and it's it's heartbreaking to look at you can see that there's there's a whole bunch um i would say it's more likely that the pain is going to be at the private company maybe around series b series c financing uh or like trying to get to that financing and having

trouble making the capital work for a longer period of time. They end up having to lay people off. You get real talented people that push back into the workforce. What's going to be interesting about this, Deidre, is you're going to have a lot of really talented tech workers, particularly engineers, marketers, product designers, people like that, who may throw up their hands and say, forget it. I'm moving to the middle of the country because I got a package, six months of severance or whatever it is. I'm like, I'm out of here. I'm leaving. That's really interesting for the companies that have committed to hybrid and or remote work. It's going to be fascinating. I predict there's going to be a rush of really talented people who sign up for the remote-first companies that are doing really interesting tech work.

Like, we don't care where you are. If you're in the middle of Iowa, fantastic. We'd love to have you. So I can see that being very interesting. It's probably more favorable for the companies with a lot of capital right now. So think the bigger companies. and probably a lot worse for these smaller mid-tier companies that were hoping to IPO in the next two years and may find that a lot more difficult now.

Yeah. The amount of venture capital, it was wide open for a while and now it's just narrowed. I know Y Combinator is doing a smaller cohort. There's all of this stuff happening. But I think what you said there is really interesting because, and I know you've talked about this before, is the idea that in these periods, it's sort of like after the dot-com bust, that's when the really amazing companies are born. So right now, there is some engineer who maybe got laid off or sees what's happening in his company. He's like, nope, I'm going to go start my own thing. And we don't know what that thing is. It could be five years from now. It could be 10 years from now. But it's probably going to be a thing that changes our lives.

Sometimes when I'm feeling a little depressed about this sort of thing, I think about those people who are out there and building the next thing that I'm going to love. That is exactly right. These are the best times for entrepreneurship. There is absolutely no doubt about it. You can bet that venture capitalists are paying attention to this. The venture capitalists that are putting real money to work at the seed and A stages, early stages of the company, those are the venture capitalists to be watching. The ones that are putting a lot of money or have stopped putting money into the late stage companies, those are the ones that are giving up too early. Really, those were the ones that were looking for an easy

payout and they're going to get out of the game and that part of the market is going to dry up a little bit. So yeah, it could take some time for these companies to emerge, but you're 100% right. It's a brilliant time for entrepreneurship. Also, if you're a public company investor, it is a brilliant time to be watching companies that are being widely ignored, but still have capital. And they're not just going to go away. So I'll give you one that I think is small, but beautiful in this sense. Like Jamf, J-A-M-F, they're a tiny little company that nobody cares about, but they still provide a really valuable service orchestrating Apple devices in the enterprise. They are not going away, Deidre. They have capital. They've been around for a long

period of time. They get zero attention. They had as far as their earnings go, but they are not going away. Is it going to be a blockbuster over the next 10 years? I have no idea. But what I do know is that in a time like this, when things are weird and difficult, a disciplined company like that becomes more valuable. Well, Tim, I love that we started off a little bit depressing, but we've wrapped it up on an optimistic note. Thank you so much for chatting with me today. Thanks, Deidre. Up next, a reminder that just because a company is buying back stock, that doesn't mean you win as a shareholder. Jason Moser and Matt Argersinger talk about

some companies that are handling their share counts well, and some that could use a little work. Hey, Matty, it's great to catch up again. Today, we're jumping into the wide world of watching your company's share count. Now, this is not a metric that you see published often, but it is a very valuable one that can offer some clues as to how management is allocating capital And it, of course, plays along with the share repurchases. Another headline we see often, something management will often do to try to return value to shareholders. But it's not always a case of everything being as it seems. And when I say that share count is not something we often see published, I mean in the financial media, right? We have ways that we can

find it. And, Matty, I think that's really what I want you to start us off with here. So, first and foremost, let's start with, what is the share count? And furthermore, where can I find it? Yeah, you bet, Jason. Great to be with you. So, share count, I know most people listening probably know what that means. But share count refers to the number of shares a company has outstanding. So, just remember, when a company goes public or wants to raise money from the equity markets, it usually issues shares to do so. Some of these shares are held by insiders. but for a typical company, most shares are held by institutional investors, banks, and investors like us. As you know, Jason, we like to talk about the size of companies

a lot on this show. We usually talk about the market capitalization or market cap. Well, to figure out the market cap, you can simply take the number of shares outstanding, multiply it by the company stock price, and bam, you have the market cap. For example, I was looking recently at a company called Iron Mountain. Iron Mountain has just under 300 million shares outstanding. Its stock price is around $50. Multiply those two numbers together, and you get $15 billion, which is roughly the size of Iron Mountain's market cap. One pro tip, or maybe semi-pro tip, generally want to focus on diluted shares outstanding. You know that, Jason. Rather than basic shares, the diluted share count includes all stock options,

restricted stock that haven't invested yet, but are likely to. To be more conservative, you want to focus on the diluted share count. As to where to find the info, I don't know if you have a preferred way. I tend to go to the source. You can go to a company's investor relations site, look at the press release for just the most recent quarterly earnings, for example. That should have an income statement. Usually, at the bottom of an income statement, you'll find the list of basic and diluted shares outstanding. You'll see the number there. Let's take this one step further. Share count, I like the mechanics of that and how you explain how that helps us determine the size of a company. We also see in the financial media often,

a big headline, companies love to get out there, share repurchase authorization. We are buying back our own stock. And on the surface, that just sounds like such a bullish sentiment. Wow, the company thinks their stock is worth buying. Well, certainly, I should buy it, too. Let's talk a little bit about share repurchases. What are they, and why do companies do them? Right. In stock market history, it's a relatively new phenomenon. I blame Warren Buffett a little bit. If you go back, he was the investor that was writing about share buybacks and was encouraging a lot of companies like The Washington Post or Coca-Cola, the companies where he was sitting on the boards at the time, to buy back their shares because he

thought they were cheap. That's, of course, why Berkshire Hathaway was buying them. And it kind of took off, I think, especially in recent decades. I think a lot of companies with excess cash or generating a lot of cash don't often have a really good way of putting that cash to work. A lot of the reasons is because there aren't really good places to put that to work. They're not finding good ideas to earn a good return on capital. So, why not buy back my own shares? Because I think it's undervalued, and that's a good place to invest our money.

And shareholders like it because the one thing shareholder purchases do, if they're done correctly, or I should say, if they're done in a vacuum, let's say that, they will or should bring down the share count. If you bring down the share count, that means your ownership stake as an investor in the company rises, and the company's earnings per share will go up, not necessarily because the company's raising earnings, but because the share count's going down, so the denominator of earnings is shrinking, which means the earnings per share will increase, That usually increases the value of the overall company. It's a popular practice and one that's been put in place a lot, especially recently. Yeah. It feels like you have two basic ways

in returning value to shareholders, share repurchases and dividends. One being that cash-in-the-pocket dividend. I know a lot of people love that. The other, share repurchases. it can be a little bit more theoretical as to whether it really does enhance the value of that stock. I think that's ultimately what I wanted to get into here next. We want to look at some examples of companies that do the share repurchases well, that they do them effectively. And then also look at some examples of companies that, yeah, they're repurchasing their own stock, but maybe it's not having necessarily the effect that you would hope it would. Let's start with a company that does a good job with share repurchases.

What's an example you have for us? One company that comes to mind for me is NVR. The ticker is NVR. They're one of the country's leading homebuilders. They're legendary, almost, for buying back their shares. They've done it really since they've been a public company. It's one of the best-performing stocks, actually, over the last 20 years. believe it or not, NVR has actually outperformed Amazon, if you start from the beginning of the century, January 1st, 2000. But that aside, I mentioned their big share purchases. Over the last 10 years, they've spent about $7 billion on share buybacks. It's pretty big. The company itself is only about $16 billion. By spending that money, they've been able to reduce the

outstanding share count by more than a third. A lot of those billions were spent when the share price was much, much lower than it is today. One of the things I like to see is, if a company is investing in their stock, then I want to also see earnings power increase. If you look at earnings per share over the last 10 years, it's gone up almost 14X. You have a company that's share price is way up, earnings are growing, they've been buying back a lot of shares, investors have done really, really well because of those efforts. Yeah, great example there. One that came to mind that we'd spoken about recently on an episode of Motley Fool Money is Lowe's. Lowe's, interesting business because it had,

up to this point, been in a little bit of a turnaround. I think that CEO Marvin Ellison has done a wonderful job getting that company back on track. We know the home improvement space is just a wonderful one, very resilient. Lowe's has spent $29.5 billion over the past five years in repurchasing stock. The good news for shareholders is that their share count has followed suit. It's down almost 23% all the way back since 2018. They're buying back a ton of stock. They're bringing that share count down. And oh, yeah, by the way, Lowe's is a dividend aristocrat, so they pay a dividend on top of that, which I think is just really cool to hear. Double whammy.

Yeah. Shareholders have really been winning on both fronts there with Lowe's. Another good example of a company that's done it fairly effectively. What's an example of a company that you feel like is maybe not doing it so well? Well, you mentioned Meta Platforms, formerly Facebook, earlier. They started buying back stock pretty meaningfully about five years ago, but really stepped it up over the last couple of years. In fact, over the last five years, they spent around $105 billion buying back stock. Just in the last 18 months, they've spent about $70 billion.

Really gotten aggressive. Roughly a quarter of Meta's current market cap is a stock they bought back. But if you look at Meta's shares outstanding over the last five years, down less than 6%. They spent roughly 25% of the market cap buying back stock, but the share count has not shrunk that much. Of course, like a lot of companies in the big tech space, Meta issues a lot of shares because they're paying out a lot of stock options to employees. It's part of their compensation practice. That, unfortunately, offsets the vast majority of the share buyback money they've invested. Yeah, well, I've got a bad example. It's in line with what you're talking about there with Meta. Actually, it's a business

that I think a lot of folks in our universe love. It's a company that's performed very well over the past several years. But Nvidia, you go all the way back to 2018, and they've spent $8.5 billion in share repurchases. The share count has actually gone up. That's the opposite. That's the George Costanza. They're doing the opposite of what we're looking for. To add even more confusion to the mix, though, and this is what I found very fascinating When I was looking at both Lowe's and NVIDIA, when you look at the performance of both companies' share prices over the last five years, NVIDIA is up 313%, Lowe's up close to 160%. Even with that less-than-effective share repurchase strategy, NVIDIA shares have performed very well.

Speaking of Meta, I wonder if maybe one of the reasons why that is, is when we talk about tech companies, tech companies have a reputation for really using those repurchases to offset that share-based compensation. If the expectation is already set going in, then there aren't really any surprises. I wish that Nvidia was bringing that share account down, but it seems like the market more or less is giving them a pass and saying, we know that it's more or less just to offset share-based compensation, and we're still OK with that. Yeah, that's true. And I think that's okay. I think companies that are growing earnings, like NVIDIA or as Meta has done in recent years, they definitely get a pass. They should get a

pass. I mean, share repurchases shouldn't be the reason any kind of company that you're going to invest in the company because they're buying back stock or because you think the share count is going to go down, so earnings per share are going to get used. I mean, it really still comes down to earnings power. And those companies have demonstrated tremendous earnings power in recent years, and they should get the benefit of that. I still question investing so many billions of dollars in doing that. If you really want to return value to shareholders and you don't have any better way to do it, consider doing a dividend, because at least an investor gets to make the choice, and it's not being made by the company's CFO or the board, which may

not have the investor's best interest, especially if it's being used to offset, as we talked about, share-based compensation. Before we wrap up here, I just wanted to get your take real quickly on a bigger-picture issue. Obviously, we don't get political here on these shows, but this is something where politics intertwines here. It's the Inflation Reduction Act, which looks poised to pass. This is going to include a 1% excise tax on share repurchases. My question is, 1% doesn't sound like a lot. Do you think this will have an impact on how companies approach share repurchases in the future? I'd love to get your opinion, too, Jason. I don't think 1% is quite enough of incentive

for companies to stop buying back stock. You have to remember, the cost of equity, depending on how much risk you're weighing, can be pretty high, ranging from, say, 8% to 12% for your average company. If that's my cost of equity, a 1% haircut feels like a pretty low bar. However, we talked a little bit about dividends. I do think it will cause a few companies to consider paying a dividend rather than do buybacks. If not the companies themselves, I could see more shareholders, institutional investors demanding it, hey, don't do a buyback and incur this extra 1% cost on our capital when, you know what, you can just keep paying a dividend or pay a dividend to us, let us decide what to do. Especially when you consider there's so many

bad examples, and we just mentioned a couple, but there's so many bad examples of companies who just don't do share buybacks well at all. I mean, gosh, we didn't bring about Bed Bath & Beyond, which I think has spent three times its market cap on SharePoint buybacks. But anyway, most companies just don't do really well. Maybe this will just be another little kick for companies to pay dividends instead. Yeah, I think I'm with you. I think for the most part, it probably doesn't have a material impact. It really is just a rounding error for many of these large authorizations. It ultimately bumps up the cost basis by just a smidge, but it may force some companies to rethink their dividend policy. Maybe that's

not such a bad thing. 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 Thanks for listening. We'll see you tomorrow.