Motley Fool Hidden Gems Investing - Wake Me Up When September Ends

Episode Date: September 1, 2022

When it comes to the stock market, the 1st day of September is looking an awful lot like the entire month of August. (0:25) Jason Moser discusses: - Okta shares falling 30% as the company deals with ongoing challenges integrating its acquisition of former rival Auth0 - Snap's restructuring plans, layoffs, and increased focus on revenue growth, user growth, and augmented reality - Five Below's stock getting a boost from optimism for the discount retailer's plans for the holidays Host: Chris Hill Guest: Jason Moser Engineer: Rick Engdahl Learn more about your ad choices. Visit megaphone.fm/adchoices

Volvo is leaving the chaos of rush hour outside. Start by settling into your saddle-stitched Nappa leather seats. Notice the open space around you. Uncluttered, elegant, intentional, warm ambient light, and natural wood details to ground you. This is Volvo's Scandinavian sanctuary for every journey. Learn more at volvocars.ca. Optional features mentioned. Chris Hill. I don't know about you, but the way stocks have been going lately, I'm looking forward to the market being closed next Monday. Motley Fool Money starts now.

I'm Chris Hill. Joining me today, Motley Fool Senior Analyst Jason Moser. Thanks for being here. Jason Moser. Hey, hey. Chris Hill. Happy September 1st. Jason Moser. Well, Chris. I was going to say, I'm so happy that August is over, but in terms of the stock market, September 1st seems to be picking up right where August left off. Well, it's conflicting, right? I mean, it is welcoming in sort of the idea of fall and like the change in seasons. I love this time of year, but yeah, I mean, it is worth noting, as difficult as August concluded, yeah, September doesn't have a very good track record when it comes to the

market. It's reasonable, at least I think, for investors to keep their expectations in check here and maybe prepare for a tough month ahead. Let's hope for the best. Let's try to be glass half full. Let's prepare ourselves for the possibility that the tough times may be here for a little bit longer. Let's try and be glass half full, although I think that's going to be challenging given that the first thing we're going to talk about is Okta, because Okta's second quarter profits and revenue were higher than expected. Their guidance for the rest of the fiscal year was in line with expectations. But shares of the identity management software company are down a whopping 30%. Help me understand this. Management

talked about the challenges they're running into with the integration of the acquisition they made of Auth0, I get that. 30%, that's a lot. I don't want to just come out and say, well, this is an overreaction, but it sure seems like one. Well, I could certainly understand that sentiment based on the results and the near-term outlook that management quoted. It was a good quarter, it was a respectable quarter. And at least in the near-term, it does seem like they feel like they'll have some control over the cost side of the business for the remainder of the year. They suspect they'll continue to witness the top-line headwinds, but the aim is to focus on improving costs in order to ultimately bring some bottom-line performance

into the back half of the year, and that's encouraging. But I think that when you look at, there was a point in the call where, and I think this is really what has the market spooked, management talking about headwinds and enterprise software, this is not just Okta, I mean, we're seeing it across the board with all of these companies, but ultimately forcing them to reevaluate their longer-term targets. And so, they basically pegged this $4 billion revenue target for fiscal 26, they're taking that off the table, they're basically reassessing the situation. And And so, when you look at the longer-term picture, when you look at the next few years, I mean, anytime you see management basically take those aspirational targets off the table to

sort of reassess, I mean, the market is going to, at the very least, put things on pause and try to reassess as well. But most of the time, in particular with a business like this, I mean, you're going to see a lot of dumping there. I mean, because even today, I mean, this is still not by any stretch of the imagination what we would call a cheap or affordable stock. I mean, it's still valued at somewhere around 10X sales, and I mean, it's a business that doesn't make any money, there's zero profits, I mean, there's zero free cash flow.

I mean, you have to account for stock-based compensation with a business like this, it's 40% plus of total revenue and that doesn't look like it's going to be changing anytime soon either. You put that all together and I certainly understand the market's concerns today. The stock has fallen to more than a three-year low. You talk about hitting the pause button. I can see some investors looking at this and looking at how far this stock has fallen and think, oh, this might be a buying opportunity. But it sounds like, based on everything you said, there are enough question marks about where they're going over the next 6, 12 months that sounds like you personally, I don't want to put words in your mouth, but is it safe to assume

you personally would want to see some progress from the business side before you maybe bought shares of this? Yeah, I'd say that's a fair statement. I don't own Okta shares, I've not recommended the stock. I do find it to be a fascinating business. I like what they do, generally speaking. But yeah, it does feel like there are a lot of question marks that I'd like to see a little bit more clarity on. When you look at the OffZero deal, for example, integration there is presenting some near-term challenges, that's impacted the business. They referred to in the column, seeing the tightening of IT budgets, the spending is being delayed, they're seeing longer sales cycles. It's very consistent with what we're

hearing from other enterprise software businesses. You have some leadership changes there, the co-founder and COO of the business is going to take a year-long sabbatical, the Chief Product Officers taking off as well. And then you couple that with just the nature of the business, the business itself, the stage of its lifecycle. It's still a young business, still growing, still investing a ton back into the business, which of course impacts the profitability picture, and that's something to keep in mind as well. And then the longer-term revenue target now up in the air. It's not to say this can't be a successful investment from here. I think the chances are pretty good that it will be actually.

When you look at the actual numbers, the business continues to perform pretty well. Revenue was up 43% from a year ago. Subscription revenue being such a strong driver of the actual business added 600 new customers in the quarter, now have 16,400 customers and that was up 26%. They continue to do well on the larger customer side too, and the dollar-based net retention rate holding the line at 122%. There are a lot of positive indicators that what the business is doing, its customers are liking. They're signing up more customers, they're expanding those relationships. There are some near-term challenges clearly on that off-zero acquisition, that'll take some time, of course. Then just to get a little bit more clarity on where they see

the next few years for this business, I think would be helpful for investors. It's very understandable on a dip like this to feel like, oh, okay, this is an opportunity. It could be. I mean, if you're interested in this business and you don't own shares yet, maybe this is a time to dip a toe in the water. I'm not telling investors not to add shares on this dip, but do so understanding the challenges and the question marks that exist, why they exist and ultimately what we're going to need to see to get some resolution there. I want to get your thoughts on something that happened a little bit earlier in the week. Snap announced it's laying off 20% of staff as part of what appears to be a major

restructuring. Snap says they're going to be focused on three areas, user growth, revenue growth and augmented reality. As part of that, they are discontinuing several initiatives, including their photo-taking drone and original programming and games. The stock, which has been crushed over the past year, popped about 10%. This is a business you and I have talked about since before it went public. What did you make of these announcements? Well, I think it's a good move. I mean, obviously, it's a painful move, of course, for those who will be losing their jobs. And that's a significant number. I mean, you've got close to 6,500 employees as of the most recent earnings report. So we're talking around 1,300 people that are

going to be impacted by this and their families. And so, I mean, that's something always to keep in mind. Tough obviously from that angle, but I think for the business, it's absolutely the right thing to do. I think that what we've questioned with this company over the last several years as they redefined what they were, that redefining of Snap into ultimately a camera company and what does that ultimately mean. What came with that was the pursuit certain hardware aspirations, the spectacles, the little flying drone, things like that, that really the investments, they just haven't seen the return on those investments. I think it made sense to dabble on the content side because you want to create a reason for people

to go to your site or to your app. I think oftentimes, just exclusive content is a way to do that. Exclusive content in the social space, I think, is a little bit more difficult these days. It's tough to differentiate. Social content does feel the same across platforms anymore. Ultimately, they just don't see the returns on those investments. This is a business that was spending 40%, still spending 40% of revenue on research and development, which is a lot. You look at Meta, it's like 25%. Even Twitter is something like 30%. I think when you look at Snap and you look at this greater social space, it's interesting to see how the space has turned. It almost feels uninvestable. I think Twitter is uninvestable just because of everything that's

going on with all the Musk stuff and everything. Twitter to me is just uninvestable at this point, because it's such a coin flip. But I think just the greater challenges in the social space, I mean, maybe the low-hanging fruit has been picked. I mean, they are dealing, obviously, with a very competitive environment. You've seen TikTok claim a lot of eyeballs there. So, it makes a lot of sense for them to really get back to focusing on what they know how to do. Community growth, revenue growth, that all makes sense. Augmented reality is something they love to play in with all of their filters. I mean, those are in line with what they know how to do. I think the biggest challenge, the biggest question mark is, what is this beyond just

Snapchat? What is Snap the company beyond just Snapchat? We had some ideas over the last few years of what it could be, but it looks like that's not going to pan out. So, now they're kind of back to square one. It really just boils down to what will they be able to become beyond just Snapchat. And I honestly don't know. I don't know that there is anything that they become beyond just Snapchat. And if that is the case, then from an investor's perspective, you definitely have to question what kind of growth this business could be lobbying up over the next several years because it's obviously become a much more challenging environment for the social space. I was thinking of you when I saw some comments from Joanna Stern from the

Wall Street Journal because knowing your interest in augmented reality, she was making the comment that she was happy to see that Snap was continuing to make those investments in AR because in her opinion, they're doing some of the most interesting stuff with AR so far. Yeah. And I actually agree with that. I mean, the thing about augmented reality and the reason why I think it can have such a greater impact, at least in the near term over something like a virtual reality is because it's bringing the two worlds together, right? I mean, you're seeing, sort of, the digital world overlaid with the physical world. And I think for the mass consumer, I think that becomes a little bit more, just it's an easier hurdle to clear. You could see where it might

have some more applications in your day-to-day life, whether you're on the enterprise side or on the consumer side. So, I do appreciate that they'll continue to make those investments in augmented reality, because they've done so much with it up to this point, there are certain things in regard to mixed reality, immersive technology that are a bit out of their control. And so, we'll sort of see how that plays out as the interface develops and the consumer considers adopting things like that. But it's definitely one of those things it's very much in their wheelhouse. To see them focusing on that, I think makes a lot of sense. Second quarter results for discount retailer Five Below were weaker than expected,

their guidance was lowered, and yet shares are up 6% this morning. In some ways, this seems like the opposite of what's happening with Okta, although not to the same degree in terms of the stock movement. Help me understand this. Is this this seems at least in part due to optimism that CEO Joel Anderson and his executive team were expressing around holiday shopping. That when you go through the conference call, it really seems like they have a plan for the holidays. They weren't revealing all of it, which I wouldn't either if I were them. Because Jason, the results themselves weren't great. No. No, they weren't. They weren't that bad, but they weren't that good. Top-line

sales up 3.5%. You saw comps down 5.8% versus the same quarter a year ago, and that was driven by a decrease in both traffic and ticket. Not surprising. It's very easy to believe that traffic is down and the total ticket is down as well. But it does feel like management is very optimistic. They made this point in the call and now it's all about execution. What I mean by that is they've really focused over the last couple of years of building out the capability of this business in making sure to reach their customer in any way and every way they can, focusing on that omnichannel experience, so to speak. You look at the investments in distribution, for example, they built out this five-node network

ultimately that gives them capability to service basically 90% of their stores within one day now. I think they're very excited about the investments they've made in distribution and completing that investment more or less. Bopas, Chris, you remember last week I said Bopas and you looked at me, you're like, bless you. And I was like, no, that's not it. It's Bopas, right? Buy online, pick up in store, right? I mean, that's something that they are investing in as well as they pursued that omnichannel opportunity. And it was just fascinating. I've seen more Bopas this quarter, more mention of Bopas this quarter on calls than I think I ever have, which it's just funny even

to say the word, but they've rolled that out now in 100 stores in July. They believe they'll have chain-wide rollout of buy online, pay in-store by the end of September. Again, prepping for that holiday season. When you consider the state of the consumer and the state of the economy today, we're dealing with a heavy inflationary environment. The consumer is making all sorts of decisions here in weighing what to purchase versus what to delay. It does seem plausible at least that Five Below could be a decent option for some holiday season shopping, just given their focus on cost sensitivity. You're not going in there and spending a ton of money, but you can walk out with a ton of stuff. I do understand the optimism there.

not to take away from the challenges that the business is facing. Obviously, the numbers for the quarter weren't the greatest in the world. Earnings per share were down 35%, that was in management's range, it's worth mentioning. They pulled back on guidance, they adjusted guidance down on sales about 3%, earnings about 13%, so that's something to keep in mind as well. But they also, they're coming off of just a phenomenal 2021 in the stimulus that flow through the economy and how that ultimately played out in their business. They're dealing with a bit of a difficult comparable to begin with, and I think investors are keeping that in mind as well. On the fence with this one, I absolutely see management's

enthusiasm for the holiday season. I guess it just remains to be seen whether that actually plays out. I agree with you 100% about the potential here in terms of everything we've talked about regarding inflation, the state of the consumer, and we have seen sort of this move towards value shopping. Doug McMillan and his team talked about this recently at Walmart, about the increase in the number of households earning over $100,000 a year shopping at Walmart in the most recent quarter. So it does play into that narrative. There just seems to be on a day when the market in general is not doing well, in a week where the market's not doing well, after a month in which it didn't do well, I just feel like the Five Below management team is getting slightly more benefit

of the doubt than, I don't know, any other business I've seen in the last few weeks. So I'm not knocking them. I'm not rooting against them. I guess I'm just a little surprised that they're getting this benefit of the doubt today. It just feels like maybe the best thing they've got going for them right now, Chris, today at this very moment, is that they are not in enterprise software. And chips. They're not in chips. Exactly. Jason, those are always great talking to you. Thanks for being here. You got it. Thank you. As always, people on the program may have interest in the stocks they talk about, and The Motley Fool may have formal recommendations for or against,

so don't buy or sell stocks based solely on what you hear. I'm Chris Hill. Thanks for listening. We'll see you tomorrow.