Motley Fool Money - How Fools Use ETFs

Episode Date: September 26, 2023

We like stocks. We also like exchange traded funds.  But first, (00:21) Ricky Mulvey and Jim Gillies discuss: - A difficult stretch for small-cap stocks. - Costco’s new healthcare offering. - One piece of Costco’s valuation that’s often forgotten by investors.   Plus, Robert Brokamp and Alison Southwick find out how Fools use ETFs in their portfolios. Companies/ETFs mentioned: COST, CIBR Hosts: Ricky Mulvey, Alison Southwick Guests: Jim Gillies, Robert Brokamp, Kirsten Guerra, Jason Moser, Bill Mann Engineers: Dan Boyd, Rick Engdahl Learn more about your ad choices. Visit megaphone.fm/adchoices

This episode is brought to you by Indeed. Stop waiting around for the perfect candidate. Instead, use Indeed sponsored jobs to find the right people with the right skills fast. It's a simple way to make sure your listing is the first candidate C. According to Indeed data, sponsor jobs have four times more applicants than non-sponsored jobs. So go build your dream team today with Indeed. Get a $75 sponsor job credit at Indeed.com slash podcast. Terms and conditions apply.

It's not very fun being an investor right now, is it? Motley Full Money starts now. I'm Ricky Mulvey, joined today by Jim Gillies. Jim, thanks for being here. Thanks for the invite, Ricky. So it's, I mean, it's a little bit jury for stock investors right now. In the United States, inflation's about 8%. The medicine from interest rates really hasn't kicked in on home prices or inflation. Your beloved small caps are down about 6% right now looking at the Russell 2000. I mean, we're long-term investors, but it's really not fun putting money in the market today. That is correct.

I wrote a little piece last week for the members of Hidden Jems Canada, basically saying, boy, it kind of sucks right now, doesn't it? And I went through much of what you talked about, showed at the time. The SEP 500 was down about 4% for the month as of, I think, last Thursday. Spoiler, it's gone lower since. The NASDAQ was running it close to 6% down. R2K was over 6%. It's probably getting worse.

And the reasons were, I think, because we're seeing all of these wonderful headlines, inflation, rate hikes, more rate hikes coming. The phrase, higher for longer, is enter the lexicon. You know, the Canadian economy, which is where I kind of live, is it contracted last month. You guys at least don't have that to play along. And I think both countries have got kind of, we'll say, some nascent housing problems to probably have to deal with. And I further went through and I kind of broke up the year, the last almost four and a half decades. I broke it up by returns per month. We was here, but oh, the stock market returns about 11% a year, 10, 11% a year, on average.

Not every year, obviously, but on average. But I kind of broke it down at a monthly, just to kind of try to give the members a little bit of a, hey, we acknowledge, kind of sucks right now. But September is really bad, actually. September, if you were to break out the last since 1980, you, you'd break out the monthly returns, returns by month, and just average them. The only negative month, the only negative month has historically been September, with an average of about down.9%. Spoiler, this month is going to contribute to that average, make it worse, frankly. But I said, you know,

like the other thing is if you were to chain link and look at the returns in aggregate for all the other months, they're all positive, some barely, but, you know, some have pretty good. The next three three or four months, October through January, tends to be a very good period for the market. So if all those people who did sell in May and went away, they start coming back, it tends to be pretty good. And then the other thing I want to kind of encourage people to remember is that, you know, the environment kind of sucks. However, you want to be a buyer to steal from Buffett. You want to be a buyer. You pay a high price for a cheery consensus. And what, you know, we've gotten two things this past month, whether the September Doldrum's

extend or not, we've gotten two things this month. We don't have particularly high prices and we do not have cheery consensus across the board pretty much. And so paradoxically, I kind of like those environments, even though pretty much anything I've bought in the past few months or recommended is probably not up just because it's kind of a crap market right now. But remember, these things do not persist and we are long term. Yeah. And I think there's still a at least one worry that I'm thinking about is that the housing market has had a stick poked at it and it really hasn't moved. And that's a problem in the U.S., and I know it's going to, it is a problem in Canada where you're dealing with a lot of more of those variable rate mortgages.

Yeah, exotic mortgages. Hey, our American friends and cousins, do you have any advice on situations where a country piles into exotic-style mortgages? I mean, I feel that you guys have got a pretty good example for us. It's a problem in Canada, certainly, but this is not really a Canadian audience show, so that's fine. But my take on it, the other little piece of data I'll throw out is it's the ratio of kind of the small cap environment. You referenced the small caps earlier where I do play most of the time. The valuation, just kind of the ratio of small caps in aggregate to kind of large and midcaps

in aggregate, that ratio, that valuation ratio is actually over the past 50 years. We are at A load that has been seen once in the past 50 years. We're there again. And the last time we saw this was in the wake of the run up to in the wake of the tech bubble bursting. Again, I think people were kind of, again, you pay a high price for a cheery consensus. What were people buying in 99 and early 2000? They were chasing anything with tech and internet on it, E this or E that.

And so, yeah, small caps kind of got forgotten at that point in time. Today, we've kind of had a little bit of that in 2021 and bursting in 2022. We've got a little bit of the pay any price for these great growth stocks are going to change the world, maybe less of an implosion in some of the larger caps, particularly large cap tech. They're certainly down, but the valuations generally, if you're looking at something like an Apple or an Alphabet, they're not, or Microsoft, they're not low, but they're not unreasonable, in my opinion.

But I do like the fact that we have a nice setup for small caps in terms of valuation. And the last time this happened, Ricky, so I mentioned it's only happened once in 50 years. We've gotten to this low ratio small cap valuations to large and midcaps. In the decade after we hit that low valuation, the large midcaps struggled. In fact, I think the next decade was basically flat. Small caps outperformed rather substantially. So I'm kind of like the setup for the next decade here. Let's move on to a bit of a cheerier story.

Costco, expanding its presence in healthcare. It is linked up with Sesame, a direct-to-consumer healthcare marketplace. They're setting virtual primary care visits at just $29. Health checkups, so basically a standard blood test and a follow-up at $72 and an online mental health visit for $79. Jim, I know you're in Canada, so you're used to not spending a ton of money on health care. But for us Americans, this is a really big deal. We'll focus on the business, though. Costco operates pharmacies, it has independent optometrists

in the store. How important is healthcare to the business of Costco? Well, I do love, as you've kind of alluded to, you're asking the Canadian about the American healthcare system. So thank you for that. So I'm just going to kind of do a little bit of background here. So healthcare, they have independent pharmacies. You say the gas stations in some places, the optical stuff, the food court, you know, the famous $1.50 hot dog, hearing aids, tire installation, all of those things fall into a category for Costco, a revenue category called Warehouse Ancillary and other businesses. Fun.

And you also get e-commerce, business centers, travel, and whatever else in there. So as to how important it's going to be, well, okay, Warehouse andcillary in the most recent full fiscal year, fiscal year 2022, which by the way, I believe Costco reports after hours today. So this information I'm able to give you is precisely a year out of date. But warehouse's ancillary was approximately 21% of total revenues for fiscal 2022. And that's all. That's gas, pharma, optical. So as far as how important this deal will be, probably not much in the near term as a percentage

of revenue. However, as an ongoing piece of Costco taking an ever larger share of the consumer dollar, especially with the perception of low cost or buy in bulk, although it's kind of hard to buy mental health visits in bulk, though probably some people should. This is probably not your typical bulk sale, but you are getting almost bulk. Bulk pricing, I would argue. You're getting a better deal because they, Costco, they are buying a bulk and it's adding more of the, it's adding more fuel to Costco taking an ever larger piece of your consumer

dollar fire. So, so I like that. And the other thing too is that Costco is still a pretty good growth story. Fiscal 2022, again, it's a year out of date, but fiscal 2020 grew grew total revenue 16 percent. Fiscal 2021, they grew total revenue 17.7 percent. The warehouse ancillary has actually been getting better, it's taking a larger chunk. And so it went from 16.5% of total revenue in fiscal 2021 to 20.9% of total revenue in fiscal 2020. That is a near 47% growth rate that year. So I think that's what they are trying to make Costco front of mind for all of these ancillary type things. So when you're going for your 10 gallon tub of mayonnaise, you can also get your hearing aids and your

eyes checked. So in the next couple of weeks, we're going to do a deeper dive on Costco, which I don't know if you know this, Jim. There's new food court items, mango smoothie, roast beef sandwich included, chicken Caesar salad. If you have thoughts on any of them, email us. Our email is Podcasts at full.com. That's Podcasts with an S at full.com. Maybe we'll include your review in the show.

But last question, you know, Costco always seems expensive as a stock, especially when you compare it to other retailers. As a cash flow nerd, how do you square that? Well, first off, sometimes you should be willing to pay a premium for a high quality business. This is a high quality business. For the longest time, because I'm a bit of a pest, for the longest time, whenever I would go to Costco, and I try to avoid going on weekends, so I try to, you know, I'd nip out at lunch hour or whatever, I would always take a photograph from random place inside and text to my colleague Ian

Butler and I would just say, I don't own enough Costco. We should make this a recommendation as Stock Advisor candidate. He finally listened to me, thank goodness. But, you know, so you should be willing to pay a premium for something because it's always busy and everyone's, you know, you look at the size of the carts and what they are putting in the cart. You know, I try to, you go in for some milk and eggs and you walk out with 250 bucks of stuff. You didn't know you needed.

And then another little trick to their valuation is their valuation kind of overstates the value of the business because the thing about Costco is they own, I don't have the number completely at the top of my head, but it's about, I believe, 80 to 85% of the land and buildings for their stores, okay? That asset value is not contributing to earnings or cash flows quarter to quarter, but if they had to, I mean, they could do a giant sale, lease back, and you'd get significant value. So, the way I always try to put it to people is, imagine you own a paid for million dollar house, okay? That million dollar house is paid for us, it's not costing you, well, it's not contributing anything to your bottom line. In fact, it is costing you,

You're paying property taxes. You might be paying HOA fees in America. You, of course, got your maintenance expense. But if you need to realize funds from that million dollar house, you can either put a He lock on it and take some money out. You could sell the place entirely. Now, all of a sudden, boom, you get a million bucks. So there is an asset value here that is kind of obscured in the valuation ratios that people

usually quote. They'll talk, oh, Costco's trading it 30 or 35 or 40 times earnings. Yes, it is. But it is missing a rather large piece of the puzzle that I think you do need to include. And again, just as a premium business, and there's still many more growth avenues, many more warehouses they can open both in North America as well as, you know, in certain other places if they so choose. And eventually, I think, you know, Costco will, once it hits what it perceives to be a saturation type situation,

which is kind of similar to like Home Depot about a decade ago, they'll just turn it into a cash flow engine. Because everything is, too, is the cash flow right now, a lot of it's going into building new warehouses. And at some point, that will stop. And I don't think it's going to stop and immediately drop the total cash. People will abandon Costco at that time.

I think Costco will probably, when it drops, much like Home Depot when they did it, they will probably turn into a giant cash flow engine and then start returning that capital share. holders. Jim Gilles, as always appreciate your time and your insight. Thank you, sir. The old adage goes, it isn't what you say, it's how you say it, because to truly make an impact, you need to set an example and take the lead. You have to adapt to whatever comes your way. When you're that driven, you drive an equally determined vehicle, the Range Rover Sport. The Range Rover Sport blends power,

poise, and performance. Its design is distinctly British and free from unnecessary details, allowing its raw agility to shine through. It combines, a dynamic sporting personality with elegance to deliver a truly instinctive drive. Inside, you'll find true modern luxury with the latest innovations in comfort. Use the cabin air purification system alongside active noise cancellation for all new levels of quality and quiet. Whether you prefer a choice of powerful engines or the plug-in hybrid with an estimated range of 53 miles, there's an option for you. With seven terrain modes to choose from, terrain response two fine-tuned your vehicle for the roads ahead. The Range Rover event is on now. Explore Enhance offer.

at Rangelover.com. Sure, we like stocks at the Motley Fool, but we've got no beef with ETFs. Alison Southwick and Robert Brokamp caught up with Billman and a couple of other foolish investors to learn how they use exchange-traded funds. There is nothing we love more than discovering a beautifully run publicly traded company, investing in said company, and then watching the value of our shares go up and up and up over the long run. Isn't that right, Bill Man?

You know, that is the way that we draw it up. Well, it sounds easy enough. I mean, pick the stocks that go up and to the right. But as Peter Lynch famously quipped in this business, if you're good, you're right, six times out of ten. You're never going to be right nine times out of ten. These are tough odds. But luckily, we live in a world where ETFs exist, which can easily help you diversify your holdings

and spread out your risk. So, today, with the help of a few foolish analysts, we're going to talk about how you should think about using ETFs in your portfolio. Now, bro, for our listeners who might be newer to investing, can you give us just a brief explanation of what an ETF is? And should I make it hard on you by not allowing you to say basket of stocks or bonds? I think I can do it without saying. Okay.

But let's start with the fact that ETF stands for Exchange traded fund. And let's start with the fund part, which just means that it's a way to buy many investments with just one purchase and receive, you know, at least a degree of, professional management in the process. In that way, an ETF is like a traditional mutual fund. However, the difference is that exchange traded part. So the prices of ETF's changed throughout the trading day, and you can buy or sell an ETF any time the market is open, and you'll usually get a price that's pretty close to what you see when you pull it up on your screen. That's different from a traditional mutual fund, because that only gets priced once a day

after the market closes. So when you put in your buyer sell orders, you actually don't know exactly the price you're going to get. So, in other words, an ETF is a mutual fund that trades like a stock. So how should you work ETFs into your investing strategy? I asked Motley Fool analyst Kirsten Gera before the show how she uses ETFs, and here's what she had to say. I'm an analyst, and I spend all day, every day, looking at businesses. That's where I prefer to focus my investing energies on individual companies. That's just what interests me.

ETFs are boring to me, but something like half of my portfolio is in ETFs. And that's just because I allocate the asset classes that are most boring to me into ETFs. So for me, that means I have ETFs for bonds or tips like inflation protected bonds, emerging markets equity, real estate. I either don't want to think about those things, like the bonds, or I don't think I have any specialized knowledge to help me beat an index fund like for emerging markets.

markets, where most of my equity knowledge is pretty domestic to the U.S. So some stuff is boring to me, and I don't want to think about it, but I've decided I want exposure to it in my overall portfolio. Then for that, I've got an ETF. Let's hear from another analyst, Jason Moser, on how he uses ETFs. I think ETFs are wonderful instruments for most investors, particularly when it comes to industries or markets that are a bit more difficult to fully understand. Cybersecurity strikes me as one such industry. Threats and technology are just constantly changing, which makes determining the winners and losers just a more difficult proposition. So the broad diversification of the ETF in this case could make more sense than trying to pick just one or two winners.

One ETF investors might want to dig more into is the NASDA First Trust CTA Cybersecurity Index, and its ticker is C-IBR. This ETF consists of 35 different holdings today, all companies that are focused on the cybersecurity market. So using ETFs to gain exposure to sectors you either aren't interested in or feel are too complex to fully understand. It sounds like a good approach to me, but what do you guys think? Bill, I'll start with you. We think of ETFs as being plain vanilla. They're actually more than 8,700 ETFs to choose from on the U.S. stock market. So, yes, while it seems like they may be ways to get exposure to broader areas of the market, a lot of people use them to hedge. Like, so, for example, if they want to pick a couple of stocks, they can use an ETF, like a broad

index fund and play an index plus a few strategy. I love that sort of thing, because we tend to think of the market as being, you know, kind of an average return. Most people manage to underperform the market. So the ETF itself gives you right out of the gate a very easy, cheap way to get broad exposure to the market. How do you think about ETFs in your portfolio? It's similar to what Bill said.

I like to think of it as advisor, diversification. If I'm picking my own stocks, I don't want my future retirement riding on my abilities. So I can buy a collection of index-based investments that invests in large caps, small-caps, international stocks, real estate, so that I have a portion of my portfolio diversified across different ideas on what will be the best-performing asset class from between now and the time I die. So, Bro, you mentioned how ETFs and mutual funds are very similar. How do you decide between choosing an ETF versus a mutual fund? Well, part of it is what's available to you, right?

A lot of reasons people have regular old mutual funds is because that's what's in their 401k or that's what's in their 529 plan. So you stick with that. And I think that's perfectly fine, especially for any tax-advantaged account. One of the big reasons that choose an ETF over a regular index fund, I should say like a traditional open-end mutual fund is that they tend to be more tax-efficient, not always, but generally speaking. So if you are in a situation where you're buying within just a regular brokerage account, it's generally better to choose the index-based ETF versus a traditional index fund.

ETS can be active or passive. Now, when I think of active, I think of a manager who's picking and choosing what's going to go into the ETF. And then I guess a passive one, I'm thinking it somehow just, follows an index. First off, do I have that right, Bill? More or less you have that right. I mean, a lot of passive ETFs are so narrow in their scope that they are actually some form of active. But literally the best way to think of a passive ETF is that there is some process that once the fund has been launched that is not really guided by humans. But you could

set the parameters up ahead of time. So it is the next best thing to actively managed. Whereas for an actively managed one, it is the same as the overwhelming majority of mutual funds in that there is a manager who is making decisions under whatever the parameters of the fund is. Active ETF seem to be much more popular right now. And I believe they are outperforming passive. Obviously, it depends on what time frame you're looking at, I assume. But can you talk about why you would choose one versus the other? For me, I would almost necessarily default to passively manage ETFs. One of the reasons that you want to gain exposure to an ETF, and Robert used this term earlier calling it, what was the term advisor? Advisor diversification. It was such a good

term. I couldn't remember exactly how we put it. When you're using ETFs, you are either you're doing one of two things. You're either trying to get into a broad set of instruments, we think mainly companies, in a very cheap way, or you're trying to get access to an area that you might not otherwise have, and particularly with the international ETFs in places like India and Korea, and you can go even more exotic than that. Those markets are almost impossible for us to gain access to. So to me, it is a very important. a form of access or it is a form of diversification. And since you're talking about ETFs, my advice is just to keep it simple and stick with passive. Now, another trend over the last couple of years

was the rise and fall of thematic or niche ETFs, which are ETFs that have a very narrow focus. And sometimes they get a little wacky. According to Bloomberg intelligence, investors have pulled roughly 2.6 billion from niche or thematic ETF so far in 2023. And that's the worst year of outflows since 2001, I guess. Now, Bloomberg says that the ARC investment management and their innovation fund alone has seen outflows of 450 million this year. So a lot of that is just due to people pulling out of one fund. Is there a lesson here, Bill?

Are some firms better than others when it comes to ETFs? Or is the lesson here about thematic investing? I think the lesson here kind of goes beyond ETFs is that when you're talking about, managers. We hope springs eternal for all of us. We all think we can find the hot stock or the hot manager. When you're investing in ATFs, I think you have to get into the mindset of that's not the thing that I am trying to achieve here. I'm trying to gain some level of diversification. And if you think about it, we as investors know about ourselves that as a group we're pretty bad at timing. So why would we go into an ETF and we try to time a hot ETF manager,

active manager, who is they themselves are trying to time the market? Well, thematic investing peaked, but maybe we can still get in. I know you just said it's a bad idea, but let's see if we can come up with a winning thematic niche ETF. So I want to know, Bill and Bro, if you could tie an ETF to the success of any musical genre, theme, band or musician, who or what would it be? Bill, do you want to go first? I want Weird Al Yankovic. Oh, bro, wants to take that answer. I can tell you that right now. Bro is changing his answer immediately.

No, I already had an answer, but I do have a ticker idea. It'd be TT because then you would call it parrotees. The beauty of Weird Al Yankovic is that he is not genre specific. He is a trend-following artist. And so, therefore, as an investor, I want Weird Al-Yankovic, the parat-tee. Yeah. So, bro, are you changing your answer to what Bill said? Because I know how Weird Al-Yankovic is so near and dear to your heart.

Oh, he is. But no, you know, Allison, I love my Christmas music. So I would definitely create one. The ticket would be X-M-A-S, of course, but it would be market-weighted towards new music. and, of course, we'd have a heavy waiting in the album that is coming out in October from Share. And it's just called Christmas. I wish we were called Sherry Christmas, but it's not. But it is coming out in October.

I feel like she left an easy one right on the table, didn't she? All right. Here's my last one for you. So do you ever stop and think, I love what I'm eating so much. I wish I could invest in it. The question is, if you could create an ETF based on a specific dish or meal, what would it be? Bill, you've been going first every time. Why don't you just go first again? Man, I think it's got to be a barbecue ETF.

Right? So you've got plenty of commodity exposure. You have very little in the way of trend following. I mean, if there's a food that's less trendy than barbecue, I'm not quite sure what it is. Maybe Tang. Maybe Tang is less trendy than barbecue. But there are geographical, implications, the places where barbecue is best, are in the fastest growing part of the United States of America. I think that's how I'm going to go. And because I am a Western North Carolina barbecue aficionado the most, the ticker is WNC. There you go. All right, bro. How about you? Well, my wife and I have joined the millions of people who are not eating out as much because it's gotten so darn expensive. There was a lending tree survey last month. I found that 67% of people

saying they're downing out less. So my ETA is. which short restaurant stocks with heavier wadings toward the higher-end dining. The ticker would be EATN, as in, eat in. As always, people on the program may own stocks mentioned, and the Motley Fool may have formal recommendations for or against. So don't buy or sell anything based solely on what you hear. I'm Ricky Mulvey. Thanks for listening. We'll be back tomorrow.