Motley Fool Money - Move Over, Magnificent 7, There’s a New Stock Basket in Town

Starting point is 00:00:01 The MAG 7 was so 2023, today on Motley Fool Hidden Gems Investing. Welcome to Motley Full Hidden Gems Investing. I'm your host, Tyler Crow, and today I'm joined by longtime full contributors, Matt Frankel, and Travis Hoyum, who's pulling in some spot duty away from the host chair and doing some actual hard-hitting analysis for us today. We are going to get into the state of athletic wear with some earnings results coming out of Nike, on holdings, and some others. We're going to get into a listener question on,

Starting point is 00:00:34 Gambling stocks. Travis, guys, is it gambling stocks, gaming stock, sportsbook? How are we supposed to call these things these days? Yeah, the gaming word is what I would normally use if you're talking to people in the gaming industry. But that really gets confusing with games themselves. So gambling is probably the right way to go. I feel like we're just going mask off now and just be like, they are gambling stocks. Let's not try to hide anything anymore. But we're going to start today with what we're saying the headline is basically move over the mag seven. We got a new moniker now. It's the AI-11. Yardini research put out a note yesterday, as research companies love to do when we're talking about stocks and dissecting things, is they put out a new moniker what they're calling the AI-11.

Starting point is 00:01:18 This is basically a basket of stocks that are tied to the infrastructure build-out. And I think if you squint really hard, it's basically a semiconductor sort of basket, if you will. We've We've got semiconductors in memory with Sandesk, Western Digital Micron. We've got chipmakers, Intel, Samsung, AMD, Marvel Technologies, Taiwan Semi, Broadcom. I can't also forget, SK Heinex and ASML as well. So that's the 11 stocks we're talking about here today. Kind of a fun little like pivot to what we normally talk about because this is obviously a play to drum up some, their name for themselves in terms of

Starting point is 00:02:00 of like new ideas for people to get investing in. And we could chalk this up to like a silly Wall Street game and short-term thinking. But I think there's something worth exploring here. And it's the idea of picking baskets of stocks versus individual stocks in thematic investing. When a trend has longer-term catalysts, and we can debate the AI infrastructure build on the length of it, I think, for days, do you think it's better in those instances to invest in a basket or individual companies within that trend. And Travis, I'd love to get your thoughts on this as the analyst guest today. The answer can be both. I think this is what it makes investing both fun and challenging is that I think we really like to look at those individual companies. So I would love to say, hey, I'm going to be

Starting point is 00:02:46 able to pick the winner in any given space. But the reality isn't something I've learned that over, you know, decades of investing at this point is you can get the theme wrong, the industry trend, or sorry, the theme right, the industry trend right, and get the individual stock wrong. So I think the idea of using baskets is not a bad idea. I don't know if this is necessarily the best basket to be buying right now in May 26, but it definitely tells a story about what's going on with the market. Yeah, first of all, I don't know how you can call this the AI, the AI 11 without NVIDIA being included in the basket.

Starting point is 00:03:22 I don't know. It is, it's about time we have to be asked. Well, they're part of the MAG 7, Matt. I mean, come on, we got new names, new ideas here. Come on. I know that they're trying not to have overlap, but even so, you can't call it the AI-11. So it's about time we had a new top stocks basket. It seems like the Fang thing was so long ago. The Mag 7, it's been the market's gold standard for several years.

Starting point is 00:03:45 I mean, to really answer your question, I like the basket approach, but tend not to just include the stocks at the top when I'm forming a basket, whether it's fintech, whether it's real estate, you know, all the things that I focus on. Now, in recent years, it hasn't been the best strategy, if I'm being fair. The Mag 7 has clearly outperformed all the mid-cap and small-cap baskets of tech stocks I could have made. I'd expect the 11 stocks in this particular basket. We could debate whether you think it's a bubble or whether you think it's a good time to buy, like Travis said. But I would expect them to generally move more in tandem than I would the Mag 7,

Starting point is 00:04:19 because they're really all plays on the same thing, AI-focused hardware. They're not just the largest tech companies in the market, which is essentially with the MagSeminar. And Travis makes a really good point that, you know, it might not be the best time to buy this. At least these are all stocks that could tumble if the AI investment surge cools off. And that's really kind of goes along with the movement in tandem of this basket that you need to expect. I'm going to put a pin in the is it a bubble because that feels like it's the obligatory question that we ask with any AI related you know, a segment that we do on this radio show at any given time. But before we do that, I do want to say that of the 11 companies we just mentioned here, which of those ones are you

Starting point is 00:05:03 like particularly interested in the most, regardless of valuation business strategy? Like what what are the ones in that in group 11? You're like, yeah, I do really like this business. Taiwan Semiconductor's got to be number one because almost every one of these companies are going to be reliant on Taiwan Semiconductor in one way or another. whether they're an equipment company like ASML selling to Taiwan Semiconductor or they're a customer. So that's probably going to be the company to watch. Now, that is a little bit more of a, you know, it's like a more capital-intensive business. It is also at least a little bit cyclical, but probably not going to be nearly as cyclical as something, you know, like a micron or like a sand-d.

Starting point is 00:05:43 So that would at least be kind of the bellwether. And if you, if I only had to pick one, that would definitely be the one. For me, the one I own in the basket is AMD. and it's been a roughly 5x performer in like a year and a half since I've owned it. I bought it as a value investment and I didn't think I'd be this right this fast. There's a solid case to be made that it's run too far. It's trading for about 50 times forward earnings. There's the rapid data center growth.

Starting point is 00:06:08 Tyler and I, we've talked about the potential to lead the CPU shift in the next phase of AI buildout. And they have a lot of extremely promising product rollouts coming later this year. I think all 11 are excellent businesses. wrong. Some are a little bit, let's call them frothy at the current valuations. Again, getting to the obligatory AI bubble, is it a bubble? One of the things about like monikers that we get with baskets of stocks, this has happened for decades. Like there's nothing Wall Street loves more than, you know, putting a name on a group of stocks and making it seem cool for everybody, you know, some of them worked. Fang worked. I mean, kudos to Jim Kramer, 2013. You know, Fang worked pretty well from that

Starting point is 00:06:52 on Facebook, Amazon, Netflix, Google, great idea. Mag 7, 2023. So far, it's been a great idea. Got other ones, the Four Horseman of the 1990s. I think it was like Intel, Cisco, Dell. I forgot the fourth one, but not a great idea. Microsoft, I mean, at the time, not a great idea. The nifty 50 in the 1960s, I think of all of them, maybe Home Depot and Walmart.

Starting point is 00:07:18 And after that, it was kind of like, ah. So, you know, mixed results for these moniker names and for a lot of people to be like, oh, that must be the top whenever you start using names like this. So in that vein, I'm going to let you guys have it out because I think there's differing views on, is it a bubble? Travis, you've already made your view pretty clear here. So lay out your case. Well, this is AI, I think is very confusing for investors right now because there is a ton of

Starting point is 00:07:50 a tailwinds. And that is completely undeniable. You look at what's going on with, you know, particularly memory is really hot right now. Those prices are going crazy. Margins are going up. But you have to look historically in what's sustainable and what's not sustainable. So I actually pulled all 11 of these companies. If you added up their free cash flow in 2023, so before this current wave, it was negative. These 11 companies were all negative in 2023. By the way, they were very positive if we go back to 2018, $85 billion worth of cash flow. So now that's up to 123 in 2025. So these are inherently cyclical businesses.

Starting point is 00:08:32 AI has been a tailwind for them. Historically, that does not last in these businesses forever. Once you get some sort of choke point in the industry like memory is today, developers are going to figure out how to optimize a little bit better. you know, hardware companies are going to change what they're buying and when they're buying it. Companies are going to overinvest in capital expenditures. So that's why this is sort of indicative of what I'm seeing as a bubble in artificial intelligence. That doesn't mean that that bubble is going to burst.

Starting point is 00:09:02 It may be 1998. We may have another two or three years left. But I just, this is where I get a little bit nervous about am I buying at the top or too close to the top for comfort. Yeah, we're fairly aligned on this. I mean, I could see both ways. I wouldn't necessarily buy this basket for 11 stocks today, but I also wouldn't bet against them in any form. I mean, with AMD, for example, the one that I own and talked about,

Starting point is 00:09:26 I can see a scenario where it's a trillion dollar company or even a $2 trillion company by the end of the year, but I can also see a scenario where it gets cut in half if one of its product launches doesn't go as well as expected, for example. I wouldn't necessarily call it a bubble, but it's definitely a fragile environment when it comes to the AI spending that we're seeing. And not that it can't continue for years, even more than two or three years.

Starting point is 00:09:50 This could be a long-term trend for the next decade. How many of us called the Mag 7 expensive when we first heard that name? So I wouldn't bet against them in any way. I wouldn't call it a bubble, but they're definitely, you know, they need things to go well. My two cents due to it. I think a lot of it is priced in the idea that, everything that is happening at its current trajectory is going to stay on that trajectory for four, five, six years, which maybe, but...

Starting point is 00:10:23 Has that happened for three months in artificial intelligence? But to your point, one of the things that I have discussed here before is the idea of, like, there is going to become a point where, like, efficiency and cost efficiency and, like, the, you know, cost per token or the compute per token or some sort of, like, way of bringing down costs or usage for these algorithms is going to take place. Like the amount of resources that we have to put behind this is so staggering. It's hard to wrap my mind around. And unless you have some breakthrough in, you know, compute power with like, I don't know,

Starting point is 00:11:01 major breakthroughs in quantum computing or all of a sudden energy becomes way, way cheaper than it is today, or we just get better algorithms. I'm going to bet on the better algorithmic, you know, efficiency kind of thing and say, like, yeah, it's going to continue to grow, but perhaps not at the same rates. So, again, I think we're all kind of on the same page with just some like slight nuances on where it's all going to go. All at all, fun idea, we'll see. Coming up next, we're going to look at a very different topic, athletic wear.

Starting point is 00:11:32 If you were to look at the athletic wear, athletic footwear clothing industry today, I feel like you could play a game. And that game would be, is it an actual headwind or is it a management excuse? Over the past couple of quarters, we've seen some pretty conflicting stories coming out from various players in this industry. Over the past couple days, Under Armour, On Holdings, and Adidas have recently reported. And we got some pretty conflicting numbers or conflicting commentary on those numbers, depending on how well a company did. So before we get into the kind of nitty-gritty of everyone else in the industry, what were the two, the two, two of you, what were some of the earnings reactions you had or thoughts, conference calls?

Starting point is 00:12:20 What did you see in any of these reports that really stood out to you? Yeah, well, I noticed a few common themes among them. As you said, all three of the companies you just mentioned had very different performance. But there were some common themes. I mean, for example, all three are seeing meaningful hits from tariffs to the business in one way, one extent or the other, with Under Armour taking the worst hit. In all three cases, direct-to-consumer sales, meaning like sales through a website, are outperforming wholesale.

Starting point is 00:12:46 For all three apparel sales, this is interesting, are growing faster than footwear sales because all three of these are footwear companies at heart, or at least declining less rapidly than footwear sales in Underhammer's case. All three are facing challenges in the U.S. market. Consumer spending has slowed down quite a bit. Even on, the biggest growth story of the three

Starting point is 00:13:06 reported slower revenue in North America than it did everywhere else. I mean, for me, just looking at these reports on as the most attractive, and it's not very close. Accelerating growth and margin expansion in a difficult environment for consumer spending is impressive. Gross margin improved by more than four percentage points year every year, despite the tariff headwinds that contracted gross margin for the other two.

Starting point is 00:13:30 Extremely strong growth in Asia-Pacific, and there's a lot more room to grow there. As far as what I wouldn't do out of the three, I wouldn't touch Under Armour. It seems to be a restructuring story with no clear path to finishing restructuring and recovering. Adidas is a great business, just not as exciting of a growth story as on to me. Yeah, the consumer's got to be the big takeaway, and it's both good and bad. If you look at, I think Under Armour and Nike are probably kind of in the same category. Sorry, Nike shareholders, but they've moved much closer to that, you know, discounting. We're going to win on price.

Starting point is 00:14:08 We're not going to out-innovate everybody else. So I think what investors need to look at is those companies that are kind of playing defense who are discounting. Hey, we need to move product through the ecosystem so that we're not sitting on a whole bunch of inventory. That's where you get a little bit of weaker margins. That's where you get commentary about things like tariffs. If you look at the results from on in particular, I always think their conference calls are really interesting because a year ago when the tariffs were the big topic, they just said, hey, we're going to raise our prices. You know what? like if there's tariffs, we're going to raise our prices, we're going to keep our margins,

Starting point is 00:14:41 and that's the way it's going to work. They were sort of making a dig at the industry going, hey, in a really promotional environment, we don't need to promote. We're going with a full price strategy. So that just shows you where companies are in the industry and where their pricing power lies. And so I think that's the biggest thing that we have to look at is where is their pricing power, where is their demand?

Starting point is 00:15:03 It still exists at kind of that high end of the market, the people who are spending two, $300 on a pair of shoes. Most consumers who are spending money on a pair of shoes that are spending $50 to $100 or even $150 are looking for a little bit better deal, are buying shoes for kids like I do. Sorry, my kids aren't getting on holding shoes. I'm not spending that kind of money. But Under Armour, you know, that's a much more attractive price point. And I think that's just kind of generally where the economy is going today.

Starting point is 00:15:32 So I think that's the broad takeaway. Yeah, I think to your point, too, Adidas was interesting in that way where, like, you could see, they even mentioned it in their, like, earning statement was like, you know, we did some discounting here, but on our like fresh, innovative products, we're actually driving a lot of price. And they did see margin expansion on the operating side overall because of that, you know, pricing effect there versus the discounting they're doing on some of their older stuff. And to that same point, uh, uh, on Decker's, they don't report, I think, until the 21st of May, but on their previous quarter, they were mentioning the same thing.

Starting point is 00:16:03 strong performance in Hoka with, you know, basically like we passed as much of the cost we can on their, you know, on the consumer as we could to fight tariff headwins. And I can say, buying my trail running shoes from Hoka, I can confirm. They have definitely been pushing price versus, you know, trying to go down the discount route. So, you know, in this vein, like as you are looking at the retail space, Travis, I know this on holdings has been kind of one of your favorites for quite a while now. Is there anything else in this space that looks intriguing to you? And then Matt, you said, Aung Holding as well.

Starting point is 00:16:39 Is there anything else in this industry that you're watching, keeping an eye on, like, how is this thing developing more? And are there any other interesting stories that people could be watching over the next couple of quarters? To me, Awn sort of sits alone in this category. You know, if you look at Lula Lemon or Nike, sort of the other kind of turnaround stories in the market, I have a really hard. time figuring out where there's pricing power, where is their tailwinds being in the industry.

Starting point is 00:17:06 You know, we're kind of moving to this. Working out, maybe running, maybe lifting is kind of the trend for users. We're not in the yoga is a growth category anymore. So I think those are the kind of big things that I'm looking at is who has that pricing power. And honest just sort of sits alone in that category. They said, you know, a couple of years ago when they put out their long term guidance said, hey, we're going to get to 60% gross margins.

Starting point is 00:17:30 they're almost at 65% gross margins. So that's showing you the strength of that business. And I just don't see that same analogy with even a Decker's Outdoor. Hoka just isn't quite growing as quickly. They don't have quite the same pricing power. So I think they just kind of sit alone. And that's why I find them attractive. Now, that said, this is also one of the most confusing companies to follow because they

Starting point is 00:17:53 consistently report in Swiss francs. And the market quarter after quarter seems to be confused about currency conversions and how much they're actually growing. So it is kind of a difficult company to follow from that perspective. Yeah, and I would just add, I mean, I already mentioned my little spiel on on holding a little while ago, but I would say as far as the three major turnarounds, Travis just mentioned Lulu Lemon, and I'm glad he did, because between Lulu Lemon, Nike and Under Armour, Lulu Lemon to me, is by far the most attractive of the three turnaround candidates. The reasons I say that one, kind of like onholding, but not to the same extent, they have more pricing power than either

Starting point is 00:18:30 or Under Armour in this market. They just made some missteps in their marketing strategy. For example, the percentage of new products, meaning like new lines, new styles in their stores steadily declined over the past few years, and that kind of drove customers away because they don't want to go and buy the same things they already had. And they're making a conscious effort to remedy that, you know, focusing on new products, focusing on reasons for customers to set foot in their stores. They have the pricing power. I like what management's doing. I think they're making all the right moves. And out of the three turnarounds,

Starting point is 00:19:02 that's the one that I like right now. I might go a little off topic here, but based on some anecdotal evidence, I might be waiting for the Allo Yoga IPO whenever that comes, because I feel like that might be pretty interesting. That one would be really interesting, yes. Coming up after the break, we'll dip into the mailbag. Hey, everyone, just a quick reminder.

Starting point is 00:19:22 We love answering your questions on air. So if you do have them, go ahead and email us at Podcasts at Fool.com. That's podcast at fool.com. We only have three requests when you bring them in. Number one, keep it foolish. Number two, keep it short enough that we can read it on air. And number three, we can't give personalized advice.

Starting point is 00:19:39 We might get in a little bit of trouble with the SEC or the Federal Trade Commission if we do. So try to keep it as a generic, what should investors do rather than what should I do? So today's question comes from Jack from Denver. Hey, guys, love your podcast. As a novice when it comes to stocks, I have been interested in some of the gambling stocks, mainly Draft Kings and Flutter, tickers DKNG in FLUT, Flutter, of course, owning Fandul. Since their recent drawdowns, I think mostly related to prediction markets these days, what are your thoughts on these stocks being viable long-term winners with the competition

Starting point is 00:20:15 from prediction markets coming? Thanks, Jack from Dendor. And Travis, gaming has, I don't know about sportsbook, but I know that you have followed the Las Vegas casino industry for a long time. So what do you think of Jack's question here? One of the things I really struggle with, with these online gaming companies is what is the moat? What is actually keeping you in that ecosystem and keeping those companies profitable? And the hard answer has been there really isn't one.

Starting point is 00:20:45 If the better odds are just a click away, they're just a click away. Most of these users are going to have multiple accounts. You have a lot of competition in every one of these states. The other piece that I think is really challenging. is the tax rates in each of these states. If these companies suddenly get really profitable in, I think it was Illinois recently, Illinois just goes, wait a second, we want to have a little bit of that revenue, and they just jack up their taxes.

Starting point is 00:21:10 And so that ultimately hits the bottom line of these kind of companies. This is a space that I've only invested in tangentially through MGM resorts. They have an online gaming business, 50-50 joint venture with Entain. They also own some of their operations internationally. So that's the way that I have done it because I look at it as more of a value. You're actually getting a free cash flow positive business. I know that the operations have improved in some of these online gaming companies recently, but I just really struggle with what the moat is if you don't have some sort of physical tie.

Starting point is 00:21:41 And so I think that's the challenge. And now prediction markets come in. Look, that is a real, real threat. And I think that the legality of that may change in the near future. But that just shows you what sort of, you know, They're playing a digital game and I don't know that there's a huge moat there. I mean, even in person, you make a good argument there. If you and I are at Vegas at Caesars and you tell me I can get better odds on the bet I want at MGM, I'm going to leave.

Starting point is 00:22:07 Like, I'm not that loyal about it. But this is a good question. I'm going to answer more from the prediction market side of it. Sports wagers account for 85% of all bets on these, quote, prediction markets platforms. It's gambling. This is what it is. Let's be totally honest about this. That can even be higher during major events.

Starting point is 00:22:28 It's clearly a direct competitor to these gaming companies. I mean, Draft Kings and Flutter, they're both down over 50% over the past year and for good reason. But on the other hand, I want to point out that it's still a very fluid situation, specifically on the regulatory side. I mean, that's going to be the biggest X factor to answer the question. And unfortunately, we don't have the clarity right now to answer it thoroughly. there are some pending lawsuits at the state level against prediction markets right now. With the operators, they're arguing that the platforms aren't gambling, but they're selling, quote, regulated financial instruments.

Starting point is 00:23:02 There's a strong possibility that argument is not going to hold up when we get to like Supreme Court level type cases. There's still a clear bull case for online gambling in general. I don't think either of us are saying that that trend is not real. But there's a lot of the regulatory side that's very much. much up in the air. If these prediction markets get shot down, Drafking and Flores, they're going to double in a very short period of time. It's a big if right now. Another way to get exposure to this space,

Starting point is 00:23:30 the real challenge that a lot of these companies have is customer acquisition cost. And so where is that money going? That's going to companies like ESPN, owned by Disney. It's going to advertising on Spotify. If you listen to Bill Simmons podcast, constantly talking about bandwool. So there are other sort of adjacent ways to play the market where you're actually investing in where they're spending those customer acquisition dollars, not necessarily on the platforms themselves being profitable. Yeah, and I just wanted to, before we wrap this up here, just like, you know, when we hear the regulatory thing, part of the reason prediction markets are the way, you know, it works in that

Starting point is 00:24:06 ways. It's more tax efficient for you because it's a commodities future. And if you get it wrong, you can deduct the entirety of the loss on your taxes versus if it's a sports book, you can only deduct a portion of it because it's considered gambling deductions, which are considerably smaller than futures contracts. So when you hear like the regulatory and more attractive, that tends to be part of the reason why and also why prediction markets can sometimes offer more favorable bets simply because they know that there's a more favorable tax treatment and they can, you know, get more people on their platform. So if that's, you know, if you hear the regulatory thing, that tends to be part of the reason why they're more attractive. I want to get that in

Starting point is 00:24:44 before we finished. But that is all the time we have for the day. Matt, Travis, thanks for joining us today. I think we're doing a home and home and I'll join you tomorrow with Travis on the show. As always, people on the show may or may not have interest in the stocks they talk about, and the Motley Fool may have formal recommendations for or against. So don't buy yourself stocks solely on what you're here. All personal finance content follows Motleyful editorial standards and it's not approved by advertisers. Advertisements are sponsored content provided for informational purposes only. To see our full advertising, pleasure, please check out our show notes. Thanks for producer Dan Boyd, the rest of the

Starting point is 00:25:18 Mollyful team. For Travis, Matt, myself, thanks for listening and we'll chat again soon.

Motley Fool Money - Move Over, Magnificent 7, There’s a New Stock Basket in Town

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