Motley Fool Money - Two Growth Stories

Episode Date: August 8, 2024

Wall Street may be missing something about Toast. (00:21) Ricky Mulvey and Tim Beyers discuss: - Toast’s quarter, and move into convenience stores. - Shopify’s impressive profitability. - What could put a damper on the e-commerce platform’s growth story. Then, (19:30) Mary Long and Asit Sharma discuss how to write an investment thesis. Epic members: Here's where you can access Epic Opportunities and link your premium Motley Fool account with your Spotify account. And here's the show's home on Spotify Companies discussed: TOST, SHOP, LRCX Host: Ricky Mulvey Guests: Tim Beyers, Mary Long, Asit Sharma Engineers: Dan Boyd Learn more about your ad choices. Visit megaphone.fm/adchoices

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Toast isn't playing ball, but you're listening to Motley Full Money. I'm Ricky Mulvey, joined today by Tim Byers. Tim, how are you doing? Doing well, fully caffeinated, ready to go. So I'm going to ask you that question kind of a second time because it's been, the market's been a little nuts this week, and Mary and Osset are going to talk about mindset later in the show, but not just how are you right now? As an investor, how's this past week been for you? Oh, look, this is the kind of market.

that is great for me. I know it's not good for a lot of people, and I will not dismiss that, Ricky, but for me, this is when I am at my absolute best as an investor. I get nervous and anxious when the market is going up and to the right for reasons that I cannot explain. But when we have irrational sell-offs, I'm great, man. I've bought two stocks, new positions this week, which I can't talk about because of our disclosure rules. You can ask me about that another time, maybe next week. But no, look, this is when I am at my absolute best. I love it when the market decides to do full kermit and run around with its hands in the air and just cannot figure out which way is up. I've also been buying. I talked about it with Gillies a couple of days ago.

But let's dive into some individual companies you can talk about, one of them, your favorite, one of favorites, I should say. I don't know if it's your favorite, but that's... It is still my favorite. Okay. That is the payment software that asks you a question after you check out. Just a question for you as you check out and get your cup of coffee. But Tim, before I get into the numbers, there was a moment in the Q&A where an analyst asked the CEO, basically, you know, about the international and retail expansion, asking, quote, you know, so I was hoping you could touch on that and maybe use a baseball analogy, right? Like, what inning are we in in terms of building out the platform for these new verticals? Yeah, I think that's a fair question. I'm not going to use a baseball

analogy. Yep. And then described what was happening. So let me throw that at you, Tim. When you look at Toast's quarter, how would you describe it using a baseball analogy? I would say it's very early innings. I'd say, you know, first or second inning. And I think to Amon Narang's credit, you know, he's one of the co-founders, I'm not going to use a baseball analogy, but I will say that our core business is 11 to 12 years old. So we're one, not even really two years in, so you could draw a similar conclusion here. We've barely talked about, you know, the first 10% of the opportunity here. And we may be even earlier than that.

So I think in terms of their expansion opportunity outside their core business, I mean, we've barely scratched the surface. But overall, remember, this is a company that originally targeted 800,000 U.S. restaurant locations as its core market. That's an immediately serviceable market. Now they have said, and I know we're going to get to this a little bit later, there are some other areas they can expand into that open up another 220,000 locations to them. So now we're talking over a million. Right now they're at 120,000 locations. So are we in the earliest of early innings?

Yes, we are. Absolutely. Let's look at some of the highlights from the quarter. Adding 8,000 new locations to the total now stands at 120,000. Positive gap operating income by a smidge, 5 million, but that's enough to make it positive, Tim. An annualized recurring revenue at $1.5 billion, that is a 30% increase from last year.

Sounds like good numbers to me, but what from the quarter really stands out to you? Well, so Toast has said that one of the ways you want to measure them is on their core profitability metric. And their core profitability metric, I'm going to say this twice, so you can do this math for yourself because they report all of these numbers. They take adjusted evita, that is the numerator, numerator. So adjusted earnings before interest, taxes, depreciation, and amortization. They report that on every press release. This quarter, it was $92 million.

So you take that and divide it by the sum of their subscription gross profit. That's a core piece of their business. They sell subscriptions to the core toast software, the platform that restaurants subscribe to, and then the FinTech gross profit, which is their share of the business that they help process at all of their restaurant customers. And so they believe they can get that margin, Ricky, up to somewhere between 30 and 35%. That's what they said they can get that stable. at that level over the long term.

Well, in the latest quarter, that is now up to 27.88%. 27.88. That was a year ago at 5.79%. So this is one of those businesses where Toast is saying, here's our target, here's where we think we can get to, and they have unrelentingly marched towards that goal. And they have, I mean, they haven't slowed, down. So it's interesting to me that the market says, eh, we don't care about that.

So what is that? I heard the formula for it. What is that profitability metric like, say? What's the story behind it? The story behind that profitability metric is, let me put it this way. When toast goes into a new restaurant group, they will essentially add a loss. They'll do this as a lost leader, they will deploy a bunch of people to help you install their software, and they'll put hardware in your hands, those little tablets that you have seen. If you've gone to a restaurant and you've checked out with toast and a server has come up and had a little tablet in their hand and it says toast on it, that's all stuff they sell at a loss. And then on the back end, they believe that they will make a significant long-term,

profit by doing right by you and getting their software and hardware into your hands and helping you do more business at your restaurant group over time. So the subscription gross profit and the FinTech gross profit reflect that belief that, look, the more that you use our products, the more, so subscription gross profit, the more you will make inside your restaurant group, Fintech gross profit. And for us, once you strip out all the things that we spend in order to put all this stuff in your hands, the core profits, the adjusted EBITDA, we're going to make a lot of money. And so are you.

Everybody's going to win here. So it's a metric that's designed to reflect what that win, win, win dynamic of the toast business actually looks like financially. And one of the stories we got in the earnings call was Tazikis, and they explained how they're able to help them essentially with the Toast point of sale system. They upsell different food items that go well with different drinks, that kind of thing. Tim, sounds like you're pretty happy with Toast right now, but it doesn't seem like the market is happy with Toast after this earnings release. You said they were unrelentingly going towards this profitability goal. That's usually a good sign for a company.

But what's the market so unhappy with? I have no idea. I mean, the market seems like the teenager that you cannot say anything right. Like, hey, you know, we're going to get pizza tonight. I'm a vegetarian and all you ever do is order pepperoni pizza. Like, it's that sort of thing. It feels ridiculous. I do not understand it. I think the guidance was reasonable. It was in line. They didn't beat guidance by any means, Ricky. But the last two quarters, when they have issued guidance on adjusted EBITA, they've smashed it. They have absolutely smashed their guidance numbers. So I don't get it. I don't know why there's so much angst here, but I will say this. I do think this is a good sign for anybody who has not yet opened a

Toast position because the market has not yet chosen to believe that what Toast says defines value inside the business, you know, the market is not valuing the company according to those metrics. They're just ignoring it. So what I told you about, that core profitability metric, the market doesn't care. They're not paying attention to it. That is not how the market is valuing this business. They're using something else. I don't know exactly what else they're using, Ricky, but they aren't using that core profitability metric. They do not believe that, or the institutional investors, I guess we should say, do not believe that Toast can scale up its free cash flow margins to much higher than they are today. They just don't believe it. So if it does

happen, which I believe it will, then I'm going to get paid. And, Other Toast investors are going to get paid quite well. I hope so as a Toast investor. Let's talk about the new verticals. Toast is trying to move into grocery convenience stores, bottle shops. So far, they've got a thousand new customers in this space. I think of Toast as a restaurant company, but what do you think about this move? And does it affect your thesis for the company?

It doesn't affect my thesis yet. It's way too early. But I like the idea, especially the idea of putting toast into liquor stores. Because liquor stores have something in common with small restaurant groups that have dedicated owners. Because that's really where a toast sweet spot is. It's not in the one, you know, like somebody who has a bakery shop in one location. That's not Toastcore market, nor is it like Arby's. It's not that either.

It's in the middle, sit-down restaurant, bistro, restaurant group of, say, like five to 20 locations. Liquor stores are like this. Liquor stores like in a regional area, you might have a group that owns like five to eight liquor stores. That's actually a great market for toast. And they tend to use really old point of sale technology. And they could benefit. They have to manage a lot of logistics inside those liquor stores because that's a high turnover business. People come in and they're buying wine, beer, hard liquor, buying it all the time.

So you have lots of supply chain logistics. You have payroll and inventory just like anything else. You have the other common things that are, you know, areas of interest and or pain for a retail business. I think it's a very smart idea. So regional grocery stores, small markets, you know, local liquor store groups, I think that's an excellent place for Toast to strategically. expand. Let's move on to Shopify, where we are getting a free cash flow story. Yesterday was some welcome relief for Shopify investors. Last quarter, shop told investors to expect some margin pressure, and this quarter beat expectations handedly, free cash flow is up about 250% from the

prior year. Tim, I know you like talking about unit economics. That's a unit economics story, right? What's going on at Shopify? We hope so. It does seem like it, but I think it's more a cost management story. I think they've done a really good job of getting on the other side, of selling the logistics business and getting back to core principles. So in that sense, sure, it absolutely is a unit economic story here. But what we're seeing is that Shopify is expanding its influence and it's doing good things to capture a larger market. There's just more business being done on Shopify. And so as they scale up, they do get the benefit of. it. As long as they keep their unit economics relatively steady, they are going to get that

benefit of rising cash flows, rising margins, as their customers take them up on. I'm going to just give more responsibility to Shopify overall. And you could certainly see that. I mean, the gross merchandise volume was up substantially to $67.2 billion, I believe. So now you are at, you know, what is that? $251, 252 billion in annual. annualized gross merchandise volume. That is, that's serious business, Ricky. Yeah, Shopify crossed one trillion total in gross merchandise volume. President Harley Finkelstein would like us to reflect on that. I think there's another number you want to reflect on, but you're giving me a shrug emoji right now, Tim. I mean, look, Harley Finkelstein

is a terrific salesperson. And he is, he is a brilliant hype man for Shopify. But But I think you need to know that, that he's a brilliant hype man and not take him exactly at his word. He's very good, though. He's a really good servant for Shopify. I don't think that one trillion metric matters all that much. But what I will say is that the value, that, you know, the way that Shopify can compound value for investors is when that gross merchandise volume number grows. and with it, the attach rate. So, really the way that Shopify goes up and to the right

and gets real hockey stick growth for investors is if there's more business being done on the platform, more sales, more payments processed, and then more of that activity accrues to Shopify. And so it's roughly stayed stable, though, Ricky. It hasn't, the attach rate isn't going up. It's going down, but I would say it's largely flat. In the latest quarter, that attach rate was 2.98%.

And the way you get that is $2 billion in revenue divided by $67.2 billion in gross merchandise volume. It's about 2.98%. A year ago, it was at 3.09%. So yeah, down a little bit, but I would call that roughly flat. The way that Shopify from here at its valuation, if you want the valuation, today's valuation, to look cheap, get that attach rate up to 3.5%. Get it up to 4%. If you have vendors, shoppers, the entire ecosystem of people that are participating in the Shopify experience, if they are giving more dollars to Shopify, boy, look out. You know, today's valuation will look very cheap. If the attach rate

doesn't move that much, Ricky, then I think you could make an argument that Shopify that Shopify is maybe not outrageously priced, but probably at least fairly priced. You need that attach rate to go up. So you're saying you need them to flex their pricing power a little bit for some hockey stick growth? Yes. I need them to be involved in more parts of the transaction. Yes. Any yellow or warning flags in Shopify's quarter, you said Harley Finkelstein is a great salesperson, but this is also a company where less so to do with the company, more to do with the valuation. it's gotten ahead of its snowboard before. So any signs of caution stand out to you? I don't know that this is a cautionary note, but it is something to be aware of. So payments are now

61% of gross merchandise volume. So the business that's being done on the Shopify platform, all of those dollars, a lot of it that Shopify gets credit for is, is there not because there's a lot more commerce being done on the platform. Although there is more commerce being done on the platform. The growth is coming from Shopify being involved in more of the payments, more of the transactions. That's not necessarily a bad thing, but it is at least a risk because it puts Shopify at conflict with payments processors.

So they do need to not. forget their roots. Shopify needs more commerce to happen on its platform, not just more involvement in payments on its platform. I think that'll happen. I mean, look, they are talking about like greasing the skids for things like international sales. That would be good. Like, you'd need that. You need more commerce on the Shopify platform, and you need Shopify getting involved in more of those payments transactions. If those things happen, and they don't need to happen overnight, Ricky. This can be slow and steady wins the race here.

It's a little bit at a time. Yeah, we're expanding the reach of the commerce platform. We're seeing more commerce from more regions on the Shopify. That's a good thing. And then if there's more payments and there's more Shopify involvement in those payments, that is also a good thing. And you don't need much. You know, like, little incremental improvements will generate big leaps in cash flow.

So I am cautiously optimistic about the way that Shopify is going about its business. But let's not pretend that this is, you know, smooth sailing from here. There's work still to do. Good place to end it. Tim Byers, appreciate coming on. And thank you for your time and your insight. Thanks, Ricky. As we wrap up, just wanted to note our latest premium podcast launched this week. It's called Epic Opportunities.

This is available to members of Epic and the Motley Fool's advanced investing services. You can catch the show on Spotify by linking your Motley Fool account or through the Motleyful app. We'll put links to all of those in the show notes for today's episode. All right. Up next, we've got a volatile market. And Motley Fool senior analyst Asset Sharma joined my colleague, Mary Long, to discuss how to write an investment thesis. and how a journal can help when markets get choppy. Awesome, it won't come as any surprise to you when I say that this week opened with a whole lot of market turbulence. For today, we're going to focus less on what happened, why that happened, and more talk about what do you do when this stuff happens?

Because whether the market stays, in correction territory, reverts, recorrects, goes up, goes down, what have you. The fact of the matter is that when you're investing, there will be times when the stock market gets spooked. There will also be times when it gets unspooked and then spooked again. So with all that in mind, what do you do when volatility and uncertainty seem to be everywhere you turn? Well, Mary, there are a few things that I do. I mean, one is just totally related to the investing side of it. I try to double down on businesses that I like.

There are a few reasons for this. I mean, one is the obvious. If volatility is in full swing, prices are all over the map, then maybe you get some buying opportunities for companies that you already have conviction in. So it pays to go back to your watch lists or businesses that you've studied. The second is more of a mindset thing, right? The market's going crazy. Where do you want to focus your attention on like the flashy news sites that are trying

to draw you into more angst? Or do you want to go to a safe place? Which is like, let me go back to that transcript where Satya and Nadella talked about how Microsoft was going to destroy its competition. He didn't use those exact words, but he talked about all that great CAP-X investment. I mean, that's a place where my mind should be, I think, in times of volatility, focusing on what's going to make money. It's the business results, not the share price. Fair point, but I have to hone in on something. Is Satya Nadella really your happy place? The Microsoft earnings called Transcript is your happy place?

Not really, but this is an investment focus. podcast. People don't want to hear about the mundane ways that I get to my happy place, which is this zigzaggy route. Sometimes it starts with just cleaning the inside of my grill. I think I'm starting to resonate here with some people. You know, it may end in a paperback novel. I don't know. This is off topic for us. This is not what folks want to talk about. The markets so volatile, they want to hear about that investing happy place. So that's where I went first. The investing happy place. Okay, we can bring it back to the investing happy place. So, you know, here, I'll make a smooth segue. You mentioned paperback novels. The other day, on our members-only

live stream, kind of right in the midst of this Monday market mania, whatever we want to call it, you talked a bit about keeping an investment journal and the importance of that and how the idea was that, okay, when times are tough, you've got this written record of why you believe in a company that you can return to. So talk to us a little bit about your investment journal and what goes into it. How do you write an investment thesis right off the bat? Oh, so many great questions. So first of all, an investing journal, it means different things to different people. For some of this, it's a place to sort of deal with our emotions when the markets are really coasting and we see our wealth expanding.

It could be a way to just keep ourselves grounded. Just jot down those emotions. I feel really great, but I'm sort of scared at how well this is going. or it could be the opposite. It could be a time like this where you see so much volatility in the markets and you just want to document that it's unsettling and maybe just write down what those long-term goals are, the ones that got you into your whole investing journey. That's always helpful.

For other people, and these aren't exclusive sets, it could be more about trying to document why you like a company, what you think its characteristics are that are going to advance it passed other competitors in the business world, and thus the share price should follow, why the share price will rise versus other companies or the market in general. That's always fun to return to, which gets us to your third sort of question here, which is like, how do you write a business thesis? What is it? I will tell you, when I started in this game, I thought it was about a lot of facts and figures.

In fact, if you'd ask me to write a business thesis or an investment thesis about a company, I don't know, 10, 15 years ago, I probably would have returned you three pages to prove a point. What's that point? I'm smart. I know what I'm talking about. Look at these numbers. Exactly. You should listen to me. Look at all this stuff.

Look at these reams of data. I'm supporting my points. Okay, Sharma, what are your points? I don't know. Stock's going to go up. I learned over time that an investment thesis is really simple. There's a great investor. We used to work at The Motley Fool.

Some of you may know him if you are in the gaming world. His name is Aaron Bush. And at one time he posted on Twitter Now X, sort of like this really succinct, bullet-pointed list of things you should do as investor. and one of the main tenets of that list is like just narrow it down, dial it down, make it more succinct, don't overthink this. And that is very true as I've come across other investors and learn from so many great investors here at The Motley Fool. An investment thesis should be simple, easy to grasp. You and I should be able to explain in this conversation, Mary,

before people stop listening, two or three investment thesis to each other, because what you're trying to identify is the crooks of why a company should succeed. And that usually is pointing to two or three advantages in the marketplace, how that company is going to capitalize on them. If there are a gazillion advantages that a company has, I will tell you, that's too good to be true. There's something on the other side of that coin you may not have looked at. So in my mind, it is something very simple. So in preparation for this conversation, I had asked you if there was a company or a stock that maybe you were revisiting in light of kind of all the ups and downs over the past few days. And if you wouldn't mind sharing the thesis of that company with us, you took what should

have been maybe a simple request and you challenged yourself because you picked a company that's kind of hard to explain. But let's see if you can do it. Could you share that thesis with us that you drafted up before this? Sure. I want to talk about Lamb Research. This company is a leader in the semiconductor industry. It makes machines that make silicon. So you need complex machines to build integrated circuits. Lamb sells these machines to companies that manufacture integrated circuits. I like this company because it's, yes, somewhat cyclical. Mary, most of its equipment is used to make electronics, computers, memory, et cetera. So it's cyclical, but it has a tailwind and an advantage in this economy,

which is shifting towards Gen. AI products. And there are really a few things behind that. One is that generative AI is increasing demand for a type of storage called NANDD flash storage. That's a type of memory that Lambs tool specialize in. And also, generative AI is pushing up demand for something called high bandwidth memory. So this is really stacking memory on a chip that often surrounds the compute functions of the chip. It's something that Nvidia is requesting more of and AMD is requesting more of. So companies that make this type of memory or the tools to make this type of memory are going to benefit. So Lamb's going to benefit from that. It's trading it really attractive forward multiples. The stock is down due to this volatility and a few other

factors. But, you know, I don't know. Macroeconomic deceleration, more angst in the market, and some slacking off of generative AI demand, which is going to happen at some point, could push shares down further. Maybe they're not such a bargain here. Also, I should note this geopolitical picture we have with China and the semiconductor back and forth between our two countries is going to catch some companies, perhaps like Lamb in the middle, lamb has about 39% of its latest revenue out of the Greater China region. So with that, I think my initial thought right now for Lamb researchers is actually to buy a few shares to dollar cost average.

And I don't own any shares right now. Okay, yeah. My next question was going to be, has your mind changed on this? But it sounds like maybe it's a newer idea that's been on your watch list for a minute that now makes sense to jump into. Yeah, I think my mind is changing because I've had it on a watch list for a long time. I've studied this company. It is a recommendation in Stock Advisor, so there's some free IP for those of you who aren't

members of Stock Advisor. We like this company very much. I've looked at it for other services. But for me personally, I'm warming to it. So the thesis is changing somewhat. Probably the price falling a bit is pushing that. And also, the more I learn about the trends within the Gen AI industry, the more I see that Lamb is an essential player.

It's not that it doesn't have competition. It does. So I wouldn't put it quite on the level of companies like ASML, another specialized company, which has literally no competition right now. But not a bad one to look at. 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 anything based solely on what you here. I'm Ricky Mulvey. Thanks for listening. We'll be back tomorrow.