Motley Fool Money - What Do Investors Underrate?

Episode Date: December 10, 2024

Riding coattails isn’t a bad thing in investing. (00:14) Jim Gillies and Ricky Mulvey discuss: - The alleged killer of Unitedhealthcare’s CEO getting caught. - A sporting goods retailer buying back a lot of stock. - Aritzia’s comeback year. Then, (17:17) Alison Southwick and Robert Brokamp address listener questions about diversification in the S&P 500 and foreign stock sales. Companies/tickers discussed: UHC, ASO, LULU, TSE: ATZ Sign up for Breakfast News: breakfast.fool.com Host: Ricky Mulvey Guests: Jim Gillies, Alison Southwick, Robert Brokamp Producer: Mary Long Engineer: 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 a retail special. listening to Moppy Full Money. I'm Ricky Mulvey, joined today by someone who doesn't like debt at all. We could call him Canada's Dave Ramsey. It's Jim Gillies. Thanks for being here. I've got more hair than Dave Ramsey, so that's good. For someone listening to the show for the first time, it may be a little confusing.

Hopefully, if you've listened to the show before, you know I'm joking. Let's close the loop on this story before we move on to some retail stories. Looks like they got the alleged killer of the United Healthcare CEO, Brian Thompson, catching him in a McDonald's in Altoona, Pennsylvania. he hasn't been convicted, but boy, it sure seems like he has some incriminating stuff on him, got a gun, got a handwritten manifesto. I'm closing the loop here with a Canadian with a few observations. One is that I wanted to bring it up on the show because this is the first major assassination

of a business executive that I can think of. This feels historically significant. I can feel the Overton window getting larger in shifting and interesting and terrifying ways. And as I'm reading these stories about American health care, I am reminded in the comment section. You never know what someone's going through. You never know what type of pain, financial hardship is on their plate and that they may be feeling anything. Anything you want to add, Jim, before we move on to some more standard stories. Well, definitely asking the Canadian about the American health care system is absolutely value-added content.

I will say that regardless of what your opinions are about some of the stories you hear from the American system and I hear a lot of them and I generally have a I range from sadness to anger for a lot of them. I will say simply that I'm not sure anything justifies murdering a guy in cold blood, frankly. So I hope this is a one-off and not the start of a trend. I hope so too. And once you're calling for essentially you're cheerleading any killing behind a keyboard, I think that's a, that's a dark and terrifying place to be. It's not good. You're the bad guy at that point. So don't do that. Let's go. I don't have a good transition. Let's go to Academy Sports and Outdoors. It's a sporting goods retailer. Let's let's do what we do better, which is talk about earnings. And this is a

company that you follow pretty closely. So Academy Sports and Outdoors is basically, think Dick's sporting goods meets a little Walmart meets a little T.J. Max. They'll sell you camping equipment. They'll sell you hunting rifles. They'll sell you basketballs. And this is actually one that I own because, Jim, when you talk up a retailer, sometimes I take action on it and put the stock in my personal account. So I'm riding this one. Now, I'm looking at earnings today. And I've also bought some declining retailers before. Sometimes that doesn't work out for me. And at first glance, it looks like things are not so good for Academy Sports and Outdoors. Comp sales down about 5% at their stores. That's not like Dick's sporting goods. Earnings and net income all down by about 30%. You rang a bell at the bottom last

time. Are we ringing a bell again? Are we at a turnaround point? Is this big lots 2.0? That would be the currently in bankruptcy proceedings, Big Lots. This is absolutely not Big Lots 2.0 because they have something that Big Lots doesn't have, and that's cash generation. This is a cash flow story. This is a valuation story. And this is what I like to think is a lull in the growth story. It was a terrible quarter.

Let's be honest. As you said, all these major numbers down 30%. And yet the stock is up today. That to me suggests, and I'm not a TA guy, but that suggests to me that a lot of the negativity was already rung out of this thing. And if anything, people were expecting worse. And so my take is, you know, look, you have good quarters and bad quarters and a long-term secular growth story. And this is a long-term secular growth story. They're trying to expand across the nation. They're trying to up their store count. I think they've done 16 so far this year. I don't have the press release in

front of me. I believe they are looking to do 15 to 20 next year of additional stores, about 7.5% store growth, I think. These are guys who have done it. This is a, this management team's been in place since about 2019, which, which followed a certain academy before they IPOed. We're listed as one of the companies most likely to go bankrupt. And so they did an intelligent thing and they got rid of the then management team and brought in new folks. long-term secular growth stories have natural ebbs and troughs. I think we're in a trough. And moreover, the stock is trading last I looked at around $52 a share.

I think I can make it reasonably conservative and a hopefully compelling case. It's worth over $80 today. So how do you square that circle? You square the circle. You did the case. I can square the circle for you. So my take on it is, look, these guys generate a lot of cash. The one thing that wasn't down this quarter, this quarter, they produced about 34 million in free cash flow. But generally Q3s are, which this was, cash flow does take a dip because they're investing heavily in inventory ahead of the holiday season.

You're probably looking at free cash flow in the $150 to $200 million when the next quarter is reported. On the overall 12 trailing months, they've done 430 million in cash flow. My take on this is, look, this is a company that's probably going to grow revenues in the very low single digits for a couple of years. I think that will probably re-accelerate. They're in the middle of the very start, actually, of a five-year plan that they call it. They previously had a five-year plan, which they hit all the goals early, so that was good. But like I don't have the trailing free cash flow reappearing for another three years. So it's four years in my model before we get back to where we are today.

That's probably reasonably conservative. My margins are slightly lower than what they just put up. My discount rate is I think reasonably high. They've got a little bit of debt. They got a little bit of cash. I think they got a net debt position about 190 million. I go out and value all of the outstanding stock options using the Black Shoals model. And the input to that is what I think the fair value is, not with the share prices, which I said, you know, it was, I think fair value is over 80. It's currently trading in 52. So I make all the outstanding options as kind of a debt equivalent and deduct that, kind of like what you would do with debt. I make sure I account for all of the performance stock units and restricted stock grants that have been given out. And with all of those things included, like so things actually slightly getting worse from here, I still struggle to.

get it below 80 bucks a share. So you can start saying, well, what do we need to see for it to be equivalent to today's price? And you start seeing like, you know, essentially growth never comes back, which is probably unreasonable because they are on a secular, like they're opening more and more new stores. Now, if they start opening stores where, you know, the returns on the cash on cash returns for those new stores start to suck, you know, then you start asking yourself, well, why are you opening these things? But for now, I think this is just a lull. And I look at what they're aiming for.

And they've made some reasonable progress on a couple of items. I think that probably by the time we get to 2027, they'll be more efficient with their inventory. They'll have a slightly higher margins than they have today. And then the other piece of the puzzles, what does management do with the cash flows? Let's talk about it. Well, in this case, management, you know,

there's a small dividend. They're self-funding all of their store growth. So when I talk about free cash flow, that includes the spending they've done for new store growth. So there's an argument to be made that some analysts would actually try to estimate, separate out your CAPEX from maintenance and growth components. And you'd add the growth component back because that is technically or effectively money that you don't have to spend. You're choosing to spend it as opposed to maintenance CAPX just to keep things moving. But they are aggressively retiring their own share. which if I'm roughly right, stocks trading for just over 50 and I think it's worth just over 80,

they're buying at a 30% discount. That's what I want to see happening. Dear listener, if you feel yourself drifting off, this is the sound of Jim Gillies trying to make you money as a stock investor. They're spending $700 million on share repurchases. This is for a company that's worth a little less than $4 billion. So put that 0.7 over 4. It's a company that had about 90 million shares outstanding to start 2022. We'll call it about 70 million today just to make math on podcasts easier. If you're listening, Jim has a decimal point that he wants to get into. But do these buybacks matter?

I know you're having trouble getting to the price justification, but this is a company that's seeing comparable sales decline lower earnings per share, even if is it's aggressively reducing its share account. Maybe it doesn't matter if fewer people continue to come into their stores. Actually, I think this is the time you want to see this. You want to see them aggressively buying back, assuming they can afford it and they're not putting it on the company credit card. I see you sleep number.

But assuming they can afford to buy back and they do make substantially more cash than they are deploying in favor of their growth initiatives, it's got to go somewhere. I guess you could pay off some debt if you wanted to, but they have actually taken the debt down, I think, by about 20% or so over the past year. There's no rush to repay that terribly quickly. They got lots of cash. And so, I mean, honestly, prudent capital allocation says, you know, buy your stock back when it's cheap. I think it's demonstrably cheap.

So I'm fine with it. Let's move on to Eritzia. Back in January, I asked you for a pullback stock. And I hope you were listening. You gave listeners, Oritza, we'll call it Canada's Lulu Lemon. You can buy really expensive stretchy things in the mall. Lulu Lemon is Canada's Lulu Lemon. Shoot, you're right. It came out of Canada.

I'll call it Lulu Lemon, too, Electric Bugaloo. This year, this year it's founder, Brian Hill, became a billionaire. And the company started opening more stores in the United States, like you said they would, including Soho and New York, Chicago's magnificent mile. A lot of in-person retail on today's show. What have you been seeing from this U.S. expansion throughout 2024? I mean, that's really what it is, right? This is a U.S. expansion story. It is a Canadian company. I want them to open no new stores in Canada. They're already saturated. They're in the best malls. I don't want an Eritzia landing in the mall that's three miles that way from my house because, you know, it's not a big town. It's a secondary mall. But I love the fact that they're, you know, in Toronto, that they're in even Hamilton or Calgary or Montreal in Tier 1 malls. But I don't want them opening anymore. in Canada. I want them opening the US. I want them self-funding their growth in the US. I want them

picking up prime locales in the US, which as you mentioned, they seem to be doing. So I am just happy to watch this. Yeah, I mean, yeah, this is what up about 83% versus the market up 27% so far this year. I'm going to take that. I'm a shareholder. So I'm going to enjoy that. But I just want to see more of the same. And I'm perfectly fine. Like, you know, they continue the next five years is growing in Tier 1 malls in the biggest cities in the U.S., I think it's a good thing. So I'm probably a bad person to notice what is cool and what is not. I learned this back in high school when I saw the band's group love and 21 pilots within the same week. And I said group love is going to be significantly bigger than 21 pilots.

People are going to want to see instruments and these are wonderful musicians. So with that out of the way, don't ask me why a retailer is popular. I'll ask you, what made Eritzia so popular in Canada? So they self-categorize in the fashion world as everyday luxury. So they're above discount fashion, which is clearly where I shop, and well below luxury, which I would advocate no one go shopping. So they call themselves everyday luxury. And I'm actually going to throw back to Lulu Lemon and throw back to just over a decade ago.

Because, yes, it is a Canadian company who gave up their Canadian stock listing. Hey, Eritzia, by the way, if you want to go list on the U.S. exchanges, you probably should. Just over a decade ago, you may remember Lulu Lemon had their problems with, you know, see-through yoga pants, and they had all kinds of issues. The stock just got rifled, basically. And the woman that I was dating at the time, we were chatting, and she was doing a master's degree at the local university, and we were chatting. And I said, you know, I go into this particular coffee shop, the coffee pub that's right by the campus.

And I know Lulu Lemon has just been beaten about the head and ears and left for dead kind of thing. I think it went from like $80 to $35. It's $400 today, fools. So it tells you how well that worked out. But it had just been pummeled into oblivion. And I walked into this coffee pub and I said, look, I see everybody is still, you know, and it's primarily obviously women. but I said like everyone's still wearing Lulu Lemon even in spite of their troubles. And she said something to me that I'll never forget and I think it applies to Eritzia with their everyday luxury area.

It is simply this. She said to me, you have to understand, Jim, Lulu Lemon makes clothes that you feel good wearing. You feel good about yourself wearing. And again, as someone who owns approximately 112 black T-shirts, that's never really been my thing. but I'm like, okay, I really, I really like that insight. She says it makes clothes for women that they feel good about wearing and good about themselves wearing. And I kind of look at Eritzia and I kind of see that same kind of trend in play. People who go to Eritzia really love their Eritzia stuff.

My daughter's got a single Eritzia sweatshirt and she wears it approximately nine days a week. That's why we're good at math on this show. I'm going to wrap up. So we got something at the Motley Fool. It's called Breakfast News. You can sign up for it, even if you're not a member, gives you a morning breakdown of what's going on in the market and all that good stuff. It finishes off with a question for investors. Today's question was, what is one thing investors underrate in a company? And for the sake of this conversation, actually, I do believe it, not just for the sake of this conversation. For me, something I like looking for is inside

ownership, is Bill Mann would say, are the leaders tied to the masts of this company? And in this case you have a founder and former CEO, Brian Hill, who became a billionaire, in part because he owns 18% of the shares outstanding for Eritzia. I like seeing that. I like being a trust fund baby along with these corporate executives. So we'll finish off with that with you. What is something maybe with Eritzia to tie this conversation together that you think investors underrate in a company when they look at it? I'll give you two. The first is growth, a growth story that lasts longer than the discounted cash flow wonks like me put into their model. Most models are about 10 years, what's called an explicit forecast period, and then you just assume a low growth rate for

all years beyond that initial 10-year explicit period or seven-year explicit period or even five-year explicit period. Oh, I'm going to say, this stock's going to grow 10 or 15 percent a year for 10 years, but then it's going to drop to 2 percent or less and this grow with the GDP. Imagine applying that to a story like, say, I don't know, Starbucks or McDonald's, companies that grow far beyond an explicit period and surprise you. So I am a big fan of thinking about, well, what are the implications of growth lasting longer than we perhaps do? The second thing is, and I've already alluded to it, and I've already even taken a shot with it, competent cash flow allocation. I would simply encourage people who are interested to go look at how Academy Sports and Outdoor has allocated their capital over the past 10 years or five or six years.

It's while you have really public. And then go look at the aforementioned sleep number and see what they did. And you will see a tale of two different stock charts. And if you do, email us, podcasts at fool.com, let us know what you get from that story. Jim Gillies, look at that. Underpromising, over delivering. I asked you for one, he gives us two. appreciate your time and your insight. Thanks for being here. Thank you.

All right. Up next, Alison Southwick and Robert Brokamp tackles some of the questions that you emailed us at Podcasts at Fool.com. That's Podcasts with an S at Fool.com. This time about diversification in the Standard & Poor's 500 and selling foreign stocks. Our first question comes from Jeff. I hear a lot of people suggesting that investors should choose an S&P 500 index fund as a way to get diversification in the stock market. But now that the seven largest companies make up over 30% of the index, it seems to me that a lot of that diversification has gone away. After a short chat with Chet GBT, I learned that depending on the times, it took anywhere from 20 to 60 companies to make up 30%. And I've been leaning toward using an equal weight S&P 500 ETF to help with some of that diversification.

Historically, midcaps, while more volatile, tend to have better return. over the long run. So wouldn't smaller companies within the S&P add more to the return when they are a larger portion of the portfolio, while in the current index, their returns are greatly muted? I know in recent years, those top few have provided a great return for the index, but I'm starting to have doubts about their continued growth compared to the other companies. Well, Jeff, this is a really good point. The SAB 500 is a market cap weighted index, which means that the companies that have the largest market caps make up more of the index. So it's always been concentrated in the biggest companies, but it's definitely more concentrated nowadays, thanks to the size of the so-called Magnificent 7, which are Alphabet, Amazon, Apple, Meta, Microsoft, Invidia, and Tesla. And as Jeff suggested, they now make up about 33% of the index. And if you look at the top 10 companies, which would also include Berkshire Hathaway, Broadcom, and J.P. Morgan, they make up 37% of the index, which is higher than the 14% that they were at the end of 2013 and the 2013. and the 27% that the 10 biggest company is made up in the index at the height of the dot-com bubble back in 2000. Now, when you look at history, it's kind of mixed on whether market concentration is good or bad. There have been times when the market is highly concentrated and the market did just fine, right?

But Goldman Sachs just issued a report last month, which predicted that the returns of the SEP 500 will average 3% a year over the next decade. One reason is valuation, but another is concentration, which they find. is near the highest levels we've seen over the past century. They argued that concentration is knocking four percentage points off the return of the index going forward. In other words, if it weren't for the high level of concentration, they believe the S&P 500 would average 7% over the next decade. Now, we'll see what they're right. Goldman Sachs is, of course, a big, impressive firm, but they're not always right.

But if you agree with them, then I do think moving some money to an equal-weighted S-P-500 index fund could make sense. One such fund is the Investco S&P 500, equal weight ETF, ticker, RSP, and it's rebalanced quarterly. Just to give you the idea what that looks like. The top two holdings in that fund are United Airlines and Pallentere, which make up each 0.4% of the fund. Compare that to the regular SEP 500, where you have Apple, Nvidia, and Microsoft, each making up about 6% to 7%. So it is definitely much more diversified. Jeff also makes the point that midcaps have over the long term outperform.

large caps, and that is true. Same, by the way, with small caps. But in the S&P 500, only about 18% of the fund is midcaps, no small caps. So another thing to do is to have money in a midcap fund, like Vanguard's with the ticker of MO, and some money in the SEP 600 Small Cap Index index, with the ticker IJR. But all that said, I still think it makes sense to keep money in the S&P 500 index fund. That's what I'm going to do. I will rebounds a little bit out of it, but I'm going to still keep my S&P 500 index fund as I have for the last 25 years or so, and it's worked out well so far. Our next question comes from Pete.

I recently bought a house partially funded by the sale of stock in a company I work for. They are Swiss, and I work for their U.S. affiliate. The shares are restricted stock units that vested at various times over the last 10 years, and I paid U.S. income tax on the shares as they vested. This stock trades on the Swiss Stock Exchange, and my company stock plan is operated by a foreign bank. Due to non-optimal company performance, the price at which I sold my company stock was considerably lower than the price at the time of vesting. I ended up with a net loss on the transaction that is considerably more than the maximum annual capital loss deduction, which I believe is $3,000.

I was thinking of selling other stock that has a gain equivalent to the loss on sale of my company stock. I've done this kind of loss offset before, but at a smaller scale, an only with U.S. stocks. I don't know if there are any restrictions on doing this same thing with a foreign stock. I did pay taxes on it after all. You guys provide an amazing service. Your insights are deeply appreciated and I hope you have a great holiday season. Oh, thanks, Pete. You too. Yes. Same back at you, Pete. Yeah. So this is the time of year where people often talk about tax loss harvesting, which is selling investments that are underwater in a regular brokerage account to offset any income or gains. Pete's kind of doing the opposite. He has already sold the stock,

already has the loss, has a lot of loss, and Pete is right, that the loss will offset $3,000 ordinary income if you don't have any other gains. Pete's asking, well, maybe I should recognize some gains now and use up some of those losses. I can't give you personal advice because it will depend on your situation because offsetting ordinary income is pretty good. Why is that? Because ordinary income is tax at your tax bracket, which is generally higher than long-term capital gains. So you may want to just keep those losses on your book because you can keep using those losses in subsequent years until you've used them all up. That said, you might want to recognize some gains, use those losses to offset them. Then when you sell that stock,

recognize the gain, you don't have to wait 30 days to buy that stock back like you would with regular tax loss harvesting. You can buy it back immediately. You've set your cost basis higher, but then you've also used up those losses. So it really depends on your situation, but it definitely makes sense to think about it. Just know that it's probably better to offset short-term gains than long-term gains because short-term gains are taxed at a higher rate. Our next question comes from Karen.

You have talked on the show about opening a Roth IRA for kids. I am working on some estate planning with my father, and I'm wondering if there is a tax advantage to gifting money to the kids now while he is still alive or after he passes. Well, let's start with contributing money to a Roth IRA for kids. And it can be done, but only if they have earned income and only as much as they have earned income. So the limit for an IRA this year is $7,000. But if the kid only earned, let's say, $2,000 at a summer job, that's the amount you could contribute.

But it doesn't have to come from them. You can help them open the account and put the money in there. All right. So assuming the kid did earn some kind of a paycheck, and it has to be earned income from a job. It can't be like interest or capital gains or anything like that. A couple of other considerations. So first of all, will your father need the money? You want to make sure that he has enough money set aside for any potential long-term care and of life care that he may need. So first of all, make sure that is the case. And then think about are the kids responsible

enough to manage the money? Because once it's in the account, it's theirs. They won't have full control of it if they're minors. But once they reach the age of majority and that changes from state to state, they have control of the money. And if they're not responsible kids, just liquidate the account and spend it however they want. Now, as for your question, whether there's a tax advantage to doing it now versus later, not really, unless your father might be subject to estate taxes. We talked a good bit about this in the previous two mailbags, but as a quick reminder, you don't have to worry about federal estate taxes unless your net worth is around $14 million, twice that if you're married, though some states have lower exemptions. So unless there's a reason

and just reduce his estate, there really are no tax advantages. So assuming your dad won't need the money and the kids are responsible, I'd be inclined to give the money now, right? It's always more rewarding to give money while you're still around to give it personally. As the saying goes, it's better to give money with a warm hand that a cold one. It's an opportunity for you and perhaps your dad to teach some investing lessons to the kids, and the kids will start learning about investing in an early age, and they'll have more time for that money to compound.

Our next question comes from Mike. When Social Security is determining your highest paid years, are earnings from a pension and side job combined? The answer is yes and no. So let's talk a little bit about how Social Security benefit is determined. It's based on your 35 highest earning years adjusted for wage inflation. But it only factors in earned income. That is income from a job. So the side job would count, but the pension wouldn't and neither would interest, dividends, capital gains, everything, like that. By the way, you can see your earnings history by creating a My Social Security account at SSA.gov. If you're like me, you'll see a lot of low earning years earlier in your career. For my first decade of working, I earned less than $30,000 a year. I'm close to having worked 35 years.

Once I reach that point, every additional year of working at my current income, which is at this point, thankfully, well about $30,000, knacks out one of my lower earning years and boosts my benefit. So I suspect that's the case for most people, and it's one of the reasons that working just another year or if you can increase your eventual retirement income. Our next question comes from, just a fool. I have a 401k from a company I left in 2010. Next year, the plan administrator will be replacing a fund with one with lower returns. Does it make sense to roll the money over to an IRA so I can choose my own investments? I already have an existing IRA. Should I roll over the 401k to that account or open a new

IRA. I am self-employed with 4.5 years to go. So I would say it's generally better to roll a 401k with a former employer to an IRA. You'll likely pay lower expenses and then have way more investment choices. It could even make more sense for someone close to retirement because that's a time when you should be playing it safer with some of your money. And most 401Ks usually just have a few choices for your non-stock money, you know, like one cash equivalent option and maybe a bond fund or two. So if you roll the money over to an IRA, you'll likely have choice. for all kinds of cash equivalents, money market accounts, CDs. You'll have many more choices in terms of bond funds and maybe even be able to buy individual bonds, if that's something

you want to do. And of course, you'll be able to buy individual stocks and choose from among literally thousands of funds and ETS, something you likely can't do in your 401 . That's said, there are a couple of reasons to keep the money in the 401 . One is that it might have a particularly attractive fund that you couldn't get on your own. For example, the funds 401ks often get institutional prices, which means they have lower expense ratios than what you could get on your own. And the other reason is that if your plan allows it, you can withdraw money from that plan if you retire at age 55 or older and not pay the early distribution penalty of 10% that is usually assessed on withdrawals before age 59.5. However, this only applies to the plan

offered by the employer you were working for when you turn 55. This does not apply to our questionnaire here, just a fool, because he's talking about a 401k. with an employer that he left in 2010. But I just wanted to mention this age, 55 exception, in case it applies to other listeners situations. And then the final question, should you roll it over to your existing IRA or a separate IRA? It doesn't really matter. So if you are happy with your current IRA provider, go ahead and roll it in the company. 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. Don't buy or sell stocks based solely on what you hear. All personal finance content

follows Motley Full editorial standards and are not approved by advertisers. for only picks products that would personally recommend to friends like you. I'm Ricky Mulvey. Thanks for listening. We'll be back tomorrow.