Plain English with Derek Thompson - Crypto Crashing, Pandemic Stocks Plunging: The Story Behind January’s Crazy Stock Market

Episode Date: January 25, 2022

Morgan Housel, the bestselling author of ‘The Psychology of Money’ and a partner at Collaborative Fund, is back to talk Bitcoin, Peloton, tech stocks, financial media myths, the psychology of stock market corrections, and the long view of investing. Host: Derek Thompson Guest: Morgan Housel Producer: Devon Manze Learn more about your ad choices. Visit podcastchoices.com/adchoices

The press box is here to catch you up on the latest media stories. Hosted by Brian Curtis and David Shoemaker, these guys have the insight on the biggest stories you care about. Check out the press box on Spotify or wherever you get your podcasts. Today's podcast begins with a bit of an economic mystery. Since the pandemic started, I know a lot of people who bought Peloton bikes. A lot, a lot of people who bought Peloton bikes. From my very narrow vantage point, Peloton was like the biggest winner of the entire pandemic.

But last week, the company announced that its business had basically collapsed. By collapsed, I mean, new bike purchases have declined so much for Peloton in the last year that they're going to pause manufacturing them entirely for several weeks just to hope that demand catches up. So I'm reading this news, and I check in on the stock. Peloton stock, I see, is down 80%, 80% from its 2020 high. This darling stock of the pandemic, is now lower than it was before COVID started. I'm like, how is this even possible?

So I go snooping around in the company's quarterly earning statements. And it is brutal in there. Bike sales are down. Marketing and administration costs have more than doubled. This company is a mess. And suddenly, my question for Peloton changes on a dime. From this company is a stallion, what the hell is going on, to this company is a disaster.

What took so long? If you zoom away from Peloton, you see a similar dynamic in the entire stock market. Tech stocks are in the toilet this year. Bitcoin and other cryptocurrencies are doing even worse. Disney, Netflix, Twitter, Amazon, Gap, Starbucks. All these companies are at or near their 52-week low. So something important and very interesting is happening in stocks right now. But the thing about stocks is they go up, they go down, they go up again,

and if you try to fit a narrative to every tiny little gyration, you were going to look like a big idiot. In fact, when I started recording this very podcast, the Dow was down several hundred points. And I checked back two hours later, it's up several hundred points. The stock market is like a Chiefs Bill's playoff game, except it happens every day. If you don't like the score, just wait 13 seconds. So to guide us responsibly through the mayhem of the 2022 stock market, I brought back Morgan Housel, the best-selling author of The Psychology of Money, which is probably for my money, the best investment book I've ever read.

Morgan is also a partner at the VC firm Collaborative Fund. We talk the history of market corrections, the dance between number crunching and storytelling and investing, and most importantly, we deep dive into what's happening in tech stocks and pandemic stocks that have tanked in the last year. I'm Derek Thompson. This is plain English. Morgan, welcome back to the podcast. Thanks, I'm you, Derek. Happy to be here.

So, Morgan, as we are speaking Monday afternoon, the Dow is down 2,000 points. last five days. Crypto has crashed, a trillion dollars wiped out there. Nasdaq, which is the tech-heavy index, is down more than any January since 2008 during the Great Recession. I don't want to do just so stories here where you and I pretend to have like a perfect understanding of everything that's happening and why it's happening. But give me your read here. What are we looking at? The first thing I'd bring up, whenever we have something like this, is to point out how normal this is, particularly if you're looking at like the S&P 500. If you go back and look at 100 years of data, you'll see that the SP500 has a 10% decline like we're experiencing

right now, on average every 11 months for the last century. Now, I think it's hard for people to remember that in real time because the stock market tends to go up. So we have this knee-jerk reaction of like, I'm invested in the stock market. It goes up, I make money. And then when it goes down, it's like, what is this? It feels broken. It feels like something is wrong. But if you look at the data, you're like, this is completely normal. And this is, you know, the worst stock market crash that we've had since the last one that nobody remembers is basically had a phrase that we're going on. If you were to look at the NASDAQ or a bunch of individual tech companies, some of which have gone down 50% in the last like two months or even more than that. That I think is a little bit something different.

That's not a normal decline. Although you could say there is this thing in investing that I really like, this heuristic where however fast your investment goes up, that's the half life for how fast it can go down. Like, if you double your money in three months, you should expect it to be able to lose half its value in three months. So if you look at some of these companies like upstart and whatnot that have declined, sometimes 80% in the last four months, really the other context of that is their stock prices are back to where they were like last July. And then in that context, it's like, yeah, it's really not that big a deal.

So really quickly, before I move on, if corrections like this aren't unusual, what is unusual? What are we seeing that might be a little bit out of the norm that's like, huh, that might be something to pay a little bit of attention to because that is not the sort of thing that happens every 11 months. I think when you see a 10% decline in the S&P 500, that's pretty normal. When you see a company go down 80% on virtually no news, that's not normal. The flip side of this, as I just mentioned, though, is a company that goes up 400% in six months on no news. That's not normal either. I mean, it was only two months ago that Rivian, the truck company, which had at the time, this is the electric truck company.

And the truck looks amazing, by the way. It looks so cool. But at the time, when it went public, they had never sold a single truck. They did not have any revenue. And they were worth twice as much as Ford. They were worth $150 billion for a company that has never sold a product before. So you look at things like that and you're like, that's what's not normal. A lot of times it's not the crash that's abnormal.

it's the bull market that preceded it that is crazy. And that context can be kind of hard to to piece together as well. There's another side of this, Derek, I'm sure you're going to have some comments on this well, which is that we are very likely heading into a period where zero percent interest rates and the bazooka of free money from the Fed is coming to an end. And that has a big impact on valuations and business cycles and the amount of cash sloshing throughout the economy that we've enjoyed for the last, not just a couple of years, but really for the last decade or more than maybe coming to an end. You even perfectly anticipated my next question.

So I want to point out before we jump into potential explanations for this broader decline, that a lot of times the financial news media will report on stock volatility with like the fool's gold of an explanation rather than an actual causal explanation. Like you'll get these headlines, stocks plummet as Putin-Mulls invasion, stocks fall as American ice skaters slips in Beijing. Like, it sounds like you're describing a causal relationship, but what's really happening here is the headline writer who's on deadline is putting together two things that happen roughly at the same time side by side, even if they're not related at all.

That said, I do want to throw out some observations, and I repeat sweet listeners. These are not complete in total explanations, just observations, that I think are developments worth keeping our eye on as we're looking at a rather dramatic. correction in a lot of stock prices. You mentioned Morgan the Fed, the Fed and interest rates. The Fed has talked about raising interest rates, rolling back quantitative easing. That overall is going to raise the price of money for companies and could pull down equity values even further than they've already been pulled down. The second thing to point out, before I throw it back to you, is that stocks by some measures are pretty rich. There's this thing called the Schiller price to earnings ratio. That's

the ratio between the stock price and the profit of that company. The historical average is about 17 to 20. In December, the PE ratio touched 39. So stocks aren't cheap, and the Fed is starting to shift the Titanic and change its strategy when it comes to interest rates and quantitative easing. So throwing back to you, Morgan, tell me a little bit about how we should think about the interplay between monetary policy, the Federal Reserve, and stock prices. Here's one way to think about this. Every investment valuation, whether it's a stock or a bond or a house, whatever it might be, is the result of taking a number from today and multiplying it by a story about tomorrow. That's what all valuations are. And when interest rates are zero,

as they've been for the last couple of years, the number from today doesn't really matter that much because there's no competition for your money from bonds or savings accounts that might earn you a good return, you're not going to earn any money in those investments. So whatever a stock company is producing today and profits, their earnings today, doesn't really matter that much. There's no competition for your money this year. So then in that situation, you multiply it by a story about tomorrow. And in today's social media economy, that story about tomorrow can get crazy. People can make up these ridiculous stories about the potential of a company. And then so that's when, like the whole value of a company,

in an era where interest rates are zero is heavily, heavily driven by narratives. That's always the case. But when interest rates are low, that's all that's driving the market virtually. And this is why for the last couple of years, you've had companies with no profits, no potential profits, no real viable business model that could be worth tens of billions of dollars. In an era, if you go back to, let's say, the mid-1990s, when interest rates were, you know, five to seven percent, that by and large did not happen in an era where interest rates looked more reasonable. One example I give of this is Michael Dell, who founded Dell Computer,

of course, he posted one time the profit and loss statement from Dell Computer when he was still running it from his dorm. He was still a dorm room company. And when he was running this brand new startup out of his dorm, he had 20% net profit margins. Like it was a very healthy, profitable company because that's what a real business was back during the day. Today, if you come to a venture capitalist and you say, I have a startup and it has 20% profit margins, they're like, get out of here. We want nothing to do with you. The idea of free cash flow and profits just hasn't really been a thing that you needed to do for the last five or 10 years. And in an era where interest rates are rising, that flips. And I think you're probably going to be heading towards an era

where profitable companies that produce real profits with cash flows become more favorable to companies that just had a story that they could sell that was so appealing during the last five years. I think this is a lovely way to think about it, that stock prices are a dance between today's reality and tomorrow's story, and that there are periods of history where the story just wins. Like, why was Rivian an electric truck company that has barely sold a single car worth more than Ford at the end of last year? Ford, a company that sells 1.8 million cars a year. That's not because of reality. It's because of a story. Like people thought that Rivian, like Tesla, would serve.

this wave of electrified vehicles that would engulf the world. And you can say, oh, that's because of speculation created by the Fed, or, oh, that's people betting on mean stocks because of the Biden's stimulus checks. And maybe they're right. Or maybe stock prices are just a dance between reality and story. And we're just in a moment where the weight is being passed from one dancer to the other, and reality is taking the lead. It reminds me of Matt Levine, writer at Bloomberg, who coined the term boredom market hypothesis. And Matt's boredom market hypothesis is basically that during the pandemic, there was nothing to do outside. So a lot of people stayed inside, posted to Reddit, and traded stocks all day because it was fun. I think betting on

stories about the world is fun. Making money on stories is fun. Morgan, are you a fan of the boredom market hypothesis? I think it makes sense. The other side of this, that's, that's, that's actually, it's kind of a function of what Matt was talking about is there's just so much momentum and inertia in markets. And if something has gone up that catches people's attention, and if something goes down that catches people's attention. And like, people are buying because it went up and it went up because people were buying. That can snowball in itself for months or years and then the process reverses again. So I think it's really just like a big extrapolation of what happened in the previous six months.

That tends to be all of investing history. It's just extrapolating what just happened into the indefinite future. One other side of us, Derek, that I think is easy to overlook is the difference between a good product and a good business. And they can be very different. And there are a lot of companies out there that are amazing products that people love with millions of customers, happy, loyal customers, but they're not good businesses. And that's important because those companies can gain a big narrative following of like, oh, this company is a future. I love this company. But really, if you dig into the numbers on the income statement, the balance sheet, they're not good businesses. And therefore, in a world where you're

heading into higher interest rates when profits become more important, those are the narratives that can unwind really quickly. One good example of this is Netflix, which is like the darling of America, everyone, I use it, you use it. I spent the weekend binging Ozark this weekend. Like, Netflix is not only like is it a good product. It's like one of the best products has been invented in the last 20 years. But Netflix is not a very good business. They don't produce very much free cash flow. They burn a lot of cash through lots of their annual periods. It costs tremendous amount of money to buy and produce all this content. So from a business standpoint, a financial standpoint, it's not a great business at all. Uber is another one of like amazing product

that people love, whether it was before COVID and you were taking rides to the airport or Uber eats, but it's a terrible business. It just doesn't produce a lot of profits. So those are the kind of companies and there's so many of them that can get unwound really quickly. And it surprises a lot of people because you're like, how can Netflix be down 20%? Everyone has Netflix. And Netflix is so amazing. Yes, but that's actually kind of a shitty business. And that's, that, that I think, plays into why this happens in a way that surprises people. I take your point. And this isn't to say, you're not saying Netflix and Uber are worthless. You're saying these are companies whose businesses are historically valued at X, and right now their stock price is 1.5x. So that would suggest

that at some point, narrative and reality will converge and the stock price will fall to X. But the thing I guess I don't quite understand yet, and maybe it's just that nobody understands this. Why now? Why is the market having this moment in January 2022 rather than sometime last year? Is there a single trigger that you can see that sparked the sell-off, or is it more complicated than that? This is one of the ultimate questions in the history of economics. For example, why did the stock market crash on October 29th, 1929? Why didn't it have happened a year before, two years before. We're almost 100 years past that, and historians, economists still, there's nothing in there. If you go back to the newspapers in September and

October of 1929, there's nothing in there. There's no trigger. It's the same thing. Like, why did the, why did the dot-com bubble collapse in March of 2000? Nothing happened in March of 2000. I think, I think these these things just reach, reach a point where, you know, one person starts selling, and that creates a little bit of momentum, and it just kind of festeres on itself from there. So when the market is that fragile, when valuations are that high, it doesn't take a little bit of selling to snowball into something catastrophic. But I don't think in any of the history of these things, there's a real trigger. Now, sometimes when Lehman Brothers went bankrupt in 2000, that was a trigger. But most of the time, there's no explanation in the newspaper that even in hindsight, you can go back and say, this is the event that caused it.

Yeah. It's sort of like a natural calamity. It's like earthquakes or tornadoes. Like someone can't explain the nature of weather patterns or the nature of tectonic plates that makes earthquakes inevitable or makes tornadoes more likely to happen in Kansas than in whatever, New York City. But figuring out exactly where and when the tornado is going to strike or where and when that earthquake is going to happen, the timing is much harder to pinpoint than the general

universe of causes. Does that make sense to say? Totally makes sense. The other example I use is, Alan Greenspan, who was the former chairman of the Federal Reserve, he first used the phrase irrational exuberance to describe the stock market in 1996. And he was right. The stock market was irrationally exuberant in 1996. And it surged for another four years. Like the big bull market in the 90s had like not even really begun when he accurately defined it as irrationally exuberance.

So there's a big disconnect between like identifying a market bubble and identifying that's crazy and knowing when that's going to turn. And I think that's always the case. You could have also said that the U.S. housing market was a bubble in 2003. And you were right. Like, in 2003, it was a bubble. But in hindsight, like, prices had not even begun their big surge upwards yet. That it kept going for another four or five years. Speaking of narrative followings, got to talk about crypto. My general philosophy of crypto prices is that crypto is basically like the entire stock market, except more so, like stocks go up, stocks go down. That's the story of stocks. crypto goes up 1,000 percent, then it crashes, and it goes up 2,000 percent.

Like, crypto is just stocks on steroids. What are you seeing right now in the crypto market? You know, the best analogy for what Bitcoin is is digital gold. That's the analogy that makes the most sense. Okay, so let's run with that. That's true. Let's look at the history of gold then. Gold is a constant history of going up 5 or 10x and then crashing and sitting there for 10 years

and then flatlining for another 10 years. That's the whole history of what gold is. And I think it makes sense, too. If you think about what we spoke about a few minutes ago of all investments is a number multiplied by a narrative, well, for both Bitcoin and gold, there's really no numbers per se. There's no earnings. There's no cash flow. So therefore, all that's really driving it is the narrative.

And the narrative can be ridiculously profitable and powerful. And that's why Bitcoin is worth a trillion dollars. It's a really powerful, appealing narrative to millions of people. But it's a narrative. It's not really anchored by anything that is unemotional. It's purely an emotional play. And that's why back to like the half-life of investments, if you can have an investment that triples in one year, you can have an investment that declines 50 or 75% in one year. That's completely normal and rational and what you should expect. And that's been the history of Bitcoin as well. Bitcoin has had several 50 to 75% declines during its roughly decade life. And I would expect that going forward. Just has been the case with, gold for hundreds of years. So it's really not that surprising to see this, particularly also in Bitcoin where there is a lot of leverage in the system, a lot of people borrowing a tremendous amount of money, huge sums of money to purchase their crypto investments. That's when these unwinds, these kind of flushes where you get these declines, just kind of fester on themselves.

And maybe it would have been reasonable for a 10% decline, but you have so much leverage in people who are forced to sell that it turns into a 20, 30, 40% decline. Morgan, let me push back just a little bit on your interpretation of Bitcoin. And it's very possible that I'm wrong or that we're saying the exact same thing. But people have been saying for years that Bitcoin was a currency. And my response to that, as I'm sure your response will be as well, was no, of course it's not. Like a good currency needs relatively stable value to encourage transactions. Like that's what money is for. Bitcoin's value goes up 900 percent. It falls 50 percent. It goes up 300 percent. Like, if the dollar did this, you would go.

go to your local coffee shop, depending on the day, a latte would be $10, $50 or $30. Like, that's not a good currency. So then the explanation was, no, it's not a currency. It's digital gold. But digital gold seems to me to be a hedge against inflation or other stock volatility. A good hedge maintains its value in the face of declining stock indices. But Bitcoin right now is down, like 40% in the last three months by more than the tech index. So I'm not saying Bitcoin is good or bad for your portfolio, whatever.

I'm just saying this thing is behaving for now more like a tech stock on steroids than it seems to me to be behaving than like digital gold. Tell me where that interpretation is wrong to you. Not wrong. I think you're definitely right. But I would go back to saying that's kind of the history of gold as well. Gold, if you look at the data, is a terrible inflation hedge. Now, what's true is that over a very long.

period of time, gold tends to match the consumer price index. If you look over 100 years, if you look at any reasonable period of like time frame, five or 10 years, it's a terrible inflation hedge. I mean, gold peaked in the early 1980s and then declined for the next 18 years. During those 18 years from, let's say, 82 to the year 2000, there was a lot of inflation. There was big inflation. Like cumulatively, I don't know, 100, 200 percent and gold declined during that period. So it tends to be like rather than just neatly tracking. the CPI index over time, it's these huge booms and busts. That's what gold's done. And if you think of Bitcoin as digital gold, that's what I would expect to do as well. It's never going to be

the case that it's just like a perfect hedge in every time period. That's never going to exist. So you're saying even physical gold isn't very good gold. If gold is understood as an inflation hedge, like even physical gold doesn't do that. That's right. That's kind of funny. So this is obviously the fall of Bitcoin and a lot of other cryptocurrencies, pretty bad news for people that are heavily invested in crypto that have been holding Bitcoin as a religious practice or investing in ETH or Doge or whatever else. What about the broader economy? The crypto drawdown is erased about a trillion dollars in wealth. Do you expect that's going to have any spillover effects in the broader economy? Yeah, I think it probably will. Now, we're also heading into a period.

have been in a period when there was so much money in the system and such a broken supply chain that we are facing real inflation for the first time in 40 years. So the fact that some of that fuzziness, some of that that fizziness is being pulled out of the economy and kind of unwinding is probably not the end of the world, particularly if you contextualize it by saying, look, the crypto market is back to where it was last July. Like this is not the Great Depression yet at least. This is like the drawdowns that we're looking at have to be contextualized to say, look, this is not the end of the world. But yeah, I would definitely think that, particularly in high-end markets of selling like high-end vacations and whatnot for people that were going out

and splurging because they made so much money in the stock market or from crypto. I mean, like the extreme example of this are like the number of Lamborghinis that were purchased when crypto was surging. So like, yeah, there is some pullback from that, but there's still just so much money sloshing around. the economy, probably too much, that it would not worry me right now relative to, if it would, say, in 2010 or 2009, that was an area where it's like when you lose that much wealth and the economy is already weak to begin with and there's already such a whole, a demand hole in the economy, that's when it can really fester on itself. I have another question for you about the intersection between COVID and crypto that right now is a little bit of an amorphous idea in my head,

but maybe you can help me tease it out. It seems to me really deeply ironic, that a lot of the investors in crypto in the U.S. are members of Gen Y and Gen Z, which are generations that have grown up at a time when stocks have basically year over year gone up and up and up and up and up, while the world around the stock market has been a cluster shit.

You had 9-11. you had the Great Recession, you had COVID, just one effing thing after another. It's like generation crisis in the physical world and generation stock boom in the financial world. And I wonder whether there's something about that intersection that might also explain why so many hopes and dreams have been funneled into the stock market. among people in this generation. I mean, one thing that I've always thought is interesting is just how kind of our generation, Derek, my and your generation,

kind of mid to older millennials, will view COVID. And the nuance here is that I graduated in college in 2008. I think you were probably similar, give or take a few years maybe. Is that, is that right? I don't want to make any assumptions. Great, perfect. 2008, right in the dot. And so when you and I graduated college,

we walked into the job market during the peak of the Great Recession, the worst jobs market in a generation, it was a terrible time to be looking for a job. That was our opening experience into the quote-unquote real world. And then there was this tepid recovery from 2010 to 2020. And then things fell apart again in 2020. And that's all that our generation has known.

And we are not kids anymore. I'm 30. I'm, we're approaching 40. I have kids. It's like we're not kids. And all we've known for our entire working life is collapse to tepid recovery, to collapse to maybe now like crazy bubble in the last two years. I think when that's all you've known, it can leave a scar on you.

And I'll tell you why, because after 2008, our generation could say this is bad, but this is a once-in-a-century experience. This is not something that's going to happen again. We just got unlucky by facing this once-in-a-century storm. But then when everything falls apart again in 2020, then it's easy to say, this is just how the world works. Every five or ten years, the world breaks, and everything that I thought I knew was stable vanishes in a heartbeat, and that's how the world works.

And I think that can leave a scar. It's like, fool me once. Shame on you. Fool me twice. Shame on me. I think people have been fooled twice by the economy now. Our generation's been fooled twice in a way that we'll stick around. Maybe it's somewhat analogous to like the generation that lived through the Great Depression.

And then as soon as that was over, they got thrust into World War II. That generation has been so well documented, went the rest of their lives. lives pretty tepid and pretty conservative, didn't invest a lot in stock market, didn't go into a lot of debt. They were left thinking, maybe rationally, that every five or 10 years the world breaks. And so that's like the biggest mindset shift that I've probably seen with COVID that I think will have a long, enduring impact on how our generation, who is in the next couple years going to come into the most managerial authority, the most wealth, et cetera, et cetera, is fundamentally scarred in just in terms of how to think about risk.

I want to close by talking about some specific pandemic stocks that are really, really mysterious to me. So Peloton at Home Fitness, Zoom, video teleconferencing, Lulu Lemon, Athleisure, Robin Hood, online trading. All of these stocks went to the moon sometime last year, and all of them are crashing right now. If one year ago you invested $1,000 into Zoom and $1,000 into Peloton, you would have lost $600 and $800 there, respectively. And I'm really interested in this turnover, like the end of the age of pandemic stocks and the beginning of something else. So to do a little bit of a deep dive here, let's start with Peloton, down 80%, 80% over the last year. Company just announced layoffs. They're going to pause manufacturing of its bikes for several months.

It really is just a total across-the-board mess. Morgan, what happened to Peloton? I mean, I would answer that question by asking a rhetorical question, which was why was an unprecedented? profitable exercise bike company worth $50 billion to begin with. That's the question that needs to be answered if you want to define, if you want to describe like why did it crash? You have to describe why it was worth that to begin with. And I don't think anyone could justify that in any reasonable financial terms.

It was kind of caught up in the hype. A lot of these companies, too, back to great products, great businesses. If you are an unprofitable company and your business surge, you have like tons of demand, that could actually be like a bad, that just means you lose more money in the future. If you're losing money on every bike you sell and your business goes up 10x, you just lost more money. So for a lot of these businesses, like that big surge in demand wasn't necessarily a good thing. And particularly for a company like Peloton that extrapolated that demand and just way overproduce their bikes.

And now they're caught. They have to shut down their manufacturing because they have warehouses filled with these bikes that nobody wants. Like that's a really tough spot to be in. Zoom, I think, is maybe something similar. It's an amazing product. You and I are using it right now as we speak. But it's an okay business. it's not the best business in the world.

And once you get caught up in the hype, I think there was really like a lot of hype in 2020, the Zoom was going to fundamentally change the entire world. And in some ways it has, but it probably just got way extended to where it was. And now it's kind of reverting to back where it should be given the realities of his business. Maybe some of these businesses, I would say,

I would take that back. Not maybe. It's almost certain that a lot of these businesses, five years from now, we will look back on as incredible bargains. And maybe you and I will be on a podcast five years now and be like, I can't believe we didn't buy Zoom in January 2020. What were we thinking? That has a long history in investing as well. You know, after the dot-com bust, you could have bought

Amazon at like $2 a share. And that was after it fell 90 percent and people were like Amazon as a joke. It's never going to work. There's a long history of that too. It's just always hard to tell preemptively what that's going to be. Yeah. So I own a Peloton bike. My wife is obsessed with Peloton. I like Peloton just fine. I was telling her about this episode and I said, did you know that Peloton stock is down like 80% in the last 12 months. And she said, I don't understand. They've sold a lot more bikes, right? And I said, yeah, they've sold a ton of more bikes. They had a huge 2020. But it's kind of like if you're a cookie store and you sell 100 cookies and then you buy dough for a thousand cookies and then you only sell 50 cookies. Like your cookie sales are going down as your

expenses are going up and that is the worst possible place for a growth stock, a growth company to be. So I look straight into the 10-Q in the second quarter or first-quarter earnings report from Peloton. Just want to read you some numbers here, because they really are pretty striking. So you're comparing the three months ending September 2020, but the three months ending September 2021. So subscription revenue is up.

That means people who bought bikes are reliably paying for that big iPad and streaming the workouts. But revenue from workout equipment declined between 2020 and 2021. So they're selling fewer and a few. fewer bikes. That's bad. But actually gets worse because the operating expenses, sales, marketing, administration, R&D, all of that more than doubled. And so you were getting to this, the unit economics, right? That is how efficient are you at selling one unit of your thing,

whether that thing is a service or a product? The unit economics here are going to hell in a hand basket. And in a way, I think that another gloss we could put over the last, say, five years is that in the last five years were like the death of unit economics. No one cared. No one cared how efficiently you were making your product as long as the product had story value, narrative value. It was cool. People talked about it. They tick talked about it. It appeared in HBO shows. Your product was an it product. But now it looks like a lot of investors are turning toward unit economics and asking, okay, we get that your bike is cool, we get that the instructors are many celebrities. What does the profit look like? What does the quarterly earnings report look

like? And if investors start asking those questions, it means they're not listening to the story. They're not listening to their narrative. They're just looking at the numbers. It makes me wonder, though, how much of this is just Peloton being and not terrible business, but okay business, that pulled forward so much revenue, so much business into 2020, they just got totally discombobulated and are now in a position where they can't match supply and demand. Yeah, lots of it. I also think there's a thing of, like, if you are an unprofitable business during a period when the market has a lot of hype, they'll be like, hey, you're unprofitable now,

but don't worry in another year or two, you're going to be super profitable. Like, don't worry about it. Like, Facebook at one point was unprofitable, but then they became this profit juggernaut. like don't worry about it. But after a year or two goes on and the unit economics keep getting worse, then it's like, okay, maybe massive growth is not your ticket to big profits. Maybe you're just an unprofitable business. Maybe it's just really hard to make exercise bikes and to sell them profitably. And the more time that goes on, the more the reality starts to show that like, hey, this just actually isn't a good business. That's when particularly if your stock has been

priced for hype, priced for perfection. And then the reality of like, this isn't great business sets in, that's when you can have these 80% unwinds. There's a long history of that, too. There are companies that are great products and amazing businesses, Apple and Google in particular, of like amazing profits, ridiculously good businesses, but it's few and far between. There's a lot of bad products. There's a lot of bad businesses. There are a lot of great products that are bad businesses. The combination of good product, good business is very, very rare. And that's why when you have it, they are these like one in a million companies like Apple and Google. So how does Pelotown become a good business?

Raise prices, lower costs? Isn't that the ticket to it? I have a third door. I have door number three. And this is a door that I think a lot of their investors want to open. Just get lucky and get bought. I don't know who buys them. I don't know if it makes the most sense for Apple.

Maybe Apple says, you know what? We could burn $10 billion in R&D developing a workout bike that can, you know, sync to your Apple Watch that can sync to your phone that can help you, you know, manage your own EKGs and health, or we could just buy Peloton in a fire sale. I could see Nike maybe getting a little bit interested in moving from, you know, shoes and software into a hardware business that people are obsessed with. And people who have Pelotons seem somewhat obsessed with it. I could even see like maybe Amazon thinking, hey, we can get you on the bike. That's mind share. That's time in front of essentially a jumbo iPad.

We can sell people certain goods on Amazon after they finish their rides and hook them into the prime ecosystem. Do you see any possibility that Peloton could be acquired by any of those companies or a similar juggernaut? Sure, that makes a lot of sense. Yeah, I mean, of course that could happen. The question is what price. But here's another point that I want to bring up here. If you look at public companies, not private startups, public companies over a long. period of time, 30 or 40 years, on average, 40% of them will go out of business, not be acquired,

not bought by another company. 40% of them will go bankrupt, basically. That's what's happened over the last 40 years. That's what happens in these 40-year periods. And that's during a period when the economy was really strong and the market was really strong. So the hard truth for all businesses, my friend Brent B. Shore says running any business is like eating glass, being punched in the face. Like, business is hard. It's just ruthlessly competitive. And a lot of times, 40% of the time, it just doesn't work out.

And that's for public companies that have already reached some level of maturity. So that's not a comment on Peloton in particular or any of these companies, but it's completely inevitable. A hundred percent guaranteed that in five or ten years, a lot of these darlings that are household names will no longer exist. And that doesn't break any historic precedent. That's always how this has worked. It also makes you kind of realize why gym businesses work.

Like exercise equipment is really effing expensive. And the best way to essentially mortgage it is to sell a bunch of subscriptions to a large diversity of exercise equipment that people use, that a large number of people use over and over and over again. That is a gym business. But buying individual exercise equipment for individual houses means you have to sell the equipment at a loss. You hope to make it up over the subscription. revenue where people are, you know, watching these workout videos week after week after week, but you might not make it. You might just run out of money before you can make up the money

that you're losing on the exercise equipment. So in a funny way, the unbundling of the gym business helps to prove why the gym business has worked. Like you need to share these costs over a large number of people. Very last point I want to bring up with you. This is the one-year anniversary of the GameStop bonanza. If you miss the GameStop bonanza of 2021, basically a bunch of dudes on Reddit helped to bid up the price of GameStop, a ho-hum gaming retailer, in part to crush a hedge fund that had shorted the stock. And it sparked this interest in so-called meme stocks, stocks that people were plowing their money into, basically, to steal your Morgan, your explanation because of the story,

that they were basically throwing their money after the most fun story of the moment. And it's not lost on me that we're talking about the revenge of value one year after maybe the height of meme stock madness. Maybe just tell me a little bit about what you see as the legacy of GameStop and how it intersects with this moment

where a lot of these exact kind of companies are crashing back down to Earth. If you and I were in an MBA finance class right now, they would teach us that stocks are valued by discounting their future cash flows back to today, adjusted for the marginal tax rate. That's in theory how a stock is valued. GameStop was just the perfect example of just like, no, that's not how it works in the real world.

That's how it works on the chalkboard and in spreadsheet. In the real world, it's totally different. In the real world, it's whatever people want to believe, for whatever reason they want to believe it, is what happens. Now, if you are a GameStop shareholder, that was amazing. You are like a beneficiary of that huge, ridiculous surge, but that can go the other way. And people can believe whatever they want in the other direction. And maybe some of these stocks are ridiculously cheap right now.

But that's the other side of investing in a market where narratives run wild. And that's just a reality of it. So GameStop was a perfect example of how crazy things can get detached from financials, from the spreadsheets and the chalkboards. And that can be fun if you're part of it. It also goes in the other direction, and it can hurt like hell when you are on the other side of it. You are a fantastic Spengali for people who are dealing with the daily generations at the stock market. What is your final piece of advice for investors on this roller coaster today?

I would just point out that every past market crash looks like an opportunity, and every current and future market crash looks like a risk. And if you understand the irony between that, I think that is a huge portion of successful investing over time is acknowledging and kind of laughing at that irony. That every time we look at a past market crash, like, oh, I wish I could have bought in March of 2020. What was I thinking? But now if I were to say, hey, Derek, the market might crash 30% next month. That's not a forecast, but just hypothetically, it's like, oh, that's terrible. I should get out. I should sell everything.

And it's like that disconnect is why investing is so hard. And I think just wrapping your head around that can go a long way to improving your investing returns. That's lovely. I think you're right. I think we're, we are, the media included linear thinkers in a trampoline world. You know, whenever stocks are going down, your mind just says, your might just extends that arrow all the way down to zero. This is the end of the stock market. When stocks are going up, it's like, nothing can stop me. And you look back over time, you look at the S&P, you look at the DAW, over the last 10, 15, 30 years, it's a lot of bungeys.

It's a lot of trampolines. And every single time you see the dip, there are 30, 40 stocks that you can think, man, if I had bought at that bottom, like, you know, how great would my portfolio look now? But these things are hard at time. The tectonic plate metaphor returns to me again, that we understand the variables,

but figuring out that the timing of the earthquakes is hard to do. Morgan, thank you so much for, coming back and we'll see you soon again. Thanks, Derek. Planning this with Derek Thompson is produced by Devin Manzi. Thank you so much for listening to this show. If you like us, follow us on Spotify, rate and review on Apple Podcasts.

We will be back with our second episode this week on Friday. We will see you then.