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00:31:30
A consumer goods company hit 40% yearly revenue growth. In this environment?
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- [00:01]
Sponsor Announcer
This episode is brought to you by Lifelock.
- [00:03]
David Meyer
Not everyone is careful with your personal information, which might explain why there's a.
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- [00:23]
David Meyer
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- [00:35]
Ricky Mulvey
Does Alphabet deserve a grocery store multiple? You're listening to Motley Fool Money. I'm Ricky Mulvey, joined today by the smirking David Meyer. David, thanks for. What are you smirking about? What's so funny?
- [00:58]
David Meyer
Oh, it's all good today. All good.
- [01:01]
Ricky Mulvey
Okay, good. Just, just making sure I don't look funny or anything. That's why we do a podcast for today. You know, politics keeps mixing with markets and we have some earnings from a fast growing apparel later in this segment. But you know, Dylan and JMO hit the trade deal ish trade agreement question mark between the US And China yesterday. But there's another move from the White House that could have significant implic for markets. President Trump signing an executive order that Americans must get a quote most favored nation price for prescription drugs. David, when I saw this, my first reaction was sweet. And you know what? I bet the big drug makers, stocks are going to dive on this. They did not flinch. The US Is where a lot of their profits come from. What's going on here?
- [01:48]
David Meyer
Yeah, the reason they didn't flinch is because the market doesn't believe that those profits are going away. I mean, it's as simple as that. If we look a little bit under the hood at what the executive order actually says, it does lay out some cases where, hey, other countries around the world pay lower prices than we do in the U.S. well, they negotiate differently. The market for drugs is way more open in the United States than it is in other countries. Governments tend to negotiate on behalf of their people because they're the ones making the purchases. So they have some negotiating power. We here in the United States tend to let markets determine prices. There are other in, you know, there are other players, there's you know, PBMs and things like that. But in, you know, this is basically the market saying that the US Markets will withstand higher prices. Basically with the stocks not really moving on the news, they don't, they're, the market says, well, we look ahead and we, we don't see how you're going to do this. And, and basically the other Thing that the said was hey, Health and Human Services secretary, go out and put together a plan in 30 days for what you think the prices will be. So you know, there's a negotiation that's going to happen in between. So we'll see what happens. But as of right now, that's what the, I think that's what the market is saying.
- [03:15]
Ricky Mulvey
Well, the pharma lobbyists are saying something else, David. They're certainly sweating a little bit. According to Bloomberg, the brand drug lobby PhRMA, my old employer had an emergency call on Sunday said that this could cost the pharma industry $1 trillion over a decade. You look at a drug like Oic, this was mentioned in the press conference with President Trump where a month of it is almost $1,000 in the United States, about 60 bucks in Germany. Okay, you know that's, that's not great if you need Ozempic. That's also a huge profit margin for Novo Nordisk. Novo Nordisk CEO D trying to defend the practice in Congress a little while ago saying hey, don't look at me, look at the pharmacy benefit managers. Those are the ones that are really screwing up prices here. So I mean the lobbyists are certainly concerned here. And you know, is this a time where if you own stock in a, in a drug maker, especially some one making weight loss drugs, is this a time to revisit your thesis?
- [04:17]
David Meyer
The short answer is yes. Should you panic? I don't think so. But you should go back. You know, given how this all tends to work and regulation does play a part in many industries. But in, you know, in pharma specifically, the lobbyists are going to have to basically make the case to the, to the HHS secretary to say, hey, this is why we think, you know, these, these drugs should be priced here. You know, again, this is about, you know, this is about pricing power. This is about bargaining power. And you know they're going to, they, the, the, the lobbyist pharma is going to have to roll up their sleeves and do some work over the next 30 days and beyond that because if I, if I read everything correctly, there's some, there's some other milestones at 180 days and a year out and multiple years out. So this is going to take a while to, to play out. They're going to have to do some work to basically say look, there's a reason that we, you know, that we, one, should be able to charge these prices and two, there are benefits to our industry as a result. Because you got to remember a Lot of that gets plowed back into research and development of all kinds to bring the next generation of drugs and next generation of care. So I don't think anybody would want higher prices just for the sake of higher prices. We should want our health care to be reasonably priced. Right. But at the same time, we don't want to disrupt the long term innovation that happens here as a result.
- [05:56]
Ricky Mulvey
So I think the administration is saying, and I would actually agree on on this point, I've, I've been accused of being too liberal and too conservative on this show. So we'll see what complaints I get this time. The administration would basically say we don't want to stifle innovation necessarily, but it shouldn't be on Americans alone to that innovation. When you have other developed countries in the European Union, Australia for example, paying significantly less for the exact same drug coming out of the exact same factory.
- [06:25]
David Meyer
And it may, and that makes sense. And then, then the question is who's going to do the negotiating, right? Is our government going to step in and do the negotiating? That would be a big change to how, how our markets work today.
- [06:36]
Ricky Mulvey
We'll, we'll see how it goes. I should also mention I've never worked for a brand name pharmaceutical lobby.
- [06:41]
Robert Brokamp
If you.
- [06:42]
Ricky Mulvey
I don't want to, I don't want, I'm afraid of catching heat today, David. I don't know why. Let's move on to earnings. Let's talk about earnings. Let's, let's focus on the fastball here, on holding the maker of comfortable shoes where rocks and mulch often get stuck at the base of it. I enjoy wearing them still. They reported this morning sales up a blistering 40% from one year ago. That is on a constant currency basis because we're going Swiss francs to US Dollars with this earnings report getting us in some Trouble. It's about $860 million in sales for the quarter. That's in US dollars. I'm looking at a retailer that is getting, earning basically 40% more sales than one year ago. So David, what is on getting right in this environment?
- [07:24]
David Meyer
They have the product that people want. I mean, you know, I don't, I'm not, I hope I don't sound glib when I say that, but that is true. Their products are very good and in demand all around the world. They had good growth in, in, in all of their geographical segments. And it's because they have taken the time and made the investments to put technology into their shoes that make them both comfortable, functional, whether you're, whether you're running, whether you're, you know, working out, whether it's casual, you know, all these things. But playing tennis. Can't forget about Roger Federer. They have product that people want and as we, you know, as we saw here this quarter, more people wanted it even as we're you know, starting to get into a little bit of the impact of the tariffs.
- [08:18]
Ricky Mulvey
Yeah, I mean On Clouds were one of my tariff panic purchases. Those included AirPods for a birthday gift. I had to get some basketball shoes. And then I was like my On Clouds have completely worn out at the bottom where rubber is like gone and I need to get these before the prices get jacked up by maybe 50 to 100%. I don't think that's going to happen now that we have the pause. But I do have some new On Clouds. I'm a big fan of the product. Is this, is this something you own? Are you, are you a Lynchian taking a Lynchian look at this company?
- [08:50]
David Meyer
So I don't, I don't own shares but I am kind of a, or I was a bit of a sneaker guy. So I have tried them and I also, I also like them. You probably aren't the only one making a purchase right ahead of what may have transpired and you did it because you liked the product. Right. And it was their direct to consumer channel that actually had the best growth. So I don't think you are in the minority in terms of maybe pulling a purchase forward. But to management's credit they actually said hey, we still see plenty of demand for the rest of the year. They it's not a top line thing for them. What they are actually saying in terms of the tariff impact is hey, we're a little, you know, maybe margins will get pinched a little bit. You know, we're doing our best to figure out what those might be. We're not really knocking them down heavily but we just want to let you know that it could be volatile but on a top line basis they say hey, you know, our product is in demand. We're making sure that all of our, all the places where we sell our shoes have plenty of product and, and good up to date product. So you know, I credit management for at least at the beginning handling this, handling this uncertainty pretty well.
- [10:09]
Ricky Mulvey
Let's dig into the numbers a little bit more. Looking at operating margin here, I think there's a story because now on is about, on par with Nike's historic average. About 10ish, 11% Nike dipped in a recent quarter. But we'll Take that out to be nice to our friends at Nike. This is significant for, you know, a younger brand that you would think needs to spend more as a percentage of their sales on marketing or maybe have less negotiating power with shoe stores like Foot Locker. And yet there they are in an efficiency basis pretty much on par with Nike. What story does that operating margin number tell investors?
- [10:47]
David Meyer
So this is actually a fantastic question. Let's use the Nike and on on holding comparison. Both companies, you know, do sponsor athletes, right? But Nike, man, think about the, you know, the, the suite of athletes that market their products, right? That's actually a huge expense for, for Nike. And they make the most of it by, you know, by getting in terms of volume and pricing that they've been able to generate for their products over the years. Even though on does have again those sponsored athletes, it's, it's, it's less compared to what Nike spends. They have actually done a good job of again creating a product that people want. Creating a product where word of mouth marketing is probably more important than necessarily the sponsored marketing. Again, getting the products to consumers in the way that they, you know, they want to buy them on has the advantage of having a, you know, a consumer that is more apt to buy in a direct consumer channel, an online e commerce type channel than Nike had when it was starting out. So the other thing I credit is in addition to putting good technology into their products, they've actually done a good job of building their business from a supply chain management standpoint, from managing their marketing, you know, all these things and figuring out where they can price their product in order to keep moving it at the volumes that, that they need. And at the same time they've been able to reinvest back into the company to say, hey, here's our, here's our latest technologies that we want to put in shoes, we want to expand into apparel. You know, hey, we need to open up a distribution center in Atlanta. I give management a lot of credit for not only creating a good product, a good, you know, an emerging brand, but they've created a very good business around this. And this is something that's important for the long run because if you look at the history of Under Armour, Under Armour had a phenomenal brand but they weren't the best operator. And eventually that caught up with them as they tried to get bigger and bigger and bigger. So we'll see, you know, going forward, we'll see how all this plays out for on. But they've done a good job of balancing all the things that they need to balance in terms of creating a good long term business.
- [13:17]
Ricky Mulvey
You don't think Elmo's getting Steph Curry rates for those commercials? I mean, you know, you know, I don't know.
- [13:23]
David Meyer
It depends, you know, it depends on how good Elmo's agent is. Right?
- [13:26]
Ricky Mulvey
It's a good question. I love the Elmo. So they have the commercial with Elmo and Roger Federer. They're using Elmo quite a bit in their commercials. I think on looked at Adidas and saw the trouble they ran into with Kanye west and said what is the opposite celebrity we can find? And then you get Elmo selling shoes for him.
- [13:43]
David Meyer
So you asked about my smirk earlier. There is not, there is nothing but good entertainment value as, as, as well as educational value in what we're talking about today. Because that is just awesome.
- [13:54]
Ricky Mulvey
Let's close out with the story on Alphabet. We've gotten a few questions about this company from listeners because of its underperformance relative to the market and storyline going into it. There's a Wall street research report from an analyst named Gil Lurie that would like, he would like to set the company on fire, basically saying the only way forward for Alphabet is a complete breakup that would allow investors to own the businesses they actually want. Making the point that the entire business is valued on the worst multiple that investors can find. That's the search multiple. It's about 17 times. Before I get to your question. Question on valuation. Why do analysts need to assign the worst multiple to the whole business? There's a lot of smart people looking at Google and I assume some of you can do math.
- [14:40]
David Meyer
So that is essentially the average, right? One way you could go about valuing Google slash Alphabet is, you know, value. The search business, which is by far the biggest business, right. Generates the most cash flow, has the most uncertainty around it today, like, you know, what is AI search going to bring in the uncertain, in the, in the uncertain macro environment, you know, is search going to go down? Is it a commodity now? Like there's all sorts of things facing the search business, but they have many other segments. And so what this analyst is basically saying is, hey, these other segments deserve higher multiples. Well, maybe that's true. As an analyst you could do that yourself and say, hey, YouTube is worth this. The cloud business is worth that. The chip business is worth something else. And you could, you know, if you think that as a whole the business should be trading at maybe 24 times a weighted average multiple instead of 16, as an analyst, you can say that the challenge in my opinion is in breaking this up is where do these companies get their capital from? All of them need investment capital in order to operate and a lot of that comes from search. So while I understand that breaking everybody up could unlock a lot of value, if you look at the most recent breakup of a very large company, go to ge. General Electric has split into GE Arrow, GE Vernova, which is the energy business and GE Health care. Right, that had a conglomerate discount and it was, it took years to, to divide that business up and now the, you know, the sum of those parts is greater than the previous whole. But it's not necessarily easy for those companies to operate on their own. Again the internal capital process, capital allocation process is taking a lot of, of cash flow that comes from search and putting it in new businesses making new investments, making new moonshots. I don't know, do we? Is moonshots a thing is still associated with, with Google?
- [16:46]
Ricky Mulvey
We can count Waymo. They got self driving stuff going on.
- [16:49]
David Meyer
There's all sorts of stuff. And while I understand breaking it up could unlock a lot of value, I also am sympathetic to the idea that hey, you know, most of the capital comes from search. And if you put these businesses on their own, does that, does that mean they have as much capital as they need in order to grow as fast as they want? I don't know, I don't know the answer to that question. And it's a risk to, to, to basically set, set all those free as individual companies in the market. And the market might say well you know, this is great but you know Waymo, you have, you have, you need a lot of capital going forward so maybe I'm not going to value you at the multiple that somebody else thought you were. Now that I can see all of your financials.
- [17:36]
Ricky Mulvey
So let's close out with the question that introduced the show. There's some narratives going against Google right now. The search business is declining. You're doing nothing compared to chat GPT. Your business there could become obliterated. And for that, Mr. Market is assigning Alphabet a lower than average earnings multiple about 17 times. David, that is what Kroger trades at a very mature grocery store business. And here you have Google which still dominates the search market. It's got a growing cloud business. It owns YouTube which is the biggest streaming service anywhere. It's free. But we can set that aside for now. I've got this company on my watch list. Should I pick up some shares while Alphabet's in value town or are we looking at a falling knife here.
- [18:19]
David Meyer
Me personally, as someone who I, I've followed this company for a long time. I, I'm in a, I'm in agreement with you. I, I think shares are probably undervalued, but they're probably under a little undervalued for a reason and that's because there's a lot of risk and uncertainty. That's, that's ahead of the company in the short term. If, if you have a case where the lawsuits don't have a big impact, if there's not a call for a breakup by, by the ftc, if the other businesses, you know, that are growing again, the ones we mentioned, YouTube, GCP, things like that, if they have all of the earnings power that this analyst thinks they do, eventually the market will be able to, to see through all of it and figure out what's the right multiple. I just personally think this is a phenomenal business. Generates significant cash flow. They have multiple ways that they can reinvest that cash flow. And yeah, it's probably a little undervalued today, even, even as a conglomerate.
- [19:24]
Ricky Mulvey
We'll leave it there. David Meyer, thank you for your time and your insight.
- [19:28]
David Meyer
Thank you so much, Ricky. This was a lot of fun.
- [19:35]
Sponsor Announcer
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- [20:50]
Ricky Mulvey
All right, up next, Robert Brokamp joins me. A look at bonds and what investors should consider before adding them to their portfolios. Investors own bonds for safety and income, but recent history has occasionally told a different story. The total return from the overall bond Market has been flat to slightly negative over the past five years. That's if you bought into this. This safe investment is Covid kicked off. And over the past few years, investors in bond funds have experienced unexpected and historically steep declines. In 2022, the Vanguard Total Bond Market ETF lost about 13%. Bro, that is nothing for a growth stock investor. But this could spook anyone who's closer to retirement.
- [21:39]
Robert Brokamp
Yeah, and 2022 was probably the worst year for the stock market in US history. It was quite notable. And the main cause of the declines has been the rise of interest rates.
- [21:47]
Ricky Mulvey
Right.
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Robert Brokamp
If you go back to 2020, in the middle of the pandemic, the 10 year treasury yielded an astounding.05%. But over the last few years it has risen to almost 5%, reaching that in 2023. It's fallen down a bit back, but it's still at around 4.5%. And when rates go up, the value of existing bonds go down. Why? Well, if you had bought a 10 year treasury back in 2020 that yielded 0.5%, it's now less attractive. Right? Because after all, who would want a 0.5% yield if 4.5% is now available? So the price of the 0.5% treasury has to adjust downward. However, there's good news. The price of that bond will return to its par value as it gets closer to maturity. As long as the issuer, in this case Uncle Sam, is still in business. So the price decline won't last forever.
- [22:37]
Ricky Mulvey
Unfortunately, that same dynamic may not play out in a bond fund which could hold hundreds or even thousands of bonds with different maturities and credit ratings that are constantly being bought and sold. What you can get varies with your 12 month trailing yield, your 30 day SEC yield, or your weighted average coupon rate. So one solution is to buy individual bonds instead of bond funds. However, it's not as simple as it sounds. So bro's got a few tips, starting with invest enough to be diversified.
- [23:09]
Robert Brokamp
Yeah, there's one rule of thumb that says you shouldn't attempt to construct your own bond portfolio unless you have at least $50,000 to invest. And that's because the issuers, whether it's corporations, municipalities, foreign governments, they can all go bankrupt and default on the debt. And that doesn't mean you'll lose everything. Actually, Investors typically recover 40 to 60% of the original value of the bonds after a company restructures gets liquidated. But it usually takes a while for investors to get some money back. So you want to spread your bond bucks around when it comes to investing in stocks, we here at the fool generally say you should own at least 25 companies, and that's probably a good starting point for bonds as well. Though if you invest in really, really safe bonds, you can get away with a smaller number. For example, you can feel more secure with a smaller bond portfolio or a smaller number of issuers if you invest primarily in U.S. treasuries, which are still considered among the safest investments in the world.
- [24:01]
Ricky Mulvey
Fledgling casino developers may not like this tip, but number two, stick to investment grade bonds.
- [24:07]
Robert Brokamp
Yeah, to minimize the risk of buying bonds from a company that may go belly up, you want to stick with investment grade issuers. And Those are rated BBB or higher by Standard & Poor's or BAA or higher by Moody's. So according to fidelity here, the 10 year default rates on bonds of different ratings from 1970 to 2022 as rated by Moody's. So AAA bonds have a default rate of only 0.34%. So pretty darn safe. Investment grade, 2.23%, speculative grade, high yield, junk, whatever you want to call it, 29.81%. That's a high default rate, which is why they pay such high yields. But even if you stick with investment grade, there's still the risk of default. In fact, if you own individual bonds long enough, you probably will see a couple of defaults. So it's still important to diversify your bond portfolio. But you can mitigate that whole default risk by choosing highly rated bonds.
- [25:00]
Ricky Mulvey
Next up, find out whether the bond can be called.
- [25:04]
Robert Brokamp
Now, every bond has a set maturity rate, but many can be called before then. And what happens is that a company decides to pay off its bondholders before maturity. You know you bought, let's say a 10 year bond, but then it got called five years in. Why did they do that? It's usually because interest rates have dropped or the bond's credit rating has improved. It allows the issuer to redeem the old bonds, issue new ones at lower rates, and unfortunately, that leaves investors left with having to reinvest the money at lower rates. So you want to make sure you know beforehand whether the bond you're going to buy is callable and if so, what the yield will be. So you'll often see at the quotes, you'll see either the yield to call YTC or the yield to worst ytw. And that's what you'd receive if it does get called. By the way, another benefit of Treasuries is that they're not Callable.
- [25:52]
Ricky Mulvey
This next one gets a little tricky. If you like owning investments in standard brokerage accounts, bro, but pursue the primary market.
- [26:00]
Robert Brokamp
Yeah, when bonds are first sold to investors on what is known as the primary market, they're usually sold in $1,000 increments and will be worth $1,000 when they mature. This is known as their par value. But once a bond is issued, it trains on an exchange. This is known as the secondary market. And at that point, a bond rarely trades for $1,000. The price is going to either be higher or lower, depending on changes in interest rates and what's going on with the company, maybe what's going on with the economy. And if you buy a bond that is below or above, this is going to add a layer of tax complexity, because when the Bond matures for $1,000, you're either going to receive less or more than you paid for it. This is a really complicated topic, but in most situations these days, investors are buying bonds at a discount, meaning they're paying, let's say, 950 bucks for a bond that will eventually mature at 1,000. And that $50 difference is going to be taxed as ordinary income in most situations, not as a capital gain. You can avoid all this tax complexity if you buy bonds right when they're issued in the primary market and then hold to maturity. That said, buying bonds in the primary market isn't easy. You're going to increase your chances by having an account with a brokerage that underwrites a lot of bond offerings. Some of the bigger discount brokers also have access to some primary offerings, but you might want to check with them beforehand to see what how big that inventory is going to be.
- [27:17]
Ricky Mulvey
And if you want to play this game, you got to know what you're buying, understand how bond prices and yields are quoted.
- [27:23]
Robert Brokamp
Now, if you've never seen the quote for a bond, it's going to look a little interesting to you. Because despite being typically worth $1,000 at issue and at maturity, bond prices are quoted in a different sort of way. You basically move the decimal point to the left. So a quote for 99.616 for a bond indicates that the bond is being offered for $996.16, and you'll likely see both the coupon and the yield quoted. The coupon was the interest rate on the day the bond was issued. But once the bond begins trading and moving above or below its par value, the yield is a more accurate representation of what you'll actually receive as a percentage of what you paid for the bond. And then finally, most bonds pay interest twice a year. When you buy a bond in the secondary market, you'll owe accrued interest to the previous owner for the time she or he owned the bond in between payments. But then you'll get the full six months worth of interest during the next payment, even though you only owned the bond for maybe less than six months.
- [28:26]
Ricky Mulvey
You know, bro, our engineer Rick Engdahl was asking for more excitement before we started recording in our segments. I really, I think he's getting it. With understanding how bond prices and yields are quoted, let's keep going with the tip of buying directly from Uncle Sam.
- [28:42]
Robert Brokamp
Yeah, so you can buy savings bonds, Treasuries I bonds, treasury inflation protected securities, otherwise known as TIPS, directly from the government. Commission free@treasurydirect.gov so it's a really convenient way to buy Treasuries. Unfortunately, it can only be done in taxable accounts because the government isn't set up to serve as a custodian for IRAs. But the consolation here might be that interest from Treasuries is actually free of state and local income taxes, so that makes them somewhat more compelling. Also, in the case of Treasuries and tips, you don't actually buy the security immediately knowing the exact yield you'll receive. Rather, you're basically signing up to participate in an upcoming auction. Once the auction is complete, you'll be informed of the rate you'll receive.
- [29:25]
Ricky Mulvey
And finally, you can get the best of both worlds with defined maturity ETFs.
- [29:30]
Robert Brokamp
Yep, if you've been listening so far, you can see that buying individual bonds requires more education and effort than just buying a bond fund. Fortunately, there's a type of bond ETF that offers most of the benefits of buying individual bonds. And these are known as Defined Maturity or target maturity bond ETFs. And these are funds that only own bonds that mature in the same year. And that year will be identified in the name of the ETF toward the end of that year, after all the bonds have matured, you just have a bunch of cash. Cash will be distributed to the shareholders and the ETF ceases to be. The two main issuers of these type of ETFs are Invesco and they call them bullet shares or iShares and they call them I bonds. But that's not to be confused with the inflation adjusted bonds issued by Uncle Sam. You can use these ETFs invest in all kinds of bonds, corporates, munis, TIPS, high yield bonds, and both the Invesco and iShares websites have tools that can help you build a bond ladder with these ETFs so you have a certain amount coming due each year, probably particularly attractive to retirees. Like all bond funds, these ETFs are going to go up and down in value depending on what's going on with interest rates in the economy, but they should return close to their initial share price, that is the price of the ETF on its very first day once the fund matures. But there are no guarantees and this is more likely if the ETF invests in safer bonds, less likely if you're choosing an ETF that invests in like high yield or junk bond bonds. But the bottom line is that with these ETFs, you can get the ease and diversification of a bond fund, yet a measure of the predictability about what the ETF will be in the future, similar to what you'd get from an individual bond. In other words, most of the best of both worlds.
- [31:14]
Ricky Mulvey
As always, people on the program may have interests in the stocks they talk about in the Motley fool may have formal recommendations for, against, don't buy or sell stocks. Basically on what you hear Our personal finance content follows Motley fool editorial standards and are not approved by advertisers. Advertisements are sponsored content and provided for informational purposes only. To see our full advertising disclosure, please check out our show notes. Motley fool only picks products that it would personally recommend to friends like you. I'm Ricky Mulvey. Thanks for listening. We'll be back tomorrow.