Block Party and Big Swings

0:21I'm Emily Flippen and today I'm joined by analysts Sanmeet Deo and Jason Hall to talk about some quintessential rule-breaking stocks, I think some of which are having better days today than others. It will also cover the IPO market and its newest entrance, as well as some beaten down out of favor businesses. But first, of course, we have to talk about Block, who effective tomorrow will be replacing Hess and the S &P 500 after its merger with Chevron. Sunmeat, it is never a bad thing to see a business added to an index. I mean, It provides some institutional credibility. It forces buying. But is all of that buying the ad still really work in today's day and age?

0:59And if it doesn't, I mean, should we just not care about this at all?

1:03Sanmeet Deo:I think buying the ad does help in the short term. I mean, you can get that short-term bounce. But you should only really care if it's a company you're interested in investing in for the long term. I'm not very familiar with Block. It's not a company I would buy myself. So while this is great news for Block and their investors, it's not something I would jump into. I think it can be a bit of a mixed bag. I pulled some data on recent additions to the S &P this year, and here's what I found. Back on March 7th, S &P Dow Jones Indices announced that it was adding four companies to the S &P 500. Of that four, only shares of Williams-Sonoma actually gained the day of the announcement.

1:43The other three, TKO Group, Expand Energy, and DoorDash. their shares all fell. The index was up too, so it wasn't affected by what the market was doing that day. Now, here's the thing. The effective date of the change was March 24th. And that matters because that's when you see institutional investors and ETFs and other funds that track that index. That's when they have to add to the index. So what did we see from the date of the announcement through the 24th when the shares were added? Expand Energy was up 14%. DoorDash was up 11%, TKO Group up 5%. They were all up. But Williams-Sonoma, that was the big gainer, if you remember the day of the announced change, actually fell 7%.

2:23Now, what happened? It's the only one that reported any major news in between those dates. Lackluster earnings on March 9th brought its stock down. Here's another quick one. May 12th, Coinbase was announced to be replacing Discover Financial, which was, of course, required by Capital One. Coinbase shares have almost doubled. They jumped a little bit the day of the announcement. What's the takeaway? There's a decent chance of a little pop, like Sammeet was talking about. You stretch it out longer term, business results and the potential for bigger profits matters more to your returns. Block has some things in its favor, but it's really going to be whether it can monetize those things that helps investors make money or not over the long term.

3:04Yeah, actually, I'm a little surprised here, Jason, because some of those returns are better than I expected. I mean, And it's true, I think, when a stock is added to an index, there's a certain amount of forced buying that happens when the index does go out, depending on its rebalancing schedule, and has to purchase shares, of course. But it's also true that when indexes add stocks to their index, they have to announce it in advance when that change is being made. And so there's like this certain amount of front running that happens from institutional buyers that I think largely has reduced the size of the price movement for stocks after the announcement.

3:36But even some of those companies, like you just mentioned, Jason, I think there is just a level of credibility that happens when you see an index adding to a business. And in the case of the S &P 500, there's certain hoops that companies like Block have to jump through in order to even be eligible. And interestingly for Block, one of those elements is a certain level of profitability. You have to have posted gap profits, not only in our most recent quarter, but over the trailing four quarters as well, the trailing year. And in the case of Block, I think if you weren't already a shareholder, this is actually a reason to maybe continue to sit on the sidelines if you weren't already interested.

4:11Like you mentioned, Jason, this is a company that, while performing well, does have a lot of exposure to things like Bitcoin. They have exposure to that on their books that can impact their gap earnings, as well as exposure through their Cash App, which is driving a lot of their revenue growth, although a smaller portion of gross profit. All of those things, I think, make me just a little bit more cautious here as an investor to say, it's great to see some institutional buying for block. But again, I'm not already a shareholder. If I wasn't, then I would not be using this as an opportunity to think either in the short term or in the long term, this is providing some reason for me to go out and buy today.

4:46Okay. We'll be back with some thoughts on our newest potential addition to the public markets right after this break. Support for the show comes from Fundrise. For the past 70 years, there's been a room in finance most people couldn't enter. A room where you could have invested in some of the biggest names in tech, companies like Airbnb and Uber before their multi-billion dollar IPOs. I'm talking about venture capital. Fundrise recently took a sledgehammer to those closed doors by launching a venture capital product that's available to anyone. Their mission is to give everyone the chance to invest in the best tech and AI companies before they go public.

5:21You can visit fundrise.com slash fool to check out Fundrise's venture portfolio and get in early today. All investments involve risk, including the potential loss of principal. Past performance is not indicative of future results. This is a paid advertisement. Jason, I'm not sure if you're much of a creative type, but something tells me you're at least familiar with Adobe and the work that this business has done amongst design professionals. I think we'd all have to be living under a rock if we weren't. Well, today we got news that Figma, which is one of Adobe's largest competitors and the business that Adobe tried to acquire more than three years ago for $20 billion has priced its IPO and is targeting a valuation that only goes upwards of around $16 billion.

6:03I mean, what do you think? What should investors be making up this pricing? Because to be frank to me, this makes me excited for Adobe, but really skeptical here for Figma. So I did some professional photography work for about a decade. So I'm really familiar with Adobe's products. I'm also a content creator for The Motley Fool. So I spent a lot of time working with many of the latest tools. And for those of us following these businesses and investors, I think the consensus was back when Adobe announced the Figma deal, it was expensive. And they were just clearly trying to take a competitive product that they had lost ground to out of the market and add it to their suite of products.

6:42And I think the outcome, frankly, the deal falling apart and Adobe having to give its biggest competitor, Figma, a billion dollars and then figure out how to innovate and compete, I think it's certainly healthier for Adobe's business in the long run. On the other hand, I'm a little bit less willing to view the down round $14 billion valuation for Figma as really necessarily being bullish for Adobe, but more than just a reminder, this is still a really dynamic, highly competitive space. Since the announcement of the acquisition back in mid-September of 2022, Adobe shares are up about 19%. Over that same period, the S &P 500 has gained almost 70 % in total returns.

7:25The tech-heavy NASDAQ 100 has basically doubled. Investors see a legacy software giant that still has a lot of work to do to retain its edge. For instance, I almost exclusively use Canva for graphics and products like Descript and Riverside for video editing. I think the lesson there is that the good enough, but a lot cheaper products are winning out for more casual professional users that don't need that full suite of tools. They just need an ultralight plane. They don't need a 747. I think Adobe's success though is going to be tied to keeping the real professionals empowered with the best suite of tools and unlocking their productivity and creativity with artificial intelligence.

8:08And Adobe's way ahead of everybody else taking really big steps there. Thinking that through, if I were picking between Figma and Adobe as an investor right now, I think Adobe is still likely to be the winner in no small part because the valuation gives a lot more margin of safety to future profits for investors. Yeah.

8:28Sanmeet Deo:I would add that while Figma could definitely be a much more rapidly growing company, it's definitely has something that Adobe values because they look to acquire it. but Adobe has been in this business for a very, very long time. They, the biggest thing for me is that they just generate steady and healthy amounts of free cashflow on a consistent basis. And it does have a competitive threats from a Figma, Canva and others. Dolby has primarily been desktop oriented versus now there's more cloud based online services like Figma and Canva. Adobe shifting towards that. So they're already making their moves.

9:05Sanmeet Deo:Their AI features have been very, very good. So while Figma could be the case could be made for Figma as a great growth oriented, higher growth, higher risk investment, the safer, more solid bet would be Adobe. And you're still getting plenty of growth out of that. Yeah, I will say at even the low range of this IPO price, Figma is still valued at nearly 17 times sales and the business barely generates profits. So when you talk about the amount of money that is likely going to be needed to be invested in things like sales growth and even AI, it might be challenging here for Figma. But interested to see where this ultimately leads us and leads investors and if Adobe is still threatened by this company a year or five years from now.

9:46But we're still in the middle of earnings season here. And as much as I think that it's important to talk about earnings, I also think that we shouldn't use it as an opportunity to overshadow maybe a contrarian or highlight a stock idea that some of the quintessential qualities that define rule-breaking stocks look for, which includes being a top dog led by a visionary founder. And Jason, I have to talk to you about Roku here, because as self-indulgent as this is, I will say Roku has been a little bit of a bust for most investors. I mean, shares are down more than 80 % from its 2021 highs. And I would argue that I think we've seen a little bit of a turnaround in Roku's business here.

10:25I've been on record saying that I think Roku is like Spotify in 2023. But I think I am a little bit of the contrarian. I'm the outside investor who is looking at Roku and getting excited. Most people have been running for the hills. Jason, from your opinion, is Roku potentially a viable stock for contrarian investors? Or is this really more like digging through the trash as opposed to the bargain bin? I think it's a good business. The core business is really good. I think that's important to acknowledge. And the trends are certainly very favorable with programmatic advertising. And when you have a supply of inventory of ads to sell, and they're growing that inventory on other platforms as well through their ad network that they're building.

11:05But what I've struggled with with Roku for years is as much as I think there's value for user, I think it's potentially capped by what is probably a realistically smaller market for its product than a lot of bulls describe, despite all of those positive things there and the moves they made to get more inventory in front of more buyers, I think the reality is the Roku brand. I want to be very specific here. The Roku brand, I think it's a lot like Peloton to me. And what I mean by that is that there are plenty of loyal users that swear by it. But the majority of people who want to connect the TV or a piece of exercise equipment, if we were to continue with that analogy, they're just transactional.

11:46Or maybe they're already in another ecosystem in the case of this. So things like Apple and Amazon, and people are part of those ecosystems for reasons that Roku can't really compete with. I think it's a good business. I think you're right that it's probably on the cusp of something big in terms of the power of adding scale. But I think, again, in terms of scale, I really do think it's more Peloton than than Spotify. This is going to turn into an episode of dueling fools. And I actually, I don't disagree with you, but I think it's a bit of the opposite of a situation with Peloton. Peloton was always a brand driven company who needed to drive pricing power and premium prices in order to make money off of its hardware.

12:27Whereas Roku purposely is not a brand driven company. They don't want you to necessarily associate with the Roku brand. They sell their TVs and their operating systems at a loss just to get people into the ecosystem. And I think most Americans don't really care what brand their TV is. They just want to buy whatever is the cheapest, most accessible product that suits their needs. And in the case of Roku, they're the largest operating system for TVs in North America. They're more than twice the size of their next largest competitor. And that has only gained market share since the company's been public.

12:57But you're right that ultimately there's a highly competitive space. We have deals with some of their largest distributors, including Walmart of the world who has an investment in Visio. Very easy for other competitors to come in and say, okay, well, you've been undercutting the apples and Amazons of the world. I'm going to start undercutting you as well. And a decline in market share here for Roku could be absolutely devastating. So Jason, I will want to hold you to your thoughts on Peloton. It's going to be a stock that I ask you about here in just a minute. But after the break, we'll be right back with some of those rapid fire thoughts and bold predictions for popular beaten down stocks of which Peloton is of course one.

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14:12They've been beaten down to the likes of Roku. Maybe we have some contrary opinions on them, but Samit, let's start with Peloton. Their shares have been left for dead, but a new management team and a growing subscription style for revenue could get some investors intrigued. Are you getting on or off this bike?

14:27Sanmeet Deo:I'm getting off. Fitness is a fantastically interesting yet fickle and challenging industry to invest in. And you can take my word for it as I've invested in a actual brick and mortar franchise. I've invested in Peloton and struck out. I've shot my shot and I'm not, I'm not made my shots with the fitness industry yet. Yet I still am intrigued by fitness, health and wellness and that whole industry. So one day I'm gonna, I'm gonna catch something. But with Peloton, I think its story is over. It had its run. It had its play. It's just I don't see anything sustainable that could last with this company.

15:04Sanmeet Deo:I mean, I would rather venture into something like a Planet Fitness, which is cheap gym, offers, has its niche, provides it and provides it well, has been around for a long time and is gaining share and members. So I would stick with something like that. Yeah. I'll add a little nuance to that. I think there's plenty of sustainability here by refocusing on what's powerful about Peloton. And that's creating that platform that users like and keeping your engaged users engaged and monetizing those users and getting things like the operating costs of owning factories to build bikes off of their balance sheet and off of their operating costs.

15:46They made that move. They took the big shot, Sandmeet, to try to take that next step to scale. And well, remember Bowflex? How about P90X? What about Jazzercise? I rest my - I still use all of those except Jazzercise. And the point is, as you said, it's a very fickle industry. Fads come and go. And I think that all of those things are still around and they're going to be around for a while. And I think Peloton is going to be around for decades. But is it an investable area? Peter Lynch said it best, guys. A great business and a mediocre industry is a mediocre business. And this is a tough, mediocre industry.

16:22And value buyers, there's opportunities at time for companies like this. And maybe the stock goes up if they keep shrinking costs and get to a steady state. But it's a notoriously fickle industry. Absolutely in my too hard pile. Emily? I have to agree here. If I saw subscription revenue from those loyal customers rising, it'd be one thing. But even that is declining. It's a hard industry to win in. But you know what else is a hard industry to win in? Furniture. And so we have to talk about Wayfair. Their shares trade at less than one time. sales. And I will say though, the home market improves here.

16:53Maybe there's some near-term demand for stocking up all of our houses with some new items. Jason, are you on board the turnaround in Wayfair? It's just a furniture and other home goods store and it's online. Congratulations, your Montgomery Ward, but without the internet. Now, in fairness, retail can be an excellent investment, but you have to be a really good operator and you have to do something better than your competitors with a value proposition that's actually a value. Just a cherry pick. Two primo examples, TGX Companies and Williams-Sonoma, on two different ends of the spectrum of what they're good at.

17:30They're both really, really good. They know why they exist, who they serve, and they're exceptional operators. Wayfair doesn't seem like it's really either of those. And frankly, I once had high hopes for it.

17:43Sanmeet Deo:I'd make it really quick with Wayfair. I think it has a fighter's chance. It has an online, a breadth of products and services online. They're trying to make it personalized and customized to users. And they're very targeted with their ads to get the right type of customer into their business, but still, still a tough, tough business. Last but not least, let's talk about Etsy, which was forced to face reality after its house of brand strategy failed, but new management's trying to turn around. I know I'm not fully sold here, but Jason, do you have any thoughts? Yeah. Full disclosure. I sold Etsy on March 6th.

18:15Shares are up a third since then. So I don't really know if I've got much credibility here. But I can tell you why I sold. In short, all of the stronger business results that we've seen over the past year or so, higher revenue, profitability, that was coming at the expense of merchants. More recently, customer traffic and merchant counts, they're down. Gross merchandise sales, that's the volume of revenue across the platform, falling. It's a solidly profitable business. If you adjust out the Goodwill write-down that they took related to Reverb, it generates plenty of cash flow. But if you can't bring more buyers and sellers together in a market where more people want to buy handmade and used items, what are we even doing?

18:54Sometimes contrarian investments are contrarian for a reason. We're just not seeing the business performance that we need to make them investable today. Sonmeet, Jason, thank you both so much for joining. As always, people on the program may have interest in the stocks they talk about, and The Motley Fool may have formal recommendations for or against. so don't buy or sell stocks based solely on what you hear. All personal finance content follows the Motley Fool editorial standards and is not approved by advertisers. Advertisements are sponsored content and provided for informational purposes only.

19:22To see our full advertising disclosure, please check out our show notes. For Jason Hall, Samit Deo, and the entire Motley Fool Money team, I'm Emily Flippen. We'll see you tomorrow.