Compounders Past vs Present

0:05Earnings from four companies that have the market beat by triple digits, but are they still growing fast enough for investors? Find out today on Motley Fool Money.

0:20I'm Emily Flippen and today I'm joined by analysts Sanmeet Deo and Jason Hall to talk about capital compounders. They're businesses that have reinvested for growth so rapidly that earnings and their market values have just snowballed over time. We have earnings out from two of these new school compounders that we'll discuss. But first, let's talk about some of the old school compounders that reported last night, both of which that have been defying that overvalued label for years. A quintessential element of being a rule breaker investment is being called overvalued. Send me, let's start with Axon.

0:53Axon Enterprises just posted its 29 % revenue growth with over$1.2 billion in annualized recurring revenue. They have contracted bookings growth of 43 % year-over-year. Management also, once again, raised guidance. Now, when I rewind to August 2020, I find a Seeking Alpha article that claimed despite the strong unit economics of Axon, the stock was too expensive at around$80 a share and that its intrinsic value is closer to 74, quote, at best. Today, Axon, after earnings, trades for over$800 a share. What are your takeaways here?

1:29Sanmeet Deo:Yeah, you know, this stock over a five-year period has grown 704%. And that is really because of a consistent, strong execution and a powerful business model that's almost like a razor, razor blade model where they're selling hardware and offering high margin subscription software cloud software to complement that hardware and they have just continued to consistently over really that whole five-year period generate double digit revenue growth and you know this quarter was no different you know they they had they beat and raise on earnings and revenues continued strong revenue growth, software services, you know, providing a high margin growth.

2:11Sanmeet Deo:I mean, I mean, it's almost like, when is this company not going to perform? And that's kind of the worry, like, and really only concern of this company right now is its valuation and that it's stretched. But with numbers like these, that kind of valuation is justified for a growth company. Yeah. It's so funny to go back and find articles that compare, you know, a mere$6 in price difference that at the time when that article was written,$80 versus$74 probably felt like a lot. When you look at it where it is today, it's almost like splitting hairs. But I do have to ask, this is the definition of what it means to be a compounder.

2:49And a quintessential definition of a world-breaking stock is that they always somehow look overvalued, but in order to compound, you just continue to grow and grow much faster than the market expects. And your opinion, I mean, does Axon have what it takes to continue to compound? Or is this truly overvalued? Because there are moments where stocks truly are overvalued for the growth that they put forward.

3:11Sanmeet Deo:Well, really, it's overvalued and it's still a great investment, compounding, because growth are like muscles. They always need fuel. Growth is always needed with fuel. Axon has proven that their products and services right now are growing. There will be a limit to that. But growth investors are always looking for what's that next leg of growth? What is that other opportunity that can cause this company to continue to grow and continue to justify that premium valuation? Axon has international markets that can continue to grow in. It's looking to also possibly get into more of the federal enforcement agencies.

3:51Sanmeet Deo:That's a little tougher nut to crack, but that's something they're doing. And like we all hear from most other companies, AI. One cool thing that they're using with AI is their AI power software. They collect a lot of data from their body cameras and their hardwares, gathering all that data and something as simple as just making paperwork easier for officers. That in itself could be a huge leg of growth. You think, oh, it's just paperwork. Paperwork takes a lot of time and takes a lot of effort away from doing the actual work that officers need to do, is being out there in the field. So things like that.

4:29Sanmeet Deo:And then now they bought a drone company called Skidio working to do something called drone as a first responder where they can send out drones to kind of monitor what's happening in the real world and maybe triaging whether the officer can really go in there. So lots of great opportunities, but they got to execute to justify the valuation. Another business that has to execute to arguably justify its valuation, although it's looking arguably a little bit cheaper today, is MercadoLibre. Now, in their quarter, they just topped 90 million unique active buyers, 68 million fintech users, with an FX-neutral top-line growth of over 50%.

5:08Now, I rewind even further with MercadoLibre back to 2014. There's a Forbes article. They asserted that MercadoLibre was significantly overvalued at$87 a share, Since that valuation implied a 17 % compounded annual growth in operating profit for the next decade, certainly a high bar. But I'll tell you what, it's been a decade, Jason. MercadoLibre posted net operating profit CAGR of over 40 % for the past 10 years. And its share price now sitting at just under$2 ,300 a share. What did you make of this report? Yeah, it's exactly what you talked about when you and Sammy were talking about Axon. Two things can be true at the same time, right?

5:49And they might seem diametrically opposing, where a stock can be overpriced, but the growth stories that can drive the results in it still being a winning stock can still be there. So, the key is, like with Axon, is the growth opportunity has to be very, very large. And the company has to be led by people who can execute on a vision that many others just really don't see. And in the case of MercadoLibre, you go back a decade ago, and this was just a company trying to build e-commerce in Latin America. And what it's actually done is build the financial tools for buyers. In this past quarter, we saw the dual flywheels of the e-commerce business and payments continue to drive that growth.

6:34So, since MercadoLibre operates in about a dozen and a half countries with different currencies, it doesn't really move a lot of money around across those borders. The numbers that I'm talking about, they are currency neutral. Gross merchandise volume, that's the sum of all the transactions on the e-commerce platform. That was up 37 % in the quarter. Here's the big one. Total payment volume, this is the value of all the transactions on its fintech platform. We're up 61%. Here's a giant number. Total payment volume, almost$65 billion versus$15.3 billion in gross merchandise volume. That's a ton of money that's flowing through MercadoLibre that's going to other merchants and going to other payments.

7:20It's a massive amount of valuable data. Now, let's look at the bottom line a little bit. Because of all the currency adjustments, MercadoLibre reports in U.S. dollars, but essentially does no business in U.S. dollars. We really have to adjust that. But net income was down, largely because of those foreign exchange adjustments. But adjusted free cash flow, very, very strong, even as it continues to spend a lot of money to build out its technology infrastructure and logistics infrastructure, the actual warehouse and distribution, and put a lot of capital to lending to consumers and merchants alike.

7:54Yeah, it's really hard to understate just how important that fintech business is also for the bottom line in terms of driving operating profits. But that's the optionality that comes with business like this. A decade ago, you didn't know about the fintech offerings. So same question to you, Jason. When you look out, this is an old compounder. Does it have the ability to keep compounding for the next decade? Yeah, just as with Axon, which used to be called Taser International, got into the body cam business, got into the SaaS businesses that started collecting all of that data. We're seeing a lot of the same thing that's driving the future for MercadoLibre, because it's really that data that it's gaining through its payments business about the spending patterns and habits of its consumers and all of the data about its merchants that it's using to inform making good credit decisions.

8:41I don't think we need any new transformative businesses like Mercado Pago, but it's starting to reach into that Amazon playbook. It's building an ad business, so there's an incremental thing there. You look at those growth rates and you think, These are crazy. They're unsustainable. Sure, they're going to come down over time. But I think we have to acknowledge how massive the market is. E-commerce, if we look at those 18 countries or so that it does business in, e-commerce is a fraction of total consumer spending in those countries. Banking services, credit card usage, even smaller penetration than we see in developed economies.

9:19Now, here's the key. Move fast and break things is great in tech, but not if you're lending money. We saw a blip on the radar last year with the credit businesses, default rates started to creep up. But what we've seen since then is that management is doing a good job so far of managing that risk. If it can keep being a good originator of debt, that's a very different operational skillset than the things that it's built its foundation on. It just ride the massive secular tailwinds of commerce and finance in Latin America. Absolutely. Mercado Libre can remain a winning investment. Yeah. And one thing I love about both those companies is that when you rewind time, it's like really hard to find an analyst that didn't call them overhyped or expensive.

9:59Even amongst people who are fans of the investments, they always looked expensive, but that execution just kept compounding. And it's like a playbook that just seems to work time and time again. So coming up next, we'll have two new school compounders that are trying to run the same play. This is Motley Fool Money. You just found out that your sales team is at risk of missing quota. Don't panic. Just ask Rippling AI. Since it's built on your real-time people and business data, Rippling AI can pull metrics from Rippling and Salesforce into a meeting-ready dashboard showing quota attainment, headcount plan, and monthly revenue to quota by region.

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11:12That's R-I-P-P-L-I-N-G dot A-I slash F-O-O-L. Sign up for exclusive access today, rippling.ai slash fool. One of the great things about history is that while it might not repeat, it does rhyme. Reinvestors keep finding great ways to grow an analyst, sometimes rightfully, sometimes regretfully, keep calling them overvalued. So let's dive into two companies that are proving the history of compounders isn't changing yet today, both HIMSS and HERS and Palantir. They both reported earnings. Both still have their fair number of skeptics. But Jason, let's start with HIMSS and HERS. This is a telehealth platform that's known for compounding more than just returns in terms of its popular compounded drug offerings.

11:54Their revenue growth has risen at triple digits in recent years, and the business is converting new customers left and right. But at the same time, there was a Seeking Alpha article posted last month that claimed HIMSS was potentially, quote, too late to buy after shares have doubled, with a fair value closer to$40 per share. Based on what you're seeing in the most recent report, Jason, do you agree it's too late for investors to jump in on this bandwagon? First of all, it's a good thing that I'm talking about hims and hers and not Palantir, considering that I'm using options to short it. And we'd get a lot of emails about that, so I'm not going to even talk about Palantir.

12:29But when you look at what's going on with hims and hers, I think it's less about whether it's an overpriced stock and whether its future is going to be more like Mercado Libre and less like some overhyped past flyer that came down to earth. And what that's going to work out to is the extremely large market opportunities that are in front of it. And in this case, we're talking about healthcare spending. Now, here's the thing. The core of HIMSS and HEARTS today is it's really about prescribing medications and ideally ones that it can compound in its own pharmacies where it can earn the bulk of the profits that otherwise are shared more with pharma.

13:05Just for example, it has about 2.4 million subscribers. Massive growth in subscribers. It continues year over year, quarter over quarter. Of that 2.4 million, 1.5 million are on what it calls a personalized treatment plan. That generally means that it's compounding a special dose or it's combining multiple medications into a single deliverable like a gummy, something that's not commercially available. The question about this business model is how large can it become? What percentage of the actual spend for pharmaceuticals can that actually be? And then it also ties to its incentive structure for physicians, which is heavily tied to writing a prescription.

13:44Can that remain viable? I think we've all read the reports of customers being written a prescription with less than a couple of minutes of interaction with a physician. So up next is expansion and more vertical integration. We're seeing they're spending a ton of money to increase their lab testing capabilities and then start delivering even more personalized medical services. So the bottom line here is the healthcare industry is worth trillions of dollars, and some disruption to the status quo in this extremely regulated space is probably a really, really good thing. But hims and hers having a future that looks more like MercadoLibre or Axon is going to require it to do more than just being a compounding prescription factory.

14:23It needs to become a vertically integrated healthcare business that beats those entrenched players at their own game by some degree, kind of reinventing how that game is played too.

14:34Sanmeet Deo:And the only thing I'll say about HIMSS is, you know, it's still very early in its growth. High risk, high opportunity. It's developing a healthcare platform unlike we've probably seen, unlike we probably can even imagine. It's going to be hard. It's going to take a lot of work, but there's a lot of growth areas that it can grow into. And it's just going to take a lot of time for it to cook. Exactly. It's an execution play, not a valuation play. That's beautifully said. And I think we spent a fair bit of time on Motley Fool Money talking about HIMSS. And in hindsight, it might be one of those companies that flames out.

15:08You know, we don't talk about it a decade from now. Or it could be the Mercado Libre, where a decade from now, the opportunity seems so obvious that we wonder why we didn't spend more time discussing it. It's binary in that regards, but I'm really excited to see where it takes us. But Jason, as you alluded to, I'm really excited to talk about Palantir here. I'll spare you. You are obviously a bear on Palantir. Maybe we'll have to have you on at some point in the future to give us some more context behind that thought. But Samit, I want to go to you. This is a really lucrative business, but one that has all these secretive government contracts.

15:41That has created an incredible opportunity for high rates of return on its capital. But not everyone is sold. One analyst claimed the stock is both overhyped and overpriced, given the fact that it trades at a forward price to sales ratio north of 70 times. I have to admit, that does sound pretty expensive. What are you seeing here?

15:59Sanmeet Deo:Oh, yeah. This is the most expensive stock on the market, probably. But this is a classic rubric in so many senses of the term that intuitively it just feels. And I will say here now, and I've said it before on some of our other shows, I think it will be a trillion dollar company at some point. it will hit its slide. Growth will slow. It will take a correction, as all rule breakers have. But the growth that they're doing right now at such a high margin, expanding from the government to the commercial side of the business and basically becoming the operating system of AI, short-term, it could be a great short.

16:37Sanmeet Deo:Long-term, I think it's going to be a fantastic compounder that I think we'll be talking about as one of the premier software companies. Well, I can't wait to have you both on at some point in the future to have the two opinions here between the actively buying puts and the belief that Palantir could be a trillion dollar company too. That is what makes a market two entirely separate opinions. I think both of those could be true though. We're going to see. We're going to see. When we get back from this break, we'll be doing tariff math in a minute. Stick with us. They say leadership isn't just about where you're going.

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17:51Whether it's through unique interior finishes or custom wheel options, the ways to personalize your Range Rover Sport are nearly unlimited. Command attention and experience ultimate luxury in motion. Exclusive offers are available now. Explore further at RangeRover.com. Policy shifts on tariffs are in motion. So as we wrap up here, let's do a little bit of tariff math that could go a long way for investors. For starters, let's take a look at hardware plus software business Zebra. Zebra reported earnings this morning and management had to spell it out clearly for investors. There's a$30 million operating profit headwind just from import tariffs alone, which reduced their EBITDA margin by nearly a full percentage point.

18:29Doesn't sound like a lot, but when you're Zebra, that's a lot of cash. And in other pure hardware companies, they're expected to be impacted even more. Caterpillar saw its operating profit fall 18 % this quarter, again, largely due to tariffs. Now, I know exact math is impossible here, but when you look at businesses that can mitigate the impact of tariffs that have decent pricing power, Jason and Samit, I want to go quick round robin. Where, if anywhere, is pricing power strong enough that the cost can be passed along enough to mitigate the cost of tariffs?

19:01Sanmeet Deo:I think that On Holdings is a great company with tons of pricing power. They have premium brands that are, you know, shoes are priced very highly,$150 and up. They have very high 50 % and above gross profit margin, which indicates pricing power. They're willing to raise prices and they have, you know, just a very significant channel to do it with their direct consumers. So I believe they have pretty strong pricing power. Yeah, I think you pretty much are going to see it in consumer brands largely. That's where you see it. Coca-Cola is a good example. One of the reasons that Warren Buffett has loved the company for as long as he has is because their ability to raise prices, even as volumes of Diet Coke in the U.S.

19:44have declined, they've raised prices enough to more than offset the loss of the volume. That's a good example. Even that company, though, has been a loser to the market over the long term. So pricing power is still no guarantee of returns. Ferrari, I think, is a primo example of a company in an industry that you don't associate pricing power. Automakers are price takers, right? They're heavily competitive. But when you control the market, yeah, there's plenty of hypercars out there, but there's only one Ferrari. And your motto is to provide the market with one less than it demands every year. You have pricing power.

20:19Sanmeet Deo:Yeah, what's$251 ,000 versus$250 ,000, right? No big deal. There you go. Exactly. I was going to say Lululemon. Now, they haven't historically been able, at least since these tariffs have been in place over the course of 2025, been able to pass those prices along. But I do think they had the type of audience and consumers, as well as the pricing power, to at least mitigate the majority of tariff impacts. But Sunmeet, actually, in hindsight, I agree. I think On Holdings is probably where it's at. They're expanding into apparel as well. So, despite the fact that I think Lululemon looks scarily cheap right now and pretty balanced risk-reward investment, I do think on is, to your point, probably in a better position there.

20:57But I guess time will tell both for tariffs as well as future compounders really looking forward to where these companies are a decade from now. Stanmeet and 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.

21:26To see our full advertising disclosure, please check out our show notes. For Sammy Deo, Jason Hall, and the entire Motley Fool Money team, I'm Emily Flippen. We'll see you tomorrow.