Motley Fool Co-Founder Tom Gardner: The Quarterly Call

0:05Even artificial intelligence, as with every other innovation in history, can become overvalued. right? I think AI is going to create things we never thought possible, illnesses and disease solved. So many complex things that we haven't been able to figure out in human history, we will actually be able to figure out with AI, but there will also be so much competition.

0:27That was Motley Fool co-founder and CEO Tom Gardner. I'm Motley Fool producer Matt Greer. Now we caught up with Tom in September for our second quarterly call. Tom talked about the current stock market, he talked about what investors should do about it, and he shared five investment ideas. Enjoy. Tom Gardner, co-founder and CEO of The Motley Fool, and my goal in our conversation today in The Quarterly Call is to make it worthwhile to have a notebook and a pen and to give you some ideas that you can actually reflect on and use in your portfolio. I'd like to start by reminding us what we talked about in episode one of The Quarterly Call, which is let's not be speculative.

1:04We pretty much should not do this at any point in the market cycle, but in the late stages of a market cycle where we've had a great bull run. I mean, the S &P 500 is up essentially 35 % since mid-April. And that's an unbelievable rate of return over a handful of months. So this is a time to take stock of where we are with our portfolio and make sure that we're not reaching in a speculative way to try and pull forward returns. If you're going to be speculative, if you're going to be aggressive, you're going to be bold, let's do that at the market bottom when everyone's scared. Then you can start to add risks in, right?

1:35Because you're getting better prices. This is not the time to increase your risk. It's time to reduce your risk. And we mentioned in that first call that options, very risky the way many retail investors use them, right? Leverage, margin debt, nearing all-time highs, not a good idea. We also talked about low-priced stocks under$10 a share, not a good idea for most investors. Occasionally, you might find a great company with a share price down below$10 a share, but for most people, no, let's not do that. And then finally, I'm going to add to the category of speculation that we see happening in the US and around the world is a lot of sports betting and start using your GPT to prompt away and really look at the odds of sports betting.

2:12If you're going to do it, it should be a light entertainment. And for most people, it's better to just stay away from it altogether. Enjoy the sport for what it is, right? But obviously, some people get into trouble in sports betting. You just have to put that warning out there that it's not a way to build your financial future. So we want to move speculation off the menu right now. There are times to go for it. This is not one of those times. It's clear that we're at richer valuations in the market today. And that means we should be taking a pause and making sure that we're ready should the market decline.

2:43There are a number of factors to look at when we look at the stock market's valuation today. It's worth taking some time. It doesn't have to drive actions in your portfolio. I mean, I guess the first thing every investor should answer is, do you think things can go too far in markets? And if you do, if you do think that's possible, if you look back in history and see major run and major collapse, you probably want to start to study what are the dynamics? What are the factors? What are some of the factors that I can look at to determine where we are in the market cycle? Let's start with a light one.

3:12We have a relatively low VIX. That's a measure of the volatility of the market. It's relatively low. And when markets are doing well, you actually see a reduction in the volatility because people feel comfortable. It's like the water's safe. I'm going to go swimming. Everything's great, right? But when things become treacherous and they start bailing, stocks become very volatile. So there's a calm sea right now in the market. And that is a precursor to volatility. The second thing is the PE on the S &P 500 is over 25. We're at over 25 times earnings. You can look back throughout history at great investors like Peter Lynch saying, you know, the market moves between a 10X multiple and 20X multiple.

3:51And you know, says Peter Lynch, when it's a 20X, you know you're richly priced because it's almost never gone above 20x in history. Well, the time he was giving that interview, it was true. There really had not been a time where the general US market was above 20 times earnings. We're now above 25 times earnings. We're definitely going to have higher margins from the deployment of AI. We're going to see productivity gains like we've never seen before in American business. So that has to be reflected in valuation. And that is part of what's happening. But have we gone too far? Well, we're at about six and a half times sales on the NASDAQ companies, about 3.3 times sales on S &P companies, that is pretty much unmatched in the last 25 years.

4:28So we're looking at peak valuations today or near peak valuations. Can they go higher? Of course they can. We know that is possible, but what are the probabilities, right? How extended is the rubber band, right? Will it break? The PGI, one of the market indicators that we use, the Motley Fool, the potential growth indicator is below 11 % now, which means that there's more cash in the market than is typical, less cash on the sidelines, right? So there's less cash to come. And remember one thing here. Sometimes you can find the greatest investment possible, but if you don't have any money saved, what are you going to do?

4:58You can't buy it. So even though we may get some great IPOs coming forward, there's not as much cash on the sidelines. And we should expect to see more volatility in the stock market, lower returns, probably lower gains from the big winners and some bigger losses from the big losers.

5:33We really at The Motley Fool are not going to say, start selling your stocks, move out of the market. That's just not our style. And it hasn't been our style for 31 years. But what is, at least in the Hidden Gems methodology of The Motley Fool, is to tilt from one direction to the other based on valuations. And we're at rich valuations today. We have had almost 35 % returns since April. So this is not repeatable over the last handful of months, but our minds start to get so excited about it. We start to get, if your stock's not up 4.5 % today in the market, it's kind of disappointing. But if you were to actually annualize 4.5 % daily returns, you would own Manhattan.

6:07So what I'm going to talk about in this quarterly call is what type of investments to make in this environment. So should you be buying the new IPO if SPACs return, right? Should you be buying those? Should you be buying the obscure crypto, right? We talked about that in the first call. Should you be on leverage? You know, should you be buying penny stocks? These things are all no in most situations. And they're, to me, absolutely, they should be forbidden among foolish members in the environment that we're in right now. It's time to reduce our exposure to risk. And that's what I want to talk about today.

6:41There are a lot of parallels and worthy comparisons between what's happening in the market today and what happened 25 years ago with the incredible boom of Internet stocks and the dot-com collapse. Let's start with what's not comparable, though. So the first thing that's not comparable is companies are making investments that are either break-even or profitable. So this isn't a heavy infrastructure spend. We had to lay down the pipes. We had to build the Internet. AI is getting to ride on top of that infrastructure right now. So mostly infrastructure companies are light companies like NVIDIA, right?

7:10They're chips, right? So we're not the heavy, heavy investments we saw to commercialize and bring the internet to households across the world. That has been built. So AI will be much more profitable. The companies back 25 years ago, first of all, a lot of them were going public very quickly, right? You would have a company created and five months later it would go public. And money that was going into them was being spread across so many businesses. You were diluting the quality of companies and you were putting a lot of retail investors at risk thinking this sounds exciting. This could change the world.

7:38But there wasn't enough talent. There wasn't enough good commercial insight. It was reckless. And the businesses had no opportunity off Broadway to practice that show and make it great. Everything was just going center stage Broadway right away. And it wasn't looking very good. That's not happening now. We don't have a lot of companies rushing to the public markets today. But what we do have is a rising enthusiasm for an acronym like AI.ai.com. We're going to see more and more of that. I think the bubble is fully formed for AI in the private markets. And what ends up happening downstream of that is that those companies need to go public because the only way that venture capitalists and private equity firms are going to get their money out is by forcing this stuff into the public market.

8:16So we need to be very careful. We need to be discerning, have a filter that's going to protect us against 80 to 90 % of the stuff that comes out that's going to end up falling apart before our eyes. For example, in Hidden Gems of the Motley Fool, we're not that excited about the Figma IPO. There was a lot of enthusiasm for the Figma IPO, but these companies are going to be an unbelievable competitive cycle right now. So I just think we need to sit with all the new companies coming public and recognize that many of them don't deserve a very, very high valuation. And we need to work with great investor teams, hopefully like the ones that you're working with at The Motley Fool to distinguish between the contenders and the pretenders.

8:55I would say to somebody that believes that artificial intelligence is presenting something new that we've never seen before, that they're not entirely wrong by saying that. So the first thing is we go through cycles and patterns, and we can look back in history and see innovative breakthroughs that changed everything. If you were hand weaving at a certain point and new technologies came along, as happened to Andrew Carnegie's father, he essentially ended his life in disrepair financially because he didn't make the transition to the new technologies. So we've seen this before, and in that way, it's not different.

9:24I think what's unique about AI is that it's a system. It'll be a worldwide system, and people with superior AI talent will be able to create new systems that will have downstream impacts that we can't foresee right now. So is it different? Yes, it does have elements that are different, but even artificial intelligence, as with every other innovation in history, can become overvalued, right? I think AI is going to create things we never thought possible, illnesses and disease solved. So many complex things that we haven't been able to figure out in human history, we will actually be able to figure out with AI, but there will also be so much competition.

9:58A lot of it will be commoditized and businesses that get very richly priced may find themselves threatened by small upstarts that nobody's ever heard of in three years because they jumped in purely with the new technology and built everything clean slate. So the competitive dynamics are different. And therefore, I don't think the valuations should run as high as they have at this point. Across our Mali Fool member base, obviously, we have executives running companies in public markets and the private markets. We have people employed in businesses in every industry around the world. And what I would say as organizations looking at the use of AI.

10:29You know, there's an MIT study that came out recently saying that 95 % of all organizations that have utilized AI have not seen any profit from it at this point. So that could be discouraging. And I think it's good to be thoughtful about the projects that people are going to be creating using AI. No question, right? We still be prioritizing, still be disciplined. And the companies that we invest in, we should see that they have a game plan and that they're moving forward. However, at the same time, were you really smart in measuring the profitability of early applications on the internet in 1995.

10:59I mean, in a way, yes, you want to know they were at least going to break even, right? But in another way, this is a major investment mode. People should be experimenting and exploring and trying to figure out what these new technologies can bring forward in their category. I think every single industry is going to show in the public market, some companies that are 10 and 20 baggers. And I think many of them will simply be recorded as the leader in AI in their category. The technology is that transformative. Obviously, we go back 30 years and see the early stages of the internet. You know, I remember a time when David and I were just traveling around on a book tour and we walked into a restaurant or a coffee shop to have a little break between one interview and another.

11:35And they said, would you like a table with the internet? And it was like this dramatic thing. There was a smoke machine in there and it was so special, right? It was elite experience that you could have. You could have a table with the internet, right? And then all of a sudden, And, you know, 15 years later, everyone's walking around watching videos on their iPhone. So this is what's going to happen with AI. And companies need to be willing to not worry about generating rising profits right out of the gate. But certainly, you know, the winners in the public markets, we are in a capitalistic system.

12:02So the companies and organizations that use their capital effectively, that know how to turn a dime into a dollar, are the ones that end up winning in our investment portfolios. So I definitely like to look at our databases at The Motley Fool and all our Moneyball databases for the companies with the highest financial scores because they know how to manage their money. They have a great CFO department and the ones that have the highest technology and AI scores in every industry because they're the ones that are being bold and creative and exploring what's possible. So pair those two things together.

12:26And I think you have some great investments out in front of us. On our Twitter account at The Motley Fool, we'll run the survey and say, you know, if the S &P 500 were to fall 20 % in the next six months, how would you feel about that? And there's a surprising number of people that say they would feel terribly about that. And that's bad news because the S &P falls 20 % once every five years. So that means every five years, 20 % of likely the people following us at the Motley Fool and our members are gonna be devastated by that. We can't have that. We can't set you up and make you think everything's gonna be fine.

12:58Just keep picking those coins up in front of the steamroller and everything will be hunky-dory. It's not gonna happen for 20 % of people that are gonna have an emotional negative feeling and are gonna react to it. And that means they're likely gonna sell at the bottom. And that is exactly what we don't want. So if you're holding Deere and IBM and a bunch of ETFs and you have a cash position of 20%, well, then when the market goes down 15%, you're fine. Your portfolio is more in line with the market and you have some cash and you can do some buying. But again, to get back to the core point, no matter where you are cautious, moderate, aggressive, I think you should move one step to the left and be more risk managing.

13:32And last thing I'll say is risk management sounds boring. There aren't a lot of people who are celebrated throughout history like you prevented this calamity. You fought it through and gave us a plan that saved us. But if you think about it in life, there are times when you really want a pessimist. Like you want somebody who's like, everything's fine. I inspected your plane before you get it on and I'm an optimist. Or do you want the person running cybersecurity at your company to be an optimist? You need certain people in life that are just rigorously looking at the downside, looking at everything that could go wrong.

14:00There are people who have largely avoided the equity markets because they keep thinking it's going to collapse. And obviously, you can go too far on the risk continuum towards risk aversion. and you can go too far towards speculative excess. What we're suggesting now, or what I'm suggesting, is that you should understand where you are on that continuum, look at the classifications by the stocks, and in my opinion, given valuations in U.S. equities today, everybody should take one step closer towards risk management. In January of 1915, Ernest Shackleton's ship, Endurance, became encased in the ice in the Weddell Sea.

14:30Through determination, grit, and savvy, Shackleton would lead his men through a brutal winter, then over hundreds of miles of Antarctic ice, followed by 800 miles across some of the roughest waters in the world. It is one of the most extraordinary and inspirational journeys in the history of exploration. Find this story and many others at the Explorers Podcast, available wherever you get your podcasts or at explorerspodcast.com. So let's put it all together and your approach to investing cautious, moderate to aggressive. And let's have five stocks that I like right now. And we're going to move from the cautious end of the continuum to the aggressive end of the continuum with these five stocks.

15:07So the first one is IBM, International Business Machines. We've all heard of it before. It's been a pretty disappointing investment for decades, right? I mean, it really started to lose its footing with the PC revolution. And all of a sudden, Microsoft and Dell computers and so many other companies come along and push IBM to the sidelines. But actually, over the last five years, IBM has been a great investment and they are in advanced technologies. I mean, they will be a leader in quantum computing as it emerges and they're very well financially managed. So I think IBM is a great cautious investment to make in a portfolio and I think you'll beat the market with it.

15:40The second more cautious investment would be Progressive Insurance. Progressive Insurance, obviously a major brand. Anyone who's a sports fan sees the Progressive ads in every commercial break. They're also the company that took the lead in telematics, that gave you rewards in your insurance policy for being a better driver because they put the system in place to track your driving habits, right? So they use new technology. Progressive is the most advanced large technology company in insurance, and that really benefits them. But it's a cautious investment. You're going to get a dividend there as well.

16:10The third now we're moving into the middle, and that's a company called Stride, ticker symbol LRN. And Stride is an online learning company. It turns out that even post-pandemic, there are a lot of families that want to have their children getting some education, at least remotely. That might be some specialized skill, like they have an amazing math student in their family and they want to pursue additional learning online. They can get that from Stride. Obviously, there are a lot of students with special needs that Stride serves, and now Stride has moved into adult learning as well. Their CEO, James Rue, we did a wonderful interview with him.

16:40I mean, he did a wonderful interview with us, and it's a very well-run company. It's more moderate. It's in the middle. Still in the moderate zone would be Sterling Infrastructure. This is a foundation laying business for now data centers. They're basically laying the cement for data centers and just made a great acquisition in Texas. Their CEO, Joe Cotillo, who we also interviewed, one of my favorite interviews, really, I would say, in Motley Fool history. Somebody who would put a$5 ,000 investment in the company back then would be sitting on over a half million dollars right now from that investment.

17:11So that's somebody who's delivered excellence for the last decade. And I think he's going to deliver great things in the next decade as the data center build out continues. And finally, in the riskiest across the continuum is Rocket Lab, ticker symbol RKLB. New Zealander Sir Peter Beck founded the company. You know, he was building jet bikes when he was 11 in remote area in New Zealand. And he stuck with that vision and that passion throughout his entire life. He's built a company now with about a market cap of$20 billion. If you look at the valuation of Rocket Lab versus the S &P and most other companies across any market in the world, you're going to say, that is so overpriced.

17:46But Rocket Lab is a really exciting company to follow. And I think even if you're only going to buy a share, I think it's a good idea to be a shareholder of an exciting business like this that's so very well run and so innovative. And in the first quarterly call, episode one, we had five stocks. They've all done reasonably well. I mean, the markets have done well, but I think we're happy with our first five stocks. And so we're sticking with them, definitely. I mean, these ideas that I'm putting for. These are five-year holding periods that I'm suggesting for these companies. And the companies are AbbVie, Bitcoin, Unity Software, TJX Companies, and Kindrel.

18:17So those five add to the five that we have here in the second quarterly call. These are all businesses that I'm excited about for the next five plus years. I wouldn't be surprised if any of those stocks fell 15 % in the next 12 months. That wouldn't surprise me at all. But as businesses for the long term, I think we've got a great collection of stocks there, and they do travel across the continuum from cautious to moderate to aggressive. Fool on.

18:43As 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 Motley Fool editorial standards and is 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. For the Motley Fool Money team, I'm Matt Greer. Thanks for listening, and we will see you tomorrow.