Investors: "You Don't Have to Be a Perfectionist in This Environment."

On this podcast, Motley Fool senior analyst Asit Sharma discusses:

  • Stocks, across the board, falling in response to the Consumer Price Index data for August.
  • Fed Chairman Jay Powell and the increasing likelihood of a third consecutive rate hike of 0.75 percentage points.
  • The importance of having a watch list of stocks.
  • Buying great businesses at lower prices.

Motley Fool senior analyst Tim Beyers joins Motley Fool host Alison Southwick and Motley Fool personal finance expert Robert Brokamp to discuss what is a tech company.

To catch full episodes of all The Motley Fool’s free podcasts, check out our podcast center. To get started investing, check out our quick-start guide to investing in stocks. A full transcript follows the video.

This video was recorded on Sept. 13, 2022.

Chris Hill: If you’re a long-term investor, today was a good day to go shopping. Motley Fool Money starts now.

I’m Chris Hill. Joining me today, Motley Fool Senior Analyst Asit Sharma. Thanks for being here.

Asit Sharma: Chris, thanks as always for having me.

Chris Hill: This is one of those days, isn’t it? This is one of those days with the market. Consumer price index rose 0.1 percent in August, month-over-month increase compared to July. That 0.1 percent increase, Asit, has sent stocks as a group straight down. As you and I are speaking, the Dow Jones Industrial Average is down nearly three percent, the S&P 500 is down three percent, and the Nasdaq is down just more than four percent. Where do you want to start? This is all because the Fed is meeting next week, September 20th and 21st, and the powers that be on Wall Street are expecting, not incorrectly, they’re expecting a third consecutive rate hike of 75 basis points.

Asit Sharma: Yes. Chris, first of all, look, it’s the power of small fractions, as you note. If you look at the big picture, nothing much has changed since the hot reading of the summer, just a marginal sequential bump, really small. But this reminds me of an old Dire Straits lyrics from the song, “Espresso Love.” At the end of this song, the narrator is talking to, in those days, I knew what they called them, but this would be at barista today, and he’s asking about is espresso and he says, “Is this another one just like the other one?” Today, investors are waking up thinking, look, we all see this three-quarters of a basis point hike that’s in the cards for September, but we might be getting another one of a similar magnitude in October.

Previous forecast, we’re saying we would have three quarters of a basis point raise and then maybe for the rest of the year, it will step down, maybe it’ll be like one percent total. This throws it off, and about this increase, what’s worrying investors is that when you pull apart two parts of the CPI, which are a little bit volatile, so that’s energy, of course, and food, the stuff underlying that looks hot. Rents are rising. The cost of medical care is rising. We saw that used car prices are finally starting to fall. But now on the flip side, new car prices are rising. So there’s all this underlying pressure on everything from food-away-from-home to commodities, that under the surface bubbling. Even though gas prices, tank prices fell, say five bucks on average in the US to about 3.70 over the past several months, it’s been offset by all these other pressures.

Chris Hill: I’m glad you mentioned the gas prices because I think that that is one of those data points that gets pushed out so often, not just in the financial media but mainstream media as well. I can understand some people being thrown by the increase in inflation month over month just because the thing that we’ve all had right in front of us for the past, let’s just call it, 10 weeks, it may even be more than that. But the price of gas has just been falling steadily day after day, week after week, for more than a couple of months now. That being said, am I wrong to think that what’s happening in the market today is a buying opportunity? Even if you’re just looking at index ETFs like the QQQ or the S&P 500 ETF, you can get it for a few percentage points cheaper than you could yesterday.

Asit Sharma: Chris, I saw you at FoolFest, our Motley Fool celebration a few weeks ago. Before that summit, I was looking over my own portfolio, what I bought a lot of this year, and it’s just that I think the thing I’ve most bought is the QQQ, alongside a lot of individual stocks because this environment is starting to play in the favor of the patient investor who can buy the index when it gets beaten down on days like this. The only issue is that we’ve had so many days like this, and the read on inflation, the fact that this will only exacerbate interest rate pressure means that we don’t know when this period starts to come to a close. So it looks like will be in for another quarter or two of this type of pressure, at least. Federal Reserve Chairman Jerome Powell is adamant that he wants to see several months of cooling inflation before he starts easing off that stern pedal of driving up the prevalent borrowing rates.

So what this means is prices are very elastic. We could see inflation start to cool pretty quickly, but the Fed will take its time to be sure that that’s not a transitory effect and that inflation is indeed going down. So investors might be in for another couple of quarters of some rough weather, but I’m with you. Look, why not keep buying things like the QQQ, other ETFs, and sectors that an investor finds attractive and just slowly build up positions. Once you take that and telescope out five years from today, 10 years from today, I think most investors will be in a good shape who employ that strategy because the underlying fundamentals of the US economy are actually still pretty strong, and if anything, the long term trends of productivity in this economy, the fact that we are trying to change to more climate-friendly economy, etc., I think all that plays into the hands of the long-term investor.

Chris Hill: What we’re seeing in the market today reminds me of something that our colleague, Matt Argersinger tweeted out early in the summer, I believe it was early June. He wrote on Twitter, “I’m not sure when or how this all ends, but I would view the following as can’t miss generational buying opportunities,” and he went on to lists several stocks, basically, saying, I’ll just pick a couple as he said. Again, this is Matty’s opinion. This is not guidance. Insert all the requisite disclaimers. But Matty looks at, if Amazon falls below $90, if Disney falls below 80, if Alphabet falls below 95, I would just point out because I looked at his list, and I was, like, wait, where are these stocks? Alphabet is within about 10 percent of being below $95 a share. It’s down today. He didn’t list companies, like Nvidia and Johnson & Johnson, but Alphabet, Nvidia, Johnson & Johnson, all three of those, huge companies, stable companies, profitable companies, they’re all within a couple of percentage points of their 52-week low so it’s not just the broad index ETFs that look like buying opportunities. There are some really great companies with bright futures ahead of them that are on sale right now, Asit.

Asit Sharma: Chris, there are so many things we can unpack from that great tweet. The first being that industry leaders with big balance sheets and a lot of in-built demand are the first to lead companies back out of a period like this, so buying them makes so much sense. The second point that Matty is trying to communicate is you don’t get these opportunities every day. Remember, after The Great Recession, for what, 10, 11 years straight, you had very few opportunities to buy great stocks at all-time lows because they were headed up. Also in this, I think what he’s pointing out I’ll quote from his exact tweet that you sent me, “What are you watching at the end?” But I’ll tell you, Chris, I actually misread that. I was in a little bit of a hurry, and I thought it said, at first, what are you waiting for?  But the point is well taken. What are you watching? Which plan are you making in advance because we know, you and I know, as investors, that when there’s so much red ink on our screens, there’s something psychological that starts to pull us away from that Buy button, which is, wow, can this go down further? How bad can this get? That sometimes is a mistake to get caught up in that trap.

 Chris Hill: It’s a great reminder. This is why you have a watchlist. But to the point you just made which is so important, Asit, don’t move the goalpost. If you have a watch list, and you go so far as to say, this is the price I’m going to put, and if this stock starts trading below this price, I’m going to buy, don’t make the mistake that I have made in the past and hopefully will never make again. But I have absolutely made the mistake of having a watch list, putting a price on a stock, and then when it falls below, I move my price target, even though I’m, like, wait, I want to try and time the bottom, which is impossible to do and is just a dumb mistake. Again, hopefully, I’ll never do that.

Asit Sharma: Yeah, same. I’ve lost out so many times on trying to be a perfectionist. You don’t have to be a perfectionist in this environment. I’ve got this great retweet I’m waiting for, now that you’ve sent me what Matty tweeted out on the 10th of June 2022, “once these prices hit this level, I’m going to tweet back out.” Matty, did you buy it?

Chris Hill: Knowing Matty, he’s on top of it. Asit Sharma, always great talking to you. Thanks so much for being here.

Asit Sharma: Same here. Thanks so much, Chris.

Chris Hill: Speaking of technology stocks Tim Beyers joined Alison Southwick and Robert Brokamp for an overview of the industry while recognizing that the term “tech stocks” is misleading.

Alison Southwick: Last week, Motley Fool analyst Nick Sciple gave us the CliffsNotes on the energy sector, and this week we’re joined by Tim Beyers to share his essay, “What Tech Did Over The Summer Break.” Tim, thanks for joining us.

Tim Beyers: Thanks for having me.

Alison Southwick: Since we have a back-to-school theme going here, it only makes sense that I crammed for today’s taping and decided to Google top US tech companies by market cap. No list is the same as some said it’s Apple, Microsoft, Alphabet, Amazon, Tesla. Others had Nvidia, Broadcom, and Cisco in there, so it feels like a tech company is just whatever we collectively decide as a people is a tech company. 

Tim Beyers: That is factually correct. It’s also too the ones that are classically determined as tech companies, like Apple, Microsoft, and so forth, they switch position so much. It’s a little bit like your old arcade video games, and you’d be one-upping each other. Someday Bro would be at the top, then I’d at the top, and Allison you’d be at the top. We’d be totally one-upping each other. That’s the way the market cap game goes in tech. But yes, it is absolutely true that tech is a terrible way to talk about investing in technology-powered companies because investing in semiconductors is really different than investing in consumer-facing software, which is really different from investing in enterprise software, which is really different from investing in server hardware, and so forth.

dynamics of each of these businesses is really different, so that’s the beautiful thing about it. One of the reasons you want to be an investor in these tech-powered companies is because they all get lumped together, and they all have really different economics which means the level of misunderstanding in the space is really high. When the level of misunderstanding is really high, the level of mispricing is also high. Sometimes that is unfavourable. The stocks are really priced at a premium. Other times it’s really favourable to investors. Stocks are really underpriced because we just don’t give them enough credit for the amount of growth that they can achieve, but it’s almost universally true that the term “tech investing” is so misleading that it makes the sector attractive to invest in, if that makes sense.

Alison Southwick: Yeah, I know, because it seems like one of the reasons we got to this place where the tech sector is just a rattlebag of companies, is because let’s say you make a car, Tesla, and you’d rather be thought of as a tech company and not an auto manufacturer because the market is going to reward you if you sidle up next to Apple and other companies like that rather than Ford. You market yourself as a computer on wheels, even though, let’s be honest, you make cars.

Tim Beyers: Right. Yes. We see this a lot. Probably the most ridiculous example of this I have ever seen, if you remember in 2019, when WeWork was a thing before it became the subject of documentaries, it put out an S1, which is essentially a prospectus. It says we’re going to go public. We’re going to sell stock. In that prospectus, WeWork said, and I’m not making this up, they said, “We are a SaaS company. We sell Space as a Service. No, you don’t. I’m sorry that you don’t. You don’t sell space as a service. What you really do is you own chairs and desks, and you serve coffee, and people come in, and they work and pay you a little bit rent. That’s what you do. You don’t sell Space as Service. Stop it.

Alison Southwick: Being a tech company was cool, and all these companies were trying to convince the doorman to let them into the club so they could party with Apple and Amazon, all these big growth companies. Here we are now, the party has ended a bit, or at least been put on pause. So what’s been going on in tech lately?

Tim Beyers: I think the headline here is that tech is finally here to be a market. That is really interesting because it has been the life of the investing party for such a long period of time that I think a lot of investors thought that could never happen. This is a little bit bold to say this and I think Bro may want to correct me on this, but there are some investors that got so warped around this that they started to think of tech is a safe heaven meaning that it could never go down. That has obviously changed. The story now is that tech was overpriced, it was dramatically overpriced in 2020. The longest honeymoon ever is finally over, investors are starting to divorce themselves from some of these stocks and especially stocks where these tech-powered companies have yet to produce a profit.

Those companies are dramatically out-of-favor right now. You get companies that are reporting good results, they may report some real revenue growth, but if their guidance shows any hint of a slowdown or if the expenses are higher than expected, the stocks get absolutely whacked. We saw this really recently with MongoDB which is a database company. They had some really good results, but they reported that their earnings per share guidance was going to be their losses, are going bigger than expected because they’re going to spend more money on their operations, investing more in sales and marketing, investing more on R&D. The market didn’t like that, took stock down by 20 percent because there’s a belief that only the tech companies that are right now navigating to profits are the ones that are going to survive the meltdown that’s coming. That’s not really true, but that’s where we’re at Allison.

Alison Southwick: If I’m understanding you correctly, it’s the sense of reckoning is coming.

Tim Beyers: Absolutely.

Alison Southwick: That’s why people are cooling off on tech and not giving them as much of a runway as they would have in the past?

Tim Beyers: Absolutely yes. Not just is the reckoning coming, but the reckoning is here. We have to keep these tech stocks in our portfolios on a very tight leash. Whereas before, hey, the water’s warm, come on in, everybody joins the party and that’s not where we’re at right now. You have a lot of good companies that are getting tossed by the wayside, along with companies that were dubious and questionable. We’re not really differentiating between the two right now, which is an interesting place to be. If you’re an investor, and that starts to happen, you should pay attention because it means there’s a better-than-average chance that some quality companies will start to go on sale.

Alison Southwick: It sounds like you feel like there are some opportunities here that investors here at The Motley Fool, we’re long-term bottoms-up investors, there’s some opportunities here. What are some of the guiding investing principles that you follow or you suggest for our listeners?

Tim Beyers: Well, if you’re going to search for quality, this is the hard part. Tech investing, even though I dislike that term, I use it because there’s a lot of opportunity in the sector. The sectors are very different. Because they’re very different and because there’s a lot of confusion, there is opportunity. But if you want to find those opportunities, Allison, you’re going to have to go under the hood and there’s really no getting around that. You have to study things like the key metrics that a lot of these companies report and get to know what they are. Examples of that would be remaining performance obligation, which is it is an official accounting term, but it just doesn’t really get used outside of the sector like large enterprise software companies. Essentially what it means, it’s an accounting way to calculate what effectively is backlog. A company let’s say has $2.5 billion in remaining performance obligation. You just think of that as backlog. It’s basically revenue that can’t be recognized yet, but it’s contracted. So they have a bunch of customers who said, yeah, we’ve signed a three-year deal with you and we’re committed for those three years. The value of the two years that they aren’t yet in, that value gets computed into the remaining performance obligation. It’s an obligation that the company has to perform in order to get the money.

This stuff, it tells you particularly in the case of like a subscription business, how healthy it really is, like how big is the backlog? What is the dollar-based net retention rate? Are they growing their relationships with the existing customers? Because when the profits and the cash-flow aren’t there yet, you have to go under the hood and determine whether or not this business is showing signs of healthy growth and growth such that you can see margins increasing over time and maybe a future where this is generating a whole bunch of free cash flow because ultimately they do need to get there. You’ve got to pay attention to the metrics. The one bugaboo I’ll give for investors, if you’re going to follow those metrics, follow them historically. Because one of the things that tips, it’s a giveaway of a company that is telling a really good story, but the story may be a little bit weird, is if they suddenly changed the metrics, oh, you know what? Pay a lot of attention to dollar-based net retention rate. You know what? We didn’t really mean that. You should really look at the expansion rate. When those things start to change and the goalpost shifts, that can be a bad sign.

Alison Southwick: I imagine there are a few traps for investors to avoid considering the high-risk, high-reward nature of the sector. Are there any other ones you’d tell the group before?

Tim Beyers: Yeah, one of the big ones particularly for the big companies, I’m thinking specifically of Cisco, IBM, SAP, older companies that have a lot of cash and what they do is roll up companies. But sometimes it’s OK. If you acquire a fast-growth company and tuck that in, there’s really nothing wrong with that. SAP has been doing a lot more of that lately. Cisco though, tends to buy a lot of companies that are, sometimes they buy growth. Other times they buy companies that are not doing all that well and they’re like, “Well, it’s really cheap and we could bring it in and we can roll it up.” A bunch of rolled-up bad companies is still just a larger bad company. You really don’t want to be paying a lot of attention to a large company that generates a lot of cash, but is doing so by vacuuming up businesses that weren’t really doing that great anyway. I don’t love the roll-up Alice and those aren’t great. I much prefer the companies like say, Datadog, which find ways to use their R&D dollars well, and they come up with new ways to serve their customers and they grow their revenue that way. That’s much better. That’s organic growth and I like that a whole lot more.

Alison Southwick: Let’s say you want just more broader exposure to the whole sector. Bro, I’m going to tap you in here. Do you have a favorite fund here?

Robert Brokamp: While I would say, the first principle is just look at what’s in an ETF to make sure it’s getting what you want. Just for an example, two of the biggest technology ETFs, one comes from Vanguard, one comes from, it’s the spider ETF. Vanguard VGT, the spider ETF is XLK. When you look at the components of these ETFs, they’re almost identical. First of all, they’re dominated by Microsoft and Apple. It makes up more than 40% of the assets in these ETFs. Then among the top five are Visa and MasterCard, which are not what you would normally consider to be traditional tech companies. I think a couple of things to consider might be some other ETFS. For example, the Vanguard growth ETF, VUG is probably more like what people would think of as a technology ETF. It’s got Apple, Microsoft, but also Amazon, Tesla, Alphabet, Meta. But even that has some quirky things like its 10th largest holding is Home Depot. But that’s one that I own. Then of course, you have to bring up the Nasdaq and the QQQ, which is the ETF that follows the Nasdaq 100. Very similar to the Vanguard growth ETF. But even that’s a little quirky. Among its top 10 holdings are Pepsi and Costco. Those are some ones to consider. I would just look at the holdings and the weightings of the companies and decide which ones you think better fit into your portfolio.

Tim Beyers: So let me add one more thing, Allison. One of the beautiful things about tech, particularly right now, is there are some big companies that generate boatloads of cash-flow, they pay really good dividends. Tech is a place right now where you can get some decent growth and some really great sustainable growing dividends. I think those dividends are safe and I think they’ll grow over time. Probably the best of them, Bro, already mentioned, is Microsoft, an amazing company growing pretty fast, has a great dividend, a long history of growing that dividend, and it’s not the only one. Taiwan Semiconductor pays the dividend. A very well-heeled company that’s growing pretty well. I think if you’re going to invest in tech, don’t forget that there are really durable, resilient growth companies that will pay you to invest in them. What is better than that?

Alison Southwick: Next week, we’re going to be joined by Emily Flippen and we’re going to cover the state of the consumer goods sector.

Chris Hill: As always, people on the program may have interest in the stocks they talk about on the Motley Fool may have formal recommendations for or against. So don’t buy yourselves stocks based solely on what you hear. I’m Chris Hill. Thanks for listening. We’ll see you tomorrow.

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