Long-Term Investing Ideas in a Volatile Market
Simon recently spoke with a $35 billion global asset manager about how they're navigating the market volatility. The key takeaways are to think long term, tune out the noise...
Our entire 7investing advisor team comes together to discuss how and why "overvalued" companies outperform the market. They also provide 4 stocks that are currently on their radar.
July 30, 2020 – By Simon Erickson
Are you noticing that the market “being overvalued” is becoming a popular topic of conversation these days?
Several investors are quick to point out how valuation multiples — such as the S&P 500’s P/E ratio — are becoming stretched beyond their historical norms. Others believe the market’s recovery from its March lows happened too soon, or that the current expectations baked into stock prices are simply too high.
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But this is a dialogue that’s also happened many times before. And history has shown us several examples of how overvalued stocks can often go on to significantly outperform the broader market.
In our 20th official podcast, our entire 7investing advisor team comes together to discuss lessons learned from three “overvalued” companies who went on to crush the market (as well as a fourth who didn’t, and the reasons why).
Each advisor also picks a company that is similarly considered expensive today — but could be poised for huge returns going forward.
0:00 – Introduction: Is the market “overvalued”? A look at past examples of overvalued companies who went on to outperform.
1:58 – Domino’s Pizza (DPZ)
10:13 – Boston Beer (SAM)
16:12 – McDonald’s (MCD) (an “overvalued” counter-example!)
24:50 – Lululemon (LULU)
30:04 – Looking to the future. What companies today could be good opportunities for investors?
30:31 – 2U (TWOU)
34:05 – Peloton (PTON)
42:40 – Microsoft (MSFT)
47:08 – Veeva Systems (VEEV)
52:12 – Outro: What are consumers’ most-loved and most-hated industries?
Publicly-traded companies mentioned in this podcast include 2U (TWOU), Boston Beer (SAM), Domino’s (DPZ), Lululemon (LULU), McDonald’s (MCD), Microsoft (MSFT), Peloton (PTON), and Veeva Systems (VEEV). 7investing’s advisors may have positions in the companies that are mentioned.
This interview was originally recorded on July 28, 2020 and was first published on July 30, 2020.
Simon Erickson 00:00
Hello everyone and welcome to the 20th official 7investing podcast here at 7investing our mission is to empower you to invest in your future. And we do that by providing our seven best stock market opportunities every month, but also educational programs such as this podcast. I’m 7investing founder Simon Erickson joined today by my colleague 7investing advisors, Matt Cochrane, Austin Lieberman and Steve Symington. Gentlemen, I hope you’re ready because we’re going to kick start our 20th show. Are you ready for us to kick in?
Matt Cochrane 00:33
Let’s do this.
Austin Lieberman 00:35
Simon Erickson 00:37
The topic I think for the show today is how the market is being considered by many to be overvalued. The term “bubble” is starting to circulate in conversations where bears are quick to point out that valuation multiples are stretched beyond historical averages. And many believe that the recovery since March was just too soon and that expectations in the market are simply too high.
Simon Erickson 01:02
But here at 7investing, we sent an email out last week with a perspectives that we all shared about companies that we personally sold far too soon. And these were painful and excruciating memories from all of us of money that we left on the table from selling some of our favorite companies too soon.
Simon Erickson 01:22
Let’s continue that dialogue in today’s podcast because I’d like to put some more context into this whole overvalued conversation. Let’s start the first segment of our show by focusing on companies that were previously considered to be too expensive, or too overvalued, but still went on to provide incredible returns for the investors that held on to them over the long term. And so I’m going to ask for every advisor to present one company that they’ve looked at that fit this scenario. And one caveat for this, it cannot be a tech company, gentlemen, because people are always calling tech out overvalued all the time.
Simon Erickson 01:58
Austin Lieberman, let’s start with you. If you can see our video, it looks like Austin, you’re in the beach somewhere [his Zoom background]. So I’m going to ask you to take five minutes away from the beautiful skyline and the beach background to tell me about a company that looked like it was overvalued.
Austin Lieberman 02:11
You know, giving up this beach vacation for this podcast, so I’m very dedicated [laughs]. Yes, I definitely echo exactly what you covered. There’s a lot of talk about the market in general being overvalued. And while I’m sure there’s companies today that are definitely overvalued, there’s companies that are always overvalued.
Austin Lieberman 02:38
I don’t know if the entire market is overvalued or not. And I don’t think we care too much at 7investing if the entire market is overvalued because we focus on finding the best individual stocks and so I love what we’re talking about today.
Austin Lieberman 02:53
The company that I’m going to talk about that has outperformed for more than a decade, has been called expensive has baffled people’s imaginations because it’s just a food company. I actually turned to our amazing hundreds of millions of fans on Twitter and I asked for some of the most boring stocks that have been, I think, returned 10 times in value. And we got a lot of great ideas.
Austin Lieberman 03:30
One of the most popular ones was this company, and it’s a Domino’s Pizza.
Austin Lieberman 03:34
So we had ships of fool. David Jacobs, Dan and ri, and multiple other people share dominoes. So thank you. I mean, everybody that got involved in that thread. Thank you. We love interacting with you all and you helped me pick the company for this podcast. So let’s talk about Dominoes.
Austin Lieberman 03:55
Domino’s over the last 10 years has returned 2,830%. Which is a massive out performer compared to the s&p 500. And it’s actually outperformed several of the FANG stocks which are our tech stocks, and what everybody is familiar with as as the top performing stocks. And Domino’s is really just kind of a boring old food company.
Austin Lieberman 04:27
And the story behind Domino’s is that they struggled for a long time. A they brought in new management, I think it was a new CEO. He basically called out the company for having a terrible recipe and they basically reinvigorated the business they turned to become, they’re not a tech company, but they turned to become a much more digitally and delivery oriented company. They came up with a new recipe for their sauce and it basically just restarted their entire menu in their entire presence. And since then they’ve completely turned the company around. And like I said over the past 10 years, the stock is up 2,830% over the last five years, they’re still outperforming, stock is up almost 250%. Three years it’s up 112%.
Austin Lieberman 05:21
So this is a serial outperformer. The reason that it you know, it’s considered or it has been considered overvalued is again because it’s kind of just a boring pizza delivery company. It has sported a PE ratio and a high was at 46, which is kind of ridiculous when you think about fast food or different food companies. And it’s currently it’s had an average p price earnings ratio of 29.66. And it’s currently sitting at about 36. So a little bit higher than average. But the interesting thing is even if somebody would have bought back when the Domino’s PE ratio was at its very highest of 46, that was in 2017. And so even since then the stock is up 112%. So, as an investor, you could have bought it at its very high of PE ratio, which was absurd. And still, if you held on to it for three years, you’re sitting at 112% return, while the PE ratio has actually contracted.
Austin Lieberman 06:32
Which taking this back to the discussion today and that you opened with Simon, we might see that in some of the stocks that were invested in today and especially me in the style of stocks that I invest in. Which are, you know, high growth tech companies and software as a service companies. Then we might see price to sales ratios contract. But what I want to emphasize is if the company is managed well, continues to innovate and continues to grow. That’s okay. And they can start. There’ll be winners over the next three, five in 10 years. And Domino’s is a great example of that.
Simon Erickson 07:05
And it was just a successful turnaround, Austin? I mean, you said they brought in a new CEO, they kind of changed the recipe was the market not giving enough credit to the fact that Domino’s was able to turn around and correct its past mistakes?
Austin Lieberman 07:18
I think, and I wasn’t heavily following Domino’s back through this. So this is just kind of the research that I’ve done. But I think there was a lot of from from the research I did, there was a lot of kind of disbelief. And it was looked at as a turnaround that people didn’t believe in until it was multiple years in. And then a lot of the articles were talking about how Domino’s hadn’t run too far too fast and was up too much. And that was three or five years ago and the stock has continued to outperform. So yeah, exactly what you said Simon, it was a successful turnaround. But at first and for multiple years, people really didn’t believe in it and then they just kind of kept doing their thing and outperforming.
Matt Cochrane 08:05
Their marketing campaign was incredible. It was very bold. I don’t know if you guys remember but like they basically were just running ads nationwide saying about how bad their pizza sucked for so long. And they would like show reel reviews, their pizza had gotten, like, one star on Yelp or wherever else people are leaving reviews. And they revamped the recipe and then they would show them like delivering pizza to these people who had left bad reviews and give us another chance and basically just kind of ended like saying, “hey, America, give us a second chance.”
Matt Cochrane 08:37
And then beyond that, like after revamping their pizza recipe, they just invested heavily in technology. Like they have the anywhere program now where you can order pizza by like, if you’re signed up for it, you can you can tweet out an emoji of a pizza to Domino’s and they’ll just from that they’ll deliver your your preferred your saved order in your Domino’s account. They have a zero click app, so we used to use this when my wife was on our way home from work, all you had to do when you’re sitting in traffic, she knew the exact moment on her commute to hit this app. So you’re sitting in traffic, you can’t really like fool around and order a pizza, but you have a saved preferred order, and you would just click it, and it would start a 10 second timer. And when that 10 second timer went off, your preferred saved order at your saved location of Domino’s would automatically get ordered. And she knew the exact second to hit it in her commute. So that’d be ready when she passed by the Domino’s on our way home and we’d have pizza that night.
Austin Lieberman 09:39
That’s a great story. Essentially, Matt when I think about even now, pizza companies, the ones that come to mind are Domino’s. And for me it’s Hungry Howie’s, which I don’t know if that’s even a nationwide chain, but it’s definitely not high quality. But I just think about the commercials. The one that doesn’t come to mind is Pizza Hut and then Papa John’s comes to mind a little bit but for negative reasons because they’ve had a lot of negative news headlines. But yeah, their marketing has just been awesome and I think it still pretty good today.
Simon Erickson 10:12
You’re talking about Domino’s and Hungry Howie’s has gotten me a little hungry. Do you have a company that also makes a product that might tie in well with pizza, Steve?
Steve Symington 10:21
Steve Symington 10:22
So you shared a link earlier to the American Customer Satisfaction Index that said the among the most loved industries and the highest customer satisfaction score in the list was breweries. And one of the stocks that I’ve covered and loved for a long time is Boston Beer Company.
Steve Symington 10:45
It’s ticker SAM. That’s “Sam” for its flagship Samuel Adams beers, but it also owns Twisted Tea, Angry Orchard, more recently, it’s Truly hard seltzer brand. They acquired I think Dogfish Head brewery a little over a year ago for like 300 million, but actually recently stumbled upon an old profile and a stock picking system I used to use where I’d picked Boston Beer a little over 10 years ago, this was in February 2010, at a starting price of about 46 bucks a share. And after a nice little earnings pop last week, right now we’re sitting at about $818 per share today. That’s a 1700 percent gain over the last decade and kind of incredible for a brewery; a beer company.
Steve Symington 11:37
But I remember thinking even in the beginning that Boston Beer always felt expensive and I always hesitated to buy it back then. I picked it as an outperform. It’s like, maybe I can get a better entry point. Maybe I can, maybe I can’t and it was always expensive, especially relative to its larger peers like AB InBev, and Molson Coors now. And actually, it just passed Molson Coors in terms of market capitalization. I think it’s a $9.5 billion company. Molson Coors was somewhere in the eight billions. AB InBev is 95 or something; it’s absurdly large.
Steve Symington 12:10
But it always felt expensive, no matter what traditional valuation metric you looked at, and even looking back over the past year and a half or so, now we see it with a trailing PE, like 42, six months ago. Or a couple months ago was trading it like 60 times trailing earnings, and 50 times forward estimates and five times sales, which seems kind of crazy for a beer company. But it was one of those interesting names that was basically working to grab slices of enormous industries and working from very small basis and that was exactly the kind of company that I love.
Steve Symington 12:51
And, again, just felt expensive all the time. And one thing to note is a huge chunk of those gains have come to this year was sort of like this sneaky I think someone mentioned on Twitter it’s like the sneaky COVID play, where everybody’s going out and they’re not not drinking beer. They’re continuing to buy alcohol. But actually, the other funny thing is that their exceptional quarter there, they’re their most recent quarterly results that smashed Wall Street’s expectations revenue was up 42% year over year and earnings more than doubled. And nobody expected that.
Steve Symington 13:31
But that came in spite of weakness from their flagship Samuel Adams brands, so they’re not even firing on all cylinders. But they really credited the relative outperformance of Truly spiked and sparkling that hard seltzer brand. They said it was the only hard seltzer not introduced this year that actually gained market share. And I dug into the seltzer segment after that call a little bit and found it’s really a fantastic place to be performing for them. So that flexibility for them to be able to branch outside of their core competencies is really helped them. Part of the reason seltzer’s interesting is because it caters to college educated millennials, who tend to spend almost twice as much on-off premise alcohol then their kind of traditional beer drinking counterparts. So it’s kind of incredible to watch this, this growth story unfold outside of their core markets.
Simon Erickson 14:29
That’s a really good one. Steve, I can’t tell you how many conversations I’ve had where I’ve heard the term “they’re just another brewery” or “they’re just another beer.” They’re kind of lumping them in with the bigger players that you just mentioned. But even though Boston Beer is doing fantastically, Anheuser Busch has gotten completely slammed in this COVID pandemic recently. Stock has definitely gotten crushed.
Simon Erickson 14:52
What’s your perspective on distribution? That’s a topic that keeps coming up, of the distribution to you know, to the bars and the restaurants and all the different locations. It seems like that’s worked against the larger brewers but maybe to the advantage of Boston Beer. How do you think about this?
Steve Symington 15:07
Yeah they talked about, like struggles because your restaurants and everything really they kind of got crushed. I think that’s why the Truly seltzer brands have helped them outperform. And that was one of those, like I mentioned earlier, off premise alcohol is what they’ve really focused on. And this hard seltzer category is one of those that, where people are spending a lot more money. And then you think of Boston Beer as “Truly.” There’s also a bunch of others out there, White Claw. And those are sort of what are the big hits for younger drinkers with money to spend. And that’s kind of where Boston Beer has basically kind of flexed their flexibility in a sense that, as a slightly smaller business, they can actually do. Whereas someone like AB InBev can say they’re working to adapt to drinkers habits. But it’s harder to to steer a ship of that size in the same way.
Matt Cochrane 16:11
Well, I’m gonna play the role of the “value investing villain” on today’s show. So it’s important to note that yes, there are plenty of examples of companies that succeed, providing investors with like life changing returns from high valuations. But also, statistically speaking, stocks with high valuations perform worse than stocks with low valuations. So I’m going to give an example of an inarguably great company that realized a lofty value valuation. And the company still went on to do great, but it saw stock price struggle for more than a decade before getting going again.
Matt Cochrane 16:46
So I’d like to introduce our listeners to the nifty 50 stocks. So in the 1960s, this was a group of 50 stocks that allegedly represented America’s greatness dominance in the free world. And you were told if you if you just bought these stocks you could forget about any other, making any other investing decision, and you’d be just fine. You know, this was in the 60s through the early 70s. And this included companies like Coca Cola, Disney, IBM, Philip Morris, McDonald’s, Procter and Gamble, the list goes on. And though today we look at some of these as has-beens, they were just coming into their heyday in the early 70s. So these were the FANG stocks of Silicon Valley Tech; darlings of their day and just buy these hold on forever and you’re going to be just fine.
Matt Cochrane 17:30
And specifically, we’re going to look at McDonald’s. So why? Well because McDonald’s franchises most of the restaurants, it’s actually an asset light, fairly high margin business. And before I get going just real quick, what inspired a lot of this was Vitali Catsanelson’s blog, thecontrarianedge.com. And Wandery’s Business wars did a great podcast series on McDonald’s versus Burger King. And the movie “The Founder”. And the all three of those resources really explore McDonald’s early years.
Matt Cochrane 18:00
So the McDonald’s brothers were geniuses as far as setting up the restaurant space for optimal speed and food prep. And they were really the pioneers in that space. And then Ray Kroc came in and bought it from them. And even though that he was a genius at franchising, and even though that relationship ended very badly, it worked out phenomenally well for the restaurant and shareholders. So in the 50s, it was a very, very simple menu, and the fish fillet was introduced in 1963. And that was their first new menu item in nine years. And then in 1968, The Big Mac was introduced. So in the early 70s, we’re still talking about a very young company, it was growing at store count within the US like gangbusters. And, you know, that’s not even counting the huge international opportunity that it would capitalize on in the coming years and decades. So in 1973, McDonald’s revenue was $580 million, which is more than 10 X. They had 10X revenue in the past seven years.
Matt Cochrane 18:56
And you go forward a decade and the revenue was $3.3 billion. So in the next decade, they were they were still going to 6x their revenue. So if you were an investor in 1973, listening to the investor pitch for McDonald’s, you could talk about how fast and great the revenue growth had been at the fast food restaurant, and the projections for that going forward and how great it would do. And guess what: the pitch was right. The company was still going to grow revenue. It was going to grow at 6x its revenue in the next decade.
Matt Cochrane 19:27
But in that decade, from 1973 to 1984, so 11 years, the stock price is annual returns were just 1.75%. And that’s not because the restaurant didn’t execute. It’s not because McDonald’s management made strategic mistakes, just because the valuation was too high. And in 1972, basically too much growth was already priced into the stock at the PE ratio was over 80. Now great companies do come back so McDonald’s returns were lackluster for that decade. But if you were a shareholder for two decades, you saw annual returns clearing 12%. Which that’s not bad at all. So it did eventually grow into its valuation and exceeded.
Matt Cochrane 20:07
But just remember, if you’re buying hold forever kind of investor take a good long hard look at yourself in the mirror, because purchase prices do matter. And while great companies will grow into even lofty valuations, it can be a long slog before you start seeing decent returns if your purchase price was too high.
Simon Erickson 20:27
That’s a great lesson about McDonald’s Matt. It seems like the bottom line for that is the expectations were just a little too high. The company did everything right. But still, too much was baked into the stock price and it turned into what was it? 1% – 2% for returns annually for a decade?
Matt Cochrane 20:40
Yeah, 1.75% for a decade.
Austin Lieberman 20:43
So is that including dividends Matt?
Matt Cochrane 20:46
I don’t know. Honestly, to be honest, I don’t know. I don’t think it paid the dividend back then. I don’t even know.
Austin Lieberman 20:55
I don’t know. But even if it isn’t including dividends…what does that add two or 3%? a year? So still not great. But yeah, that’s interesting. You just, you just made me want to sell all my stocks. Thanks. Thanks, man.
Simon Erickson 21:13
What a great franchise model though. What a great story. Remembering how well they did that. Ray Kroc, like you mentioned. Steve, any comments on McDonald’s?
Steve Symington 21:24
Not specifically. It makes me want to find the next McDonald’s. I feel like there’s other franchises that are promising. And it’s one of those crowded spaces, but it makes me want to dig back into the restaurant space and consider concepts that work. Well. You know, your Chipotle is out there that still have room to grow.
Matt Cochrane 21:50
I was just gonna say, that might have been the next McDonald’s. Might have just happened with Chipotle today.
Steve Symington 21:55
Yeah. Which was incidentally a spin off. It was true. They were owned by McDonald’s they were spun off into their own company. So yeah, there’s been some that have kind of proven to be a bust.
Matt Cochrane 22:10
It’s going to be hard to match that market that McDonald’s was going into. Because it was just a bunch of one offs that McDonald’s was competing against and Burger King did come up. Burger King was on the east coast. And McDonald’s first franchise was in California. But there’s just so much space those two companies could grow into for so long. It’s hard to the restaurant space is definitely not like that now.
Steve Symington 22:37
It’s a different world for them.
Austin Lieberman 22:39
I’m really interested to see. We just got back from the worst RV vacation ever. No it was great [laughs]. Love my family, but I don’t love RVs for vacations.
Austin Lieberman 22:54
Anyways, back on topic, we went to a couple different places. Went to Starbucks and a couple different places along the way. And most of them have their kitchens closed, or nobody’s dining inside. And you either have to order through a mobile app and they’ve got the entire store sectioned off and about a five foot area where you can stand inside the door and wait for your food. This happened at Starbucks. Or you go through drive thru.
Austin Lieberman 23:22
And I’m really interested to see over the next five years, decade, whatever, even in the next year, how the new – call it – “fast casual” or fast food restaurants that are built, how they change physically. Are they going to be smaller storefronts, with just a focus on take out? What Uber Eats or whatever the delivery apps are, and then drive throughs and so are we going to see a smaller footprint with less eating out. Or are they going to continue to build restaurants the same size. It’s just, there’s gonna be a fascinating fascinating time in it. I think the winners are going to be the companies. You know, unfortunately, I think like smaller mom and pop restaurants that don’t have the ability to go digital and do all this delivery and stuff are the ones that are going to get hit the hardest. And then the big chains that can adapt and go digital and do all these delivery things and have the cash flow are going to be the ones that that succeeds. So we might see kind of small businesses, at least in the restaurant space get hurt. Yeah.
Simon Erickson 24:24
Well, and not to mention the franchise versus the company owned model, right? I mean, correct me if I’m wrong, but I believe that Domino’s had that same franchise model that McDonald’s did.Compare that to something like Chipotle or ChikFilA, which is almost all company owned locations.
Simon Erickson 24:38
So they have a lot more control, especially over those levers. Like you just mentioned Austin about efficiency and getting people through their digital orders. Kind of a trade off you go either way for those.
Simon Erickson 24:49
I will throw in one last company for consideration. I’m going to take this in a little different direction than you guys. You know, we’ve talked about pizza and we talked about beer and we talked about junk food. I’m going to talk about yoga.
Simon Erickson 25:01
So I’m going to talk about Lululemon, which I really think is just done a fantastic job at building a consumer brand that is loved. And that’s just a competitive advantage for them for the past decade at least.
Simon Erickson 25:14
For those that have never heard of Lululemon, I’d be surprised if too many people haven’t heard of this company by this point, they’re the largest yoga outfitter out there. They really made a name for themselves with black yoga pants that they were selling 10 years ago for $70 and today for $98. But it’s just this is something that people would see others wearing. And so everyone wanted to wear those same Lululemon pants when they were a yoga classes. There was kind of this social influence of people wanting to buy them.
Simon Erickson 25:44
And Lululemon went all in on this category. It knew that it wanted to be associated with yoga. It wasn’t selling the fabric, it was selling the lifestyle. And that really insulated it from competitors that later joined this space. We saw Under Armour try to do this with yoga. We saw a Gap with Athleta try to do this with with yoga. It didn’t matter because Lululemon was all in. At its locations, its associates of its stores were instructors that were also teaching classes within the locations themselves.
Simon Erickson 26:17
It’s very focused. Very, very high customer satisfaction. And that indeed manifested in very high prices.
Simon Erickson 26:25
And so it’s incredible that this company, for the last decade, has traded with a PE ratio, a price to earnings ratio, of between 40 and 60. For a decade. And this is the market basically saying “we’re going to give you this premium valuation above other clothing retailers out there because you’ve been able to show us you can maintain those premium price points”. Because they’ve got the overall customer satisfaction. They’ve got the lifestyle and they ring true with consumers.
Simon Erickson 26:52
And that’s truly what this “consumer brand” competitive advantage really means to me. This is a perfect example of it right here. And so the stock basically kept its valuation multiple. Increased right alongside with its earnings per share. Earnings per share over the last decade increased six fold. And the stock is a 15 bagger over that same timeframe.
Simon Erickson 27:13
So it’s been incredible to see what Lululemon, a humble retailer of clothing that expanded, went into men’s category it kind of sold out of the things like water bottles and headbands and things like this too, but really got its roots with this yoga movement that it fostered and it put a lot of work behind. Even with the pandemic, where people are not shopping in those bricks and mortar locations during these past couple of months, it counteracted that with a 68% year over year increase in its e-commerce segment. And so the brand is very strong. People are still buying the clothes or doing it online now and they can’t buy them in the stores. And to me, Lululemon is just a company that’s knocked it out of the park with consumer satisfaction. They’ve always called it overvalued because it’s always been at a market premium to its competitors. But it’s been worth it because it’s really been quite a ride for the past decade.
Matt Cochrane 28:08
Is Lululemon, it’s not a fad anymore, right? I mean, it’s just fashion now, right? Is it like Nike? At some point, it wasn’t like a fad where people are dressing in athletic gear. It was just what people wore. And kind of at that spot with Lululemon, right?
Simon Erickson 28:25
I mean, they were saying fad for years, right? They’re saying the same thing about Whole Foods and healthy eating and lifestyle brands and athletic. I mean, it’s kind of something that’s maintained rather than just fizzled away.
Steve Symington 28:35
Yeah, I’ve got an almost 13 year old daughter who loves her Lululemon.
Austin Lieberman 28:48
Simon, they’ve had their their fair share of controversy.
Steve Symington 28:52
I was gonna say founder issues, notwithstanding.
Austin Lieberman 28:54
CEO changes. Yeah, and still overcame them all.
Steve Symington 28:59
Yeah. There were. There are a few times where you kind of cringe at some of the the flubs executive flubs they had along the way but man that brand is proven resilient.
Simon Erickson 29:10
Their founder put his foot in his mouth a couple of times. Austin, he said some things that were definitely not taken well by their consumers. And like you said, there was kind of a revolving door of CEOs there for a little while there.
Simon Erickson 29:21
But did that really matter to the brand that people were associated with? I don’t think so. And that’s why it continued.
Simon Erickson 29:31
And so this is kind of wrapping everything up together. Share your thoughts with us. We’re “@7investing” on Twitter. Leave us a review for our podcast here if you’re listening to it through any of your podcast distribution stations. We’d love to hear what you think info at 7investing.com. What are companies that you think did a fantastic job even when they were expensive and overvalued? We’d love to hear your stories, especially if they’re personal stories, that you held on or even sold like we did, selling several of our favorite companies too.
Simon Erickson 30:04
And so that’s a great look at the past. Let’s transition to the future. Now, let’s take this a step further and say “okay, what is a company that’s on your investing radar today”, that is similarly being called overvalued but you still think it could be an opportunity going forward?
Simon Erickson 30:19
There is no shortage of companies being called overvalued right now. In fact, I think that some people think every company in the market is overvalued right now. But let’s pick out four of them that stand out.
Simon Erickson 30:31
Steve, let’s start with you on this one. And by the way, no restrictions. You can pick a tech company. You can pick any industry you want to for this one. What’s an overvalued company that’s got opportunity?
Steve Symington 30:41
Well, then I’m gonna pick a tech company and I’m gonna go with 2U. And that’s literally the number two the letter U. Ticker “TWOU”.
Steve Symington 30:52
They’re an online education platform company. And I’ve followed 2U for a long time, and actually had the pleasure of interviewing their co founder and CEO Chip Paucek. Shortly after their IPO in 2014, 2U acquired GetSmarter, their short course, non degree specialist and they acquired Trilogy Education. Along the way, they specialize in tech boot camps, so to expand their reach. And 2U actually had some tumult a couple of years ago, when they sort of reset their growth plans. It seemed like some of their some of their smaller university partners, they have 73-75 university partners last I checked. But some of their larger partner universities appeared to be kind of scaling back admissions and the class sizes were smaller than they were initially. So they sort of reset their growth plans a couple of years ago. They’ve really rebounded nicely and they seem to have kind of momentum on their side.
Steve Symington 32:00
If you didn’t already think that the world would eventually shift to more effective solutions for online learning over time, I think the pandemic should only cement the notion that online education is here to stay. And 2U as a first mover and an obvious industry leader in that business, I think has plenty of room to grow from here. I think one of their more recent investor presentations pointed out the global market for higher education is worth about $2.5 trillion. And the online portion of that is just a tiny sliver right now. Still, I believe to us, they’ve got a market cap of about $2.6 billion. Revenue this year is supposed to be just over $700 million. I think $830 million is what consensus estimates next year calls for. But really, I think they’ve just scratched the surface of their longer term growth story that could be really interesting to watch over the next few years. But they’ve rallied pretty hard from their March lows. And there’s going to be no shortage of people calling them very expensive. They’re not profitable. You won’t find forward or trailing PE ratios. They trade at about 4 times sales right now, I think. So they’re gonna look expensive. One of the things about the company, I know with their core business, is that they incur much of the startup costs for the programs that they launch with their university partners in exchange for the lion’s share of the tuition revenue down the road. So it’s something that says as they scale, they should eventually kind of gain steam. But I think it should be really, really fun to watch the company grow over the next several years. Kind of see where they go from here. But I suspect 10 years from now they’re going to be a whole lot bigger than $2.6 or $2.7 billion business.
Simon Erickson 33:56
Good one Steve. Yep. 2U, what a tailwind right now. It’s gonna be interesting to see what happens with education as a whole during these next couple of months.
Simon Erickson 34:04
Austin Lieberman, how about you? What’s the company that’s on your radar right now, that’s overvalued?
Austin Lieberman 34:10
I am going to a company that I own, which is something I like to do when we talk about things in public, but also for our 7investing recommendations just because I believe in skin in the game. And so this is a small little fitness company called Peloton Interactive. They’re centered around empowering people to improve their lives through fitness. Their core products, which again, most people are familiar with are a stationary bike, a treadmill, and a digital app that allows users to stream workout classes through a subscription service. So none of that is a new invention, right? Treadmills have been around for millions of years. Just kidding, probably not millions of years but for a long time. Stationary bikes have been around for a long time. There’s tons of different brands and workout subscriptions have been around for a really long time.
Austin Lieberman 35:09
And so since Peloton came public there’s been even before there’s been doubt around their business model and their competitive advantage. And the reason I own shares is because the results have been outstanding. Even before COVID, which I’ll get into those results in a minute, when I think about Peloton, I think about what Simon you talked about Lululemon and a clothing company that is seen as a premium brand and has had a premium valuation for more than a decade. Peloton fits a very similar mold, with probably a pretty similar customer base as well.
Austin Lieberman 35:54
So I think it could have a future very similar to that of Lulu. And what I think they’re doing that people are undervaluing and that the market is still misunderstanding, which is why I think this is a great opportunity, is they’re building community behind it. And so it’s really the first fitness or “connected fitness” brand that I think has solved that issue of making this a community based experience. And so I see people out on Twitter all the time, talking about doing rides with their friends, and there’s leaderboards and all kinds of competitions. And you can hold your friends accountable and see different scoreboards and all kinds of things and so all of that kind of gamifies it and that’s going to give the brand staying power.
Austin Lieberman 36:46
And then you know, their model basically, I think you can either pay outright or you can basically just finance your bike or treadmill over time, and it ends up being around $100 a month. For that you’re paying off your bike, but you’re also paying for your fitness subscription, which gives you all of the live classes and stuff. And once people get that and they pay off their bike, their bill is going to go down a little bit, and they’re going to be paying less but still getting access to all the fitness classes. So I think it’s a very sticky model.
Austin Lieberman 37:18
The other thing, I think a growth catalyst moving forward. And the company I was at before I was let go, due to Coronavirus, we actually had a fitness stipend and employees that the company could charge 100 bucks a month towards their fitness and a lot of employees ordered Peloton bikes and paid for it with their fitness stipend. And so when we think about the way that work has changed, and I believe work has changed forever to where we’re always going to have some type of hybrid model, because this isn’t the first Coronavirus. It’s not the first pandemic. It’s not going to be the last and then other things are going to happen and businesses aren’t going to be able to say “Oh, this caught us off guard, we didn’t have a plan to go remote or hybrid.”
Austin Lieberman 38:03
So I think this is we’re in the future right now. I can expect I only see more businesses trying to take care of their employees as they need less office space and more people working from home. It’s actually a lot cheaper to pay 100 bucks a month for an employee to have a fitness stipend and take care of themselves and stay mentally well and physically well, then to have these massive offices in tech centers like Silicon Valley and Manhattan in New York City that they used to have. So I think that’s a catalyst as well. And then real quick, just jumping into the numbers. Third quarter highlights for the company. These came out on May 6, so remember that date may 6. The connected fitness subscribers grew 94% to over 886,000 In 100, and paid digital subscribers grew 64% to over 176,000.
Austin Lieberman 39:10
So 886,000 connected fitness subscribers, those aren’t all paid. Their actual paid digital subscribers grew 64% to 176,000. And their total members grew to over 2.6 million. Total revenue grew 66% to $524.6 million. Their workouts were up. And this was after a couple weeks of COVID. Obviously, in this quarter their workouts were up, their engagement was up people were averaging 17.7 monthly workouts per connected fitness subscriber versus 13.9 in the same period the previous year. So that was up nicely.
Austin Lieberman 39:55
Their guidance, and so this is where this date is important – this May 6 date, there, they guided for the full year of 2020 to 1.04 to 1.05 million connected fitness subscribers, which was 104% growth. And they guided for revenue growth, total revenue growth, or total revenue to be $1.72 billion, which was a 89% growth at the midpoint. Well, then on May 12, I think it was so this is six days after they reported those earnings and the number we’re paying attention to is their guidance for 1.04 million connected fitness subscribers. Six days later, they announced that they crossed the 1 million connected fitness subscriber mark. And so they’re about 70% of the way to the high end of their guide, and they’re less than halfway through their current quarter.
Austin Lieberman 41:01
And so what that means is that the trend that started early and was only a small part of that quarter that they just reported their third quarter actually intensified and surpassed the company’s own projections and own estimations. Now they’re kind of caught up and they did a live update on May 12. And they’re far surpassing their their estimations for connected fitness subscribers. Which is basically then, all of the rest of the numbers kind of build off of that. And so, the momentum is strong. It’s a strong business model. I think people it’s expensive, I think. But I think people are underestimating it and it’s currently sitting at a forward price to sales ratio of 4.9 growing revenue at 65%.
Simon Erickson 41:55
Good good company with Peloton there. Like you mentioned, it’s a connected fitness opportunity that many people are just thinking it’s a it’s a bike company.
Austin Lieberman 42:03
I think Matt’s favorite company. Matt, do you have any thoughts about Peloton and it being a value play?
Matt Cochrane 42:15
I mean, I guess I just wonder what its total addressable market is? It’s definitely a premium product, which I know can do well. It’s still, as a consumer the price tag on it seems a little daunting, if you ask me. But maybe not.
Simon Erickson 42:34
That’s the point Matt. Overvalued! [laughs]
Simon Erickson 42:40
How about you Matt? What is your overvalued company right now that you’re looking at?
Matt Cochrane 42:43
So I’m gonna say Microsoft. And so not only you know, you can look at the PE ratio is 35. But the market cap on it is $1.5 trillion dollars. So there’s all a lot of people who just say because of its size alone, it can’t grow too much more. But just reported earnings this week, or last week, and just growing real quick.
Matt Cochrane 43:07
I mean, it’s in so many areas that are growing. I think this company has a lot more room to go. So office 365, commercial revenue growth this last quarter was 19%. Office 365 consumers subscribers are now almost 43 million. LinkedIn revenue increased 10%. Microsoft Dynamics, which is like their commerce and CRM software, Dynamics 365 the revenue growth 38%. The server products and cloud services revenue rose 19%, which was driven by Azure. Which as big as it is, Azure grew by 47% this quarter. And they said it was actually hurt. These numbers were actually hurt by COVID. Windows OEM revenue, it was up 7%. You know, that’s a boring business, but it’s super high margin. It’s growing by 7%. And Xbox content and services, that was up 65%. I mean, gaming is just knocking it out of the park. And I know I don’t have the Minecraft numbers in front of me, but I know Minecraft engagement was up to that’s a franchisee about years ago and hardly anyone talks about anymore. But it’s still a huge, huge gaming franchise. Surface revenue was up 28%.
Matt Cochrane 44:24
So all I would say is that, this is a large company. On any given day, it’s one of the three largest companies in the world. Between Apple and Amazon and Microsoft. And its PE ratio is definitely high. It’s 35. Its forward PE ratio is still above 30. But I think it’s always room to grow.
Simon Erickson 44:48
It is amazing Matt, how large that company is and yet how well it has shifted gears and changed directions and added product lines like you’ve mentioned. And then also maintained those enterprise relationships as it’s transitioned in the cloud. I think it’s done a fantastic job with that. You think that investors are still underestimating Microsoft?
Matt Cochrane 45:09
Austin might say that the company’s too large to grow too much. But I think there’s going to be a first $2 trillion company. And in a few years, there’s going to be a first $5 trillion company. And I think Microsoft will be in the running. Would it really shock anyone? If I said in 10 years, Microsoft is going to be a $5 trillion company, it wouldn’t shock me. So I just think the spaces that it’s in, with AI and big data and the cloud, I just think it’s one of the few cloud infrastructure plays that still has lots of room to grow.
Austin Lieberman 45:57
Matt, quick question: Our friend Puru actually kind of pointed this out in a tweet, that point about Azure slowing down. 59% year over year growth in Q1 20, down to 47% in Q2. And what Puru pointed out was that the CEO actually said that COVID-19 has turbocharged digitalization. But then, a quarter later we saw Azure growth slow. Is that concerning to you at all? Or what are your thoughts on that?
Matt Cochrane 46:25
I would say in the first quarter, they said we’re just seeing incredible digital digitization growth. But right now, there’s a lot of economic uncertainty and until that passes, you’re gonna have companies putting off large decisions that cost money, you know? Until they have more clarity on how their business is going to do. And that goes for small companies, but also goes for large companies. To me, a little revenue and growth was pulled forward. It was 59% in the first quarter and “only” 47% this quarter. That’s not too concerning for me.
Simon Erickson 47:08
That’s a good one. Matt. I’ll bring us home here with the company that is on my radar right now that I think is overvalued, that a lot of people are missing the bigger picture. It is Veeva Systems. And the ticker on that is VEEV. Funny name, but serious company.
Simon Erickson 47:21
It’s a cloud based software company that’s helping Life Sciences companies either either produce or sell their pharmaceutical drugs. And so it kind of started as a company that was helping them get through clinical trials. A lot of that was just being done on paper submissions. It brought everything to the cloud, made everything much more efficient. Of course, that’s where pharmaceutical companies have the majority of their costs: in developing drugs and getting them to commercialize. And then once they do commercialize, they want to track those. Want to see how they’re doing and how they’re selling at different doctors offices. And so they’ve got a CRM product – that’s called now Veeva Commercial Cloud. This is just a company that has executed very well since day one. You hear about all these software companies, all of these cloud companies that are extremely unprofitable and burning through cash. Veeva was basically profitable since it IPO, in terms of operating profits. It’s now got a 35% operating cash flow margin that is growing at 46% per year. And when you think about how strong that is, in addition to the revenue growth, subscription revenue growth of 36% a year.
Simon Erickson 48:26
This is a company that listens very well to its customers. It’s providing a lot of value. It’s continued to add on products to those large pharmaceutical company offerings that it already has. And it’s just been rewarded with solid top line growth and then very profitable cash from operations that come. That it brings in and just puts it right back into R&D.
Simon Erickson 48:46
And this is one of those that along the entire way people have said “No, it’s too expensive.” It was not a large enough addressable market, wasn’t growing fast enough to be a cloud based companies. All these things that Veeva just kind of scoffed at and said, “Hey, we’re going to put our head down. We’re going to focus on listening to our customers and provide them with solutions that are valuable.”
Simon Erickson 49:04
And it’s been rewarded because the stock continues to go up. And it’s continuing growing. One of its products it developed just several years ago, Veeva Vault, is now 50% of revenue. And so, you can kind of see how something that was small that can be an R&D project from listening to its customers, can grow into something much, much larger. So Veeva Systems is my company that I still think has got plenty of opportunity. Even as people have said it’s overvalued, the whole way up.
Austin Lieberman 49:31
And it’s built on the Salesforce platform, right? I’m not super familiar with this, but I know they have a very deep partnership. Is that at all a risk for Veeva in your eyes? Or is it almost a strength, because they’re they’re such great partners?
Simon Erickson 49:45
They’re very strong partners. It’s very much a benefit, not a risk. And that’s because Peter Gassner of Veeva came from Salesforce. He was VP of Salesforce. Before he started Veeva, he made sure that he locked it down and made non-compete clauses with Salesforce. He designed much of the Salesforce CRM platform. And so they loved him there, and they were really excited to work with him as his infrastructure provider for Veeva. I think that’s a huge opportunity. I don’t think that’s a risk actually.
Matt Cochrane 50:17
They’re really kind of too specialized for a company like Salesforce or Microsoft too, to try to usurp right? I mean, they’re in such a specialized market that larger software companies like Salesforce or Microsoft, they’re not going to try to get into that.
Simon Erickson 50:37
Healthcare is a massive market that is underestimated, I think, by many people. There’s just so much opportunity for personalized medicine right now. You hear a lot about CRISPR. You hear about CAR-T. You hear about all these kind of personalized therapies, and even gene edited opportunities that this is something that’s going to require a lot more work. And I think that maybe that is true, Matt. That Salesforce doesn’t have an interest in this anyways.
Simon Erickson 51:03
But I think that in the grander scheme of things, the US is spending $3 trillion a year on health care. A lot of that is through prescription drugs. And I think this is going to be something that we’re going to be talking about for at least the next decade, if not more than that. Cloud-based growth in life sciences.
Austin Lieberman 51:21
I was thinking more not from competition, but more on I think they’ve got to renew their agreement in 2025 or something. If Salesforce were to hike fees or something like that, or probably not going to happen. But if anything happened to Salesforce platform since since Veeva relies solely on Salesforce, we see a lot of companies not want to build on a single cloud vendor like only AWS or only Azure. So they use, you know, two or three of them. That was kind of what I was thinking about, about a potential risk to Veeva.
Simon Erickson 51:55
Steve Symington 51:56
Yeah, we could also turn them into a potential acquisition candidate. The market’s big enough. They’d be like, “well, this makes sense.” You know, you rely on us.
Simon Erickson 52:07
We know that Salesforce likes to make acquisitions out there. So that would probably fit nicely.
Simon Erickson 52:12
So there’s four companies for your radar. Again, Austin mentioned Peloton, Steve mentioned 2U, I just mentioned Veeva Systems, and Matt mentioned Microsoft.
Simon Erickson 52:20
Just to close out our podcast. Earlier in the podcast, Steve was mentioning the American Customer Satisfaction Index, which kind of measures how happy people are with different industries overall. And he mentioned breweries. Breweries was the highest rated industry in terms of customer satisfaction.
Simon Erickson 52:40
To close out the podcast, would you gentlemen like to guess what the lowest rated industry is for customer satisfaction?
Austin Lieberman 52:47
Matt Cochrane 52:51
Steve Symington 52:54
Simon Erickson 52:57
So number one was “Subscription Television.” “Internet Service Providers” was the second worst. So you nailed them.
Simon Erickson 53:09
The companies with low customer service scores, obviously people don’t like sitting on hold waiting for your cable TV or your internet to come back online. Almost kind of the opposite of so many of the companies we talked about that have really high customer satisfaction scores, here today.
Austin Lieberman 53:24
Hey, Simon, this is coming out on Thursday. Don’t we have some some recommendations coming out soon?
Simon Erickson 53:34
We do! We’re going to have our new recommendations come out on Saturday, August 1st. Which like you just said Austin, conveniently two days after this podcast. So come check out 7investing.com to see our latest picks.
Austin Lieberman 53:49
And if you don’t get in before the first, it’s not too late. These are designed to be picked for multiple, multiple years. So come check us out.
Simon Erickson 53:58
Absolutely. Thank you for the reminder on that. One again, Steve Symington, Austin Lieberman, and Matt Cochrane. And my name is Simon Erickson. Again, we are your team here at 7investing. You can check out our site: 7investing.com.
Simon Erickson 54:12
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