Motley Fool senior analysts Andy Cross and Ron Gross discuss:
- Wholesale prices rising higher than expected.
- Costco's surprisingly disappointing quarter.
- DocuSign ending the year on a positive note.
- Casey's General Stores hitting an all-time high thanks in part to beer cheese pizza.
- The latest from Lululemon, RH, Campbell Soup, and Chewy.
Rachel Warren talks with Jay Jacobs from BlackRock about megatrends to watch in healthcare, infrastructure, and electric vehicles.
Andy and Ron discuss the FTC suing Microsoft over its proposed acquisition of Activision Blizzard and share two stocks on their radar: Stanley Black & Decker and Houlihan Lokey.
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 Dec. 09, 2022.
Chris Hill: Microsoft's battle for Activision Blizzard is moving to a federal courtroom. Motley Fool Money starts now.
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It's the Motley Fool Money radio show. I'm Chris Hill. Joining me in studio Motley Fool Senior Analysts Ron Gross and Andy Cross. Good to see you as always gentlemen.
Andy Cross: Hey, Chris.
Ron Gross: How're you doing, Chris?
Chris Hill: We've got the latest headlines from Wall Street, including the FTC suing to block Microsoft's acquisition of Activision Blizzard. As always, we've got a couple of stocks on our radar.
But we begin once again with the big macro. Wholesale prices rose 0.3% in November, higher than economists were expecting. Friday's Producer Price Index report capped a down week for investors, and, Andy, we had been getting some signs that inflation was cooling off, and you see some of that reflected in this report, but you also see the cost of food continuing to rise.
Andy Cross: Yeah, Chris, you actually see a lot of it in this report. The producer prices, which are suppliers that charge businesses and other customers before they get to the end customers like us, over the past year, those prices were up 7.4%. That's the lowest in 18 months. It was down from 8.1% in October. Again, year over year, the 0.3% number is November versus just the October before that. Down 8.1% for October, year over year, 8.2% in September, year over year, and 8.7% in August.
If you look at the numbers, it basically has trended down pretty consistently, year over year, for the past few months. Those prices are moving down from the 11.7% we had, the record we had in March since they started tracking these numbers in 2010.
You saw the core numbers at the lowest of the year, that strips out the energy and food prices, you mentioned food prices are still increasing a lot, but it's still coming down. We're seeing the trend. I see this, the trend is our friend in this number.
But obviously, it's still, inflation is a challenge. I don't think this is going to necessarily change any direction the Fed may have for later this month. I think that number is pretty much baked in to go maybe probably 50 basis points now they're increasing.
But we are starting to see these shifts, the good numbers continue to come down. We're seeing a lot in costs and services, including in cost and financial services like brokerage services, investment advice, the jump in that area contributed one-third of the increases in the services. I'm just thank goodness this podcast right here for Motley Fool Money is basically free.
Ron Gross: I think the silver lining is that folks are eating their vegetables, because vegetable prices are up 38% and that's a pretty big number that probably will not be sustained in the future. I think that that is a one-time, maybe two-time artificially high number that will help inflation to moderate.
But I think what Andy said is right. The trend is good, but this is going to be a slog. We're not getting out of this overnight. I don't think anyone is, certainly not the Fed. Market is not cheap yet, from a multiple, price-to-earnings multiple perspective, but we're getting cheaper. Listen, I just wanted a Santa Claus rally and some modest appreciation for 2023, can I get a little something?
Chris Hill: I think we all want that, but I go back to what you said at the start there. It's going to be a slog, and increasingly, it feels that way.
Ron Gross: Yeah, I just think it's going to be this continued range of volatility. It's going to be more and more volatile. It's going to be more of a stock pickers market, I think, that benefits those of us who love investing in businesses, we're going to find prices attractive at certain points that we'll be able to buy, thinking about holding those businesses for the next five years. But over the next, 12 to 18 months, we're just going to continue to be in this volatile, uncertain moment that investors have to learn to live with.
Chris Hill: Inflation has some people cutting back on spending, and that affected Costco's first-quarter results. Profit and revenue came in lower than expected, and Costco's operating expenses are also ticking up a bit, Ron.
Ron Gross: A relatively weak corridor from one of my favorite companies. But maybe shouldn't be surprised on the heels of a worse-than-expected November sales report. Total company same-store sales were up 6.6%. Not too bad, but that's a pretty big deceleration from last year's 15% increase. I don't think anyone thought that number was sustainable, but we're seeing certainly a deceleration. U.S. comp sales up 9.3%, Canada up 2.4%, but all other international locations minus 3.1%.
For me, a surprise for us to see e-commerce down 3.7%. The weakness there was due to high-single-digit declines in consumer electronics and appliances. I don't think I would have necessarily guessed seeing e-commerce down that much, maybe a little bit of weakness. That was a surprise.
Traffic was up, average transaction size was up. Those both metrics are still moving in the same direction. Membership fee income was up almost 6%. There's still plenty of good news, especially in things like retention rates, 92.5% in the U.S.
The company is still getting the done, and the business model is very strong. It's not putting up the numbers that had been putting up and this stock is never cheap, we say it all the time, it's over 30 times earnings. But you can't support that multiple with numbers like this. The company is going to have to get a little bit back in some more growth mode there, especially, I think, in e-commerce.
Chris Hill: Third-quarter profits in revenue for Lululemon came in higher than expected. But guidance for the holiday quarter was lower than Wall Street was hoping to see, and shares of Lululemon down 12% on Friday. Is that an overreaction, Andy? I know it's not a cheap stock, but the guidance wasn't lowered that much on a percentage basis.
Andy Cross: I don't think it's necessarily the guidance, Chris. I look at what is happening with the cash flows for Lululemon, and that's what really stood out for me for this report, because their sales were up 28%. That beat the guidance. Their earnings per share were $2 versus $1.62, that's up 23%, that beat their own guidance. Then their guidance looking forward was somewhat muted, maybe even a little conservative.
But for me, it was really what's happening on the inventories, we've talked about this as retailers, their inventories were up pretty dramatically, just for the year to date. For the last nine months, inventories have taken out $832 million of cash flow for Lululemon versus this $289 million for the same period ago. Capex is up 62% versus a year ago. While the business continues to do well, comps were up 22%. The direct-to-consumer was up 31%. The direct-to-consumer sales as one thing, they continue to go directly to the consumers, that now represents 41% of sales versus 40%.
There isn't benefit on gross profit. They don't do a lot of markdowns, a little markdowns, or maybe a little bit higher. They're very careful on pricing. But for me, this is really thinking about the cash flow. Their cash on the balance sheet fell to $353 million versus $994 million a year ago.
Chris Hill: In terms of moving the inventory, isn't that a fine line they have to walk there? Because as you said, they're very good about pricing. They start dropping their prices, that could move the inventory.
Andy Cross: Well, definitely and their inventories were up 85% versus the same period a year ago and up 38% if you look at it over a three-year period. Tut they did that on purpose because they thought they were to lean last year. It's a strategic decision to build up those inventories, and they're expecting their inventories to increase about 60% next quarter. They are continuing to stock their own warehouse shelves, but that's a cost for investments.
Now, I think the business is doing still pretty well. It's actually priced at around 32 times next year's earnings. For a company that can grow like that, it's not too inexpensive.
Chris Hill: RH had a little something for everyone this week. Third-quarter profits in revenue for the company formerly known as Restoration Hardware came in higher than expected. But management said weakness in the housing market will adversely affect the business in 2023. What do you think, Ron?
Ron Gross: I thought the report was relatively weak. The shares are down a whopping 57% from the 52 week high. But that's after having a pretty stellar performance for years and years. But the report left some things to be desired. Revenue was down 14%, gross margins narrowed by half a percentage point. That was primarily due to fixed occupancy costs, revenue gets weak so you de-leverage from expense perspective. Operating margins were down 6.9 percentage points. That's a huge number, and it's primarily as a result of investments in RH Contemporary, RH Guesthouse, RH International, and the rollout of RH in Your Home.
I RH Personally think they're doing too much and they better calm down and stick to their knitting, I think a little bit, get the business back in growth mode. Adjustd earnings down 19%, as you said, management sees some continued weakness on the horizon. They characterize these results as better than expected. That's putting a nice silver lining on it. I think they have some work to do just to get the business back into growth mode.
Chris Hill: You wouldn't know it from the overall market, but two stocks hit new highs this week. Details after the break, so stay right here. You're listening to Motley Fool Money.
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Chris Hill: Welcome back to Motley Fool Money. Chris Hill here in studio with Andy Cross and Ron Gross.
After a rough 2022, DocuSign appears to be ending the year on a positive note. Third-quarter results for the electronic signature company came in better than expected. Shares of DocuSign up 13% on Friday. But, Andy, expectations, they couldn't have been that high, right?
Andy Cross: Well, they were fairly low, but reasonably means still they grew 18%. That beat revenues by 18% to $646 million, that beat by $18 million. But this is really a story of Allan Thygesen, the new CEO they brought in after Dan Springer left. Starting his career off right, just setting the expectations and with a fairly nice quarter earnings per share of $0.57. That was down a little bit from last quarter but a beat by $0.15, Chris.
Subscription revenues, that's the big bulk of DocuSign's business. Those revenues were up 18%. Their non-GAAP gross margin was 83% versus 82% a year ago. They're making some progress on the cost side. Dollar retention was 108%, but that was down from 121%.
I guess from the expectations for DocuSign, there wasn't a lot for this quarter, I think, as long as it didn't get too worse and their guidance is reasonably still fairly low relative to what they were a year ago. I mean, they guided revenue growth for the quarter at 10% growth versus 35% a year ago. They are really trying.
Allan Thygesen is getting on board, meeting with a lot of clients, thinking through the product strategy, and trying to find out where DocuSign is, what they need to set it up, and we think forward for DocuSign at $50 stock price-to-sales less than 4 times, forward earnings about 25 times, and they generate a lot of free cash flow.
If you add back the stock compensation, it's actually you can start to build the valuation case. It's not going to be the massive grower, it was during COVID, Allan talked about that on the call. Probably more of like single high digits revenue side and might get some profit growth and you can start to build the case. DocuSign might actually be turning this around.
Chris Hill: It's a $10 billion company. Do you think another company would build the valuation case for just buying DocuSign?
Andy Cross: Yeah, they might. It's interesting. Like Adobe wouldn't because they'd probably be huge regulatory concerns. But would Microsoft go in or Google or Alphabet? They have their own solution, but they are a small part of their business so you might start to see a little bit of that. But I think we're thinking about document management and life cycle management. Allan's looking ahead and he and his team start to see there's more value to get from DocuSign clients, which continue to grow, than they're getting right now.
Chris Hill: Microsoft's got their own regulatory concerns at the moment. We'll get to that later in the show.
But let's go to Campbell Soup. Shares hit a five-year high this week after first-quarter results reflected steady improvements in the company's supply chain. Campbell Soup also exercising a little bit of pricing power, Ron.
Ron Gross: Yeah, three times during the past year, they were able to raise prices. Campbell's soup is good food, it turns out. It's a pretty successful turnaround engineered by CEO Mark Clouse, who joined the company in January 2019, and some of the things he's done, he redesigned the can labels, he took away some out-of-favor ingredients like high-fructose corn syrup. He introduced a new line of spicy soup under the Chunky brand, which has been successful, a marketing campaign named it young men through social media, football, celebrities, and Madden video games, and really seems to have paid off.
Sales were up 15% this quarter, better than expected, as you mentioned, really driven by higher prices. They do have that pricing power, which is nice to see for them. Not necessarily for the consumer, but for them. Gross margin's down just a bit, but earnings up 19%. That's pretty impressive for a soup company, so they were able to raise outlook for the fiscal year in light of these results and improvements in the supply chain, as you said, and if things look like they're moving along full steam ahead.
Chris Hill: Chewy surprised Wall Street with a profit in the third quarter. The pet products retailer also raised fiscal-year revenue guidance, and shares of Chewy up 7% on Friday, Andy.
Andy Cross: Yeah, an impressive profitable quarter boosted the guidance, like you said, ended with 20.5 million active customers, up 30,000 gross customers adds up 6% from the previous quarter. Customer attrition stable from the COVID period. Of course, many of us who shopped at Chewy's got to know Chewy's jumped in during the COVID, so they are still dealing with that. Revenue's up 14.5%. EPS profitable at a penny versus -8% estimate, gross margin up 200 basis points, 28.4% versus 26%.
Some really nice operational performance you're starting to see from Chewy, especially, Chris, on their fulfillment network. They spent a lot of money, and they are building that out and that is, I think becoming an advantage for them. They have a greater fulfillment network, drove 120 basis points of improvement of operating leverage. Their cost per order fell. They're seeing the investments they're making is starting to pay off, not just with customer retention but also with the profitability. I think it really speaks well for the initiatives they are putting forward at Chewy.
Chris Hill: Yeah, I don't know anyone who is a Chewy shopper who isn't pleased with the experience. But at some point, does retention need to not take a backseat to acquisition, but at some point, does the company needs to prioritize new-customer acquisition?
Andy Cross: Well, I think it's still they have such a loyal customer base, and if you think about so much of their business, more than 70% is tied to Autoship, and a lot of it is tied to the goods like food and healthcare, the they really non-discretionary goods. That's a real loyalty base. Now they do spend and continue to try to attract customers, and that's a big part of their business too. But I think really, the continuing to serve that core member is going to be the key value driver for Chewy and for shareholders going forward.
Chris Hill: Casey's General Stores is the third-largest convenience store chain in America, and we can talk about these strong profits and revenue in their second-quarter results, Ron, and we can talk about the role their beer cheese pizza played in those results. We should probably talk about the fact that shares of Casey's General Stores are up nearly 25% this year.
Ron Gross: Trading at their all-time high. It's very rare in this market environment. You can talk about that for a company. That is very impressive, as is this report. Very strong despite some light revenue versus expectations, but still pretty good, up 22% on the top line. Inside same-store sales up almost 8%, inside gross profit almost 9%, driven by prepared foods, dispensed beverages, pizza, as you mentioned, fountain sales, all very strong. Alcoholic and nonalcoholic beverages were strong. Same-store fuel gallons, the outside business, were just up slightly, but fuel gross profit was up 23% on additional profit per gallon for the company during the quarter.
That helped lead to diluted-earnings-per-share number up a strong 42%. That is a number you don't see very often in this business and it allowed them to raise guidance. They expect same-store sales inside to be approximately 5% to 7%. They expect operating expenses to be at the low end of their range, which is about a 9% to 10% increase.
Things look very, very strong for Casey. They have a little more than 2,400 stores, and they should be able to continue to open new ones at a fairly good clip. We're not at saturation yet. Stock is not cheap at 25 times for a convenience store, but they really are doing quite well.
Chris Hill: I'm not a beer drinker, but why is beer cheese pizza not more widely available? I'm hundreds of miles from a Casey's General Store. How are we not seeing more of this?
Ron Gross: We will have to go on a road trip. Interestingly, cheese was one of the highest-priced goods that you ate into their margins that they had to deal with and they were able to exhibit some pricing power to offset that. But it turns out cheese is expensive.
Chris Hill: Could've put more beer in it. Ron Gross, Andy Cross, guys, we will see you a little bit later in the show. But up next, a conversation with one of the top investors at BlackRock, so stay right here. You're listening to Motley Fool Money.
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Welcome back to Motley Fool Money. I'm Chris Hill. Jay Jacobs is the U.S. Head of Thematics and Active Equity ETFs at BlackRock, a $100 billion investment firm. Rachel Warren caught up with Jacobs to get his thoughts on megatrends for investors to watch in healthcare, infrastructure, and electric vehicles.
Rachel Warren: You just released BlackRock's 2023 outlook for thematics entitled "Rethink Growth." Maybe just start today's discussion off, can you provide us with an overview of the biggest trends that you see shaping the market in 2023 and beyond?
Jay Jacobs: Sure. Well, I think a lot of investors are looking forward to 2023 after the year that we've had, which has left no asset class unscathed, from equities to fixed income within equities. In particular, we've seen a sell-off in growth, so a lot of investors have been asking us, when is the right time to get back into growth? We've seen a sell-off. Is the time now, is it later?
The reality is with the macro situation today, we don't think it's a question of on or off with growth. We think it's about getting much more refined about one's exposures within the growth segment.
One of the reasons behind this is if you look at the last three years or so, growth has had a very high correlation to itself. Meaning if you look at the stocks within growth, they tend to trade up in the second half of 2020 through 2021, and they've all tended to trade down significantly in 2022.
That's actually unusual. Usually, you expect to see more divergence where some growth stocks do well and some don't. We believe 2023 will be more of that story, whereas we don't see, major Fed moves, either massive rate cutting or massive rate hiking, but more of a tapered approach. We think that's going to lead to more dispersion.
Investors will need to get more targeted with their growth exposure to really isolate the opportunities and not only benefit from long-term tailwinds but also can really thrive in a difficult economic environment.
Rachel Warren: The report touched upon some really fascinating key themes, and I want to dig into three of these themes a bit more. One of the things the report pointed out was one of the trends that investors will be witnessing more in 2023: beneficiaries of fiscal spending and other areas of healthcare innovation and a third: countercyclical segments of the technology sector.
These are three themes, tailwinds that are going to be really impacting the markets in general. I'd love if you could dive into each of those a bit more and then also, how can long-term investors who are ideally focusing their capital on companies for a minimum of three to five years, how can we draw from these themes to make appropriate asset allocation decisions?
Jay Jacobs: As I was saying, around with the need to balance long-term growth opportunities with near-term economic resilience. That is really the key overarching theme here. When we look at the opportunity within growth, it's not so much about chasing the biggest, growthiest, most disruptive idea anymore. It's about what is a technology or what is a theme that already has powerful tailwinds behind it and is sustainable in the sense that it's generating profit.
There's people who are using this technology. It is already enjoying some level of adoption because this is not the environment where we think companies are going to be taking on a lot of risks to develop the next revolutionary product. Instead, it's one of the products we have today. How do we make incremental improvement and how do we get more adoption and monetize it better within our customer base?
That's happening in infrastructure where we have government really driving a lot of investment in areas like US infrastructure, clean energy and even electric vehicles and transportation. It's happening in healthcare, where we see a long pipeline of revolutionary pharmaceutical drugs finally reaching maturity. They're going to go from the R&D phase hopefully into being sold and commercialized.
Then finally, it's happening within technology itself. There's companies in robotics, there's companies in cybersecurity that are not massive disrupters, but they are staples, and this type of economy where people are looking for automation to get more efficient or looking to service cybersecurity to provide a level of digital security in their corporate world.
Rachel Warren: One of the things I'm getting from what you're saying here, which I think is fascinating, is there has been this idea among investors for many years, especially when growth stocks were rising at such a rapid clip. You're looking for the next big thing. What you're saying is very much searching for those stable trends that are going to drive steady growth over the next year, and it doesn't necessarily mean looking for huge disrupters or super-high-growth businesses but looking for where those durable tailwinds are, is that right?
Jay Jacobs: Yeah. We love disruption, we love moonshot ideas, we love technological advancements, but we think that part of the technology ecosystem is likely to slow down. It makes sense with the macro environment.
When interest rates are very low, it's cheap for companies to borrow. Valuations are high, so companies want to grow because every dollar they bring in in revenue has a multiplier effect on their valuations, but that's not the case anymore. Money is a scarce resource again, so where are they going to channel their spending? They're innovators, and just generally where our government's consumers and businesses going to spend their money?
It's just a more restrained environment, and that makes us believe that on the continuum of technological advancement, the opportunities are a little bit more in the "where can money be made today profitably" rather than "what are the technologies 10 years from now?" It could shift. If we end up in a falling rate environment at some point, we're not expecting that anytime soon, but if you end up in that environment, you could see the pendulum shift again back toward those moonshots, but that's not where we are today.
Rachel Warren: There was another section from the report that really stuck out to me, and I quote,
We do not believe heightened growth stock correlations are likely to persist. We anticipate a reversion back to historical norms. Given that recent developments from the end of central banks, easy money policies to the beginning of a multiyear deglobalization trend may contribute to greater economic uncertainty and market volatility.
End quote.
One of the things as well the report also notes that growth and tech stocks may be undervalued relative to recent valuations. I think this is something that interests a lot of investors and our audience. We have a lot of growth-oriented investors, and this is obviously stocks that fit into this type of profile has been heavily depressed across sectors in recent months.
I'm curious to hear your thoughts here on that section, but also, how is this impacting how you invest in growth-oriented businesses moving forward?
Jay Jacobs: Well look, again, it comes down to that finding the right opportunities and growth. It is not growth at all costs anymore. It just simply can't exist in a rising-interest-rate environment where growth is expensive. It's expensive to fund new ideas. But go back to a few years ago, l used to get these offers in the mail all the time for $200 off a box of some subscription food service. That's a couple of weeks of food, and they were giving it to people for free because there were so driven by "how do we grow our consumer base so quickly?" Money was so easily available to these high-growth companies.
That's just not where we are anymore, so it's not really about "how do we get a new consumer base and how do we grow that as fast as possible?" It's "how do we leverage what we already have? How do we take technology that already exists and get it in some more people's hands?"
Really, at the macro level, we think that it just, it creates a little bit more of a restrained growth environment. There are absolutely opportunities out there. In fact, with the lower valuations, we think there could be some great opportunities out there, but it's not just about "what is the new technology people aren't talking about yet?" It's "what are the technologies today that have a lot of potential that are still in their adoption phase?"
Rachel Warren: That leads me to another question as well. What are your thoughts on how we, as investors, we can survey companies operating in this current environment? What are some things to look for to identify those quality companies that are just trading down in a volatile market from those that maybe don't actually have the underlying tailwinds to drive future growth?
Jay Jacobs: I think one of the questions we have to ask ourselves is, where's the revenue coming from in these companies, and how resilient is that revenue in what could be a challenging economic environment in 2023?
One of the themes that we write about in this piece is infrastructure as well as clean energy. These are both powerful themes. You can look at the American Society of Civil Engineers gives the U.S. a C-minus rating in infrastructure. You can look at the growth that's happening in clean energy and how fast we've added solar and wind to the grid. But the reality is what makes these themes exciting in this economic environment is how much is being funded by the federal government.
I would feel a lot more concerned about those technologies if they were entirely dependent on consumer discretionary spending or corporate discretionary spending because there's going to be less discretionary dollars if we enter into a flat or declining economy next year.
But the government provides some level of stability in those cash flows. We look at something like the Inflation Reduction Act of this year, which reallocates about $370 billion toward clean energy and electric vehicles. We can look at the Infrastructure Investments of Jobs Act of last year, which is a $1.2 trillion bill. These are massive amounts of money that the government has set aside to invest in infrastructure and clean energy and electric vehicles.
There's nothing started in markets, but that gives us a higher level of confidence than depending on consumers right now given where we are in the economic cycle.
Rachel Warren: What are some of the types of companies and ways, as we're heading into 2023, that you're focusing on incorporating these long-term structural megatrends?
Jay Jacobs: Absolutely. They're broad and varied. Within infrastructure, we really like companies that are not only the asset owners, the companies that run infrastructure today, but also the builders of infrastructure tomorrow to benefit from that government spending that is going to rebuild and repave highways and airports and seaports around the country. We like companies across the electric vehicle ecosystem. They're not just building cars but building the parts and batteries that go into those electric vehicles.
In the healthcare space, we really like pharmaceutical companies that have done their research already. They spent the money, now they can potentially monetize it with a successful trial results or FDA approvals. In particular, we like areas in genomics and neuroscience there.
And then in technology looking across robotics and cybersecurity. There's a lot of robotics companies that have been around for several decades. They are technologically advanced, but they are also established companies that are generating profits.
Similarly, in the cybersecurity space, we think that's just a narrow cut of the software world where there's profitability and there's long-term tailwinds.
There's a lot of opportunity out there, and it really requires looking across the ecosystem that looking at powerful themes to find that opportunity.
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Chris Hill: Are you looking for more investment ideas? Stick around, because after the break, Andy Cross and Ron Gross return with a couple of stocks on their radar. You're listening to Motley Fool Money.
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Chris Hill: As always, people on the program may have interest in the stocks they talk about and the Motley Fool may have formal recommendations for or against, so don't buy or sell stocks based solely on what you hear.
Welcome back to Motley Fool Money. Chris Hill here in studio once again with Andy Cross and Ron Gross.
On Thursday, the Federal Trade Commission sued Microsoft to block the company's planned acquisition of Activision Blizzard. This was a move expected by many, including Microsoft's legal team. That expectation was reflected in the fact that shares of both Microsoft and Activision Blizzard, Ron, were basically flat after the FTC made this announcement. There are few things we can get to, but let's start with this: Where do you think this is going?
Ron Gross: In the end, where do I think it's going? These are hard to predict. I think very often, the acquiring company will cut a deal with the Justice Department or the FTC and say "we'll divest this division or we'll stop this line of business if you let this go through." Microsoft has been saying "we will sign on the dotted line and make Call of Duty available to Sony PlayStation platforms if that's what you're concerned about."
That is what Sony is concerned about and, I guess, the Justice Department as well. I think some contractual agreement to keep Sony competitive and Microsoft less monopolistic will end up occurring, and it will go through. But I'm by no means certain of that.
Chris Hill: What do you think, Andy?
Andy Cross: The more I think about this, I'm just wondering if Microsoft... they're not in the habit of giving up things. They've been through plenty over the decades and decades, plenty of legal skirmishes and challenges with regulators and with lawmakers. They haven't in a while, and it seems like this is a challenge that they may want to actually reconsider.
Just seeing where this has come, I'm just picturing this army of lawyers and the amount of time and effort and distraction in a world that continues to be very challenged for their business to be able to compete in the cloud and such a large business to be able to just operate efficiently. I'm just wondering if they really shouldn't maybe just consider throwing their towel in. It just, from an investor perspective, might not necessarily be the best use of capital and the best use of time at this point.
Chris Hill: That's where I was going to go next. If you're an investor, if you're a shareholder of Microsoft or Activision Blizzard, what should you be hoping for? Because I think there was at least one Wall Street firm that when this action got announced by the FTC, upgraded shares of Activision Blizzard, thinking if the deal doesn't go through, I'm more bullish on Activision Blizzard as a stand-alone company.
Ron Gross: That's interesting. I think Activision as a stand-alone company is absolutely a fine company to own. If you want to play the arbitrage as Mr. Buffett and BerkshireHathaway are doing, with an 8% stake, that got a little bit more risky just recently with this lawsuit. There's 26% upside to the acquisition price. That gap has been around for a while because people were uncertain.
There's some precedent from when Microsoft acquired Bethesda Softworks, that they backtracked on some assurances that they made to the European Union, which I don't think the FTC appreciates, and so the risk level of it going through went up a little bit. But if it doesn't go through, I think it's fine to own Microsoft and Activision both as stand-alone companies.
Chris Hill: Andy, how do you think Warren Buffett is feeling about his arbitrage play here?
Andy Cross: He's a pretty smart guy and has a history of doing smart things. I mean, not always, but I think he's feeling OK. I mean, if Microsoft continues to push this and makes the divestitures and takes the approach, I think there's a chance that it will continue to go through and they'll be able to figure it out. I just, in thinking through it as a shareholder of both companies, whether I'd like to rather get a nice dividend from Microsoft as opposed to disinvestment. Still noodling through whether he gets ultimately a good deal and we'll have to see how it all plays out.
Chris Hill: One more thing to look forward to in 2023.
All right, let's get to the stocks on our radar. Our man behind the glass, Rick Engdahl, is going it with the question. Ron Gross, you're up first. What are you looking at this week?
Ron Gross: Late in September, I took a small position in Stanley Black & Decker, SWK, at around $78 a share. It's right where it is today. Hasn't moved around that much. I'm thinking about adding to the position, but this really is a turnaround to some extent.
As most people know, they're a manufacturer of tools for both industrial and retail customers. Paid a dividend for 146 consecutive years. It's a Dividend King. Haven't increased its dividend for 55 consecutive years. Yield is at 4.2%.
But they've got some issues. They've got weekend customers, they've got supply chain challenges that persist, they've got rising raw material cost, so the business is not great at the moment. They've got cost-cutting measures in place to try to improve profitability; management cut earnings.
So you've got to take a little bit of a flyer that this business will be rightsized. If that happens and the dividend is safe, all of the debt levels high, we should keep an eye on that, I think you could get a nice dividend and some nice stock appreciation as well.
Chris Hill: I'm sorry. Did you say this company has been paying a dividend -- they started paying a dividend in the 1870s?
Ron Gross: Did you do the math? Is that 146 years ago?
Chris Hill: Yes.
Ron Gross: Okay, yes.
Chris Hill: Rick, question about Stanley Black & Decker?
Andy Cross: I think some of the tools that I have in my house are from the 1870s as well. [laughter] Are you telling me I need to upgrade my tools in order to help with this dividend?
Ron Gross: For shareholders, yes, we would appreciate it. Thank you.
Chris Hill: Andy Cross, what are you looking at this week?
Andy Cross: Well, I'm looking at a dividend payer, but not from the 1870s. But Houlihan Lokey, symbol HLI, is one of the leaders in mergers and acquisition. In fact, they're the largest. We think Goldman Sachs and JP Morgan and Morgan Stanley, but actually, little Houlihan Lokey a $6.85 billion company, when you measure by numbers, is actually the leader in mergers and acquisitions consulting.
They do M&A, they do global restructurings, they do fairness and value opinions. It focuses on much smaller deals, to be fair, than those big players, but that's where most of the deals are. Most of the mergers and acquisition deals happen at the sub-$1 billion valuation, and that's really where Houlihan Lokey specializes.
They're very profitable. They've been growing more than 20% annually since 2017, generate very nice returns on equity, pay a little dividend.
When I think about how I want to allocate capital, I don't own shares, but I'm continuing to look at it. Stocks at $93, has doubled over the last three years. That beats the market. Yields 2.3% and pretty consistent dividend. Only payout ratio about 35%, so they have lined to maybe increase that over time now.
Recessions might actually hit this business a little bit but also could really boost their restructuring businesses as well. They make most of the money in M&A, but they have a very stable employer force. When I look forward, I think this business actually could do pretty well to continue to support the dividend, get a little appreciation, and do shareholders pretty well.
Chris Hill: Rick, question about Houlihan Lokey.
Ron Gross: When I hear "Houlihan," I think Hot Lips. When I hear "Loki," I think Marvel. Is that the first merger? I am sorry, I just don't know about this company.
Andy Cross: That was not the first merger. But that's actually very interesting whether you think that they're tied to both M*A*S*H and to Disney. But it's not.
Chris Hill: What do you want to add to your watch list, Rick?
Rick Engdahl: I think I'll go with the tools.
Ron Gross: Good choice.
Chris Hill: Got to do some shopping first.
All right, Ron Gross, Andy Cross, guys, thanks so much for being here.
Ron Gross: Thanks, Chris.
Andy Cross: Thanks, Chris.
Chris Hill: Drop us an email, podcasts@fool.com. Hit us with your year-end questions. That's going to do it for this week's Motley Fool Money radio show. The show is mixed by Rick Engdahl. I'm Chris Hill. Thanks for listening. We'll see you next time.
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Suzanne Frey, an executive at Alphabet, is a member of The Motley Fool’s board of directors. Andy Cross has positions in Activision Blizzard, Adobe, Alphabet, Berkshire Hathaway, Microsoft, and Walt Disney. Chris Hill has positions in Activision Blizzard, Adobe, Alphabet, Chewy, Costco Wholesale, DocuSign, Microsoft, and Walt Disney. Rachel Warren has positions in Alphabet. Rick Engdahl has positions in Activision Blizzard, Adobe, Alphabet, Berkshire Hathaway, Costco Wholesale, DocuSign, Microsoft, Sony Group, and Walt Disney. Ron Gross has positions in Berkshire Hathaway, Costco Wholesale, Microsoft, Stanley Black & Decker, and Walt Disney. The Motley Fool has positions in and recommends Activision Blizzard, Adobe, Alphabet, Berkshire Hathaway, Chewy, Costco Wholesale, DocuSign, Goldman Sachs Group, Houlihan Lokey, Lululemon Athletica, Microsoft, and Walt Disney. The Motley Fool recommends Casey's General Stores and RH and recommends the following options: long January 2023 $200 calls on Berkshire Hathaway, long January 2024 $145 calls on Walt Disney, long January 2024 $420 calls on Adobe, long January 2024 $60 calls on DocuSign, short January 2023 $200 puts on Berkshire Hathaway, short January 2023 $265 calls on Berkshire Hathaway, short January 2024 $155 calls on Walt Disney, and short January 2024 $430 calls on Adobe. The Motley Fool has a disclosure policy.
