In this Market Foolery podcast, host Chris Hill is joined by Foolish investor-at-large Tim Hansen to discuss a couple of interesting earnings reports. First up, Electronic Arts (NASDAQ:EA), which lost $200 million last quarter, but saw its shares bounced 8% to an all-time high on the news. (Spoiler: It's a tax-cut thing.)
Then comes Align Technology (NASDAQ:ALGN), maker of Invisalign clear dental aligners. Its growth for 2017 was excellent across the board, but shares slid anyway -- and longtime Fools will perhaps have a good guess as to what keyed that decline. Finally, they discuss one way many companies are likely to deploy the tax-cut largesse the GOP has showered upon them, and whether it's a smart use for the money.
A full transcript follows the video.
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This video was recorded on Jan. 31, 2018.
Chris Hill: It's Wednesday, Jan. 31. Welcome to Market Foolery! I'm Chris Hill. Joining me in studio today, investor-at-large Tim Hanson. Welcome to the end of January!
Tim Hanson: I love that title. Thank you for bestowing it upon me!
Hill: Are you going to slap that on a business card? I think you should.
Hanson: You know what? My best practice, given the frequency with which people change titles around here, I just have my name on my card.
Hill: That's a good move.
Hanson: And then you can use Comic Sans to write in your title for the day.
Hill: A pink Comic Sans.
Hanson: Exactly. That way, everybody takes you seriously.
Hill: [laughs] We're going to dip into the Fool mailbag. We're going to talk about the Fool 100 Index. We have to start with some earnings, though. Earnings season is starting to heat up. Let's go with Electronic Arts, which reported a third-quarter loss of nearly $200 million. And I'm assuming that's better than Wall Street was expecting, because shares of Electronic Arts are actually up 8% this morning and hitting a new all-time high.
Hanson: Yeah. It was a good report from an operating metrics standpoint. One thing to watch this quarter from an earnings standpoint is, a lot of companies are reporting losses associated with the new tax plan that got passed in Congress, just because some deferred tax assets and things being revalued, so there's a lot of lumpiness in the results. That's just writ large for everybody. But for Electronic Arts, yeah, a good quarter on operating levels. Guided to a strong finish to the year. Their fiscal year finishes in March '18. This is just one of those stories where they have some dynamite franchises, gaming franchises like FIFA, Madden, The Sims, that continue to attract users online, both on console and mobile. They're increasingly monetizing them through digital sales, power ups, things of that nature, which is high-margin business. You're not actually even making a tangible object. And that paid off for the company in the quarter.
Hill: We've talked before about the money that television networks are paying to sports leagues for the rights. One of the stories this morning, Fox just locked up Thursday night football for the next five years. When it comes to the video game companies and these franchises, I'm assuming that they're paying more to renew those, because they are valuable franchises. Maybe not, hopefully not, on the level that the television networks are paying. But, is that part of the financial equation for these companies?
Hanson: Yeah, they have licensing fees that go out to FIFA and Madden and so on and so forth. You have to pay for the use of likeness is of players and so on and so forth. But that's not nearly as expensive as buying the rights to the physical product. Additionally, EA has a history of building those franchises like FIFA and Madden from the ground up. That's one of those things where there are a lot of video soccer games out there and video football games out there, but they've built a fairly significant competitive advantage with their branding and their platforms. And with the rise of e-sports, I think there's a highly rated television show of competitive Madden. It's kind of like professional wrestling, in a way, which people often scoff at, but it's a very profitable business. And that's an advantage that EA has. At the end of the day, content is king. That's something we talked about with regards to Amazon Prime and Netflix and so on and so forth, and those companies are getting into making more of their own content. EA is one of those companies, like Disney, that has two or three decades of valuable content and branding behind it.
Hill: Let's move on to Align Technology, which is the parent company of Invisalign. One of those situations where the underlying brand is probably better known than the parent company. Fourth-quarter profits much higher than expected, their revenue was higher than expected. The shares are down a little bit, and my assumption is that that's about management guidance.
Hanson: Yeah, this is an example of, why did you have a conference call, stupid? Is it Dan Pink who has the book about timing, about conference calls in the afternoon being more negative than conference calls in the morning?
Hanson: I think this is a great example of that. They had their conference call yesterday afternoon. They had bang-up results for the year, both growth in pricing and units and expanding into new geographies. And then, on the conference call, everybody got hung up around why they didn't forecast 2018 growth to be as aggressive as it had been in 2017. And after they got hung up on that growth -- they said a few things about why they weren't forecasting super-aggressive growth, and then all the analysts got hung up about the fact that maybe your doctor is going to like the fact that you're opening retail stores, or maybe you don't have enough capacity in Mexico to meet demand. And all of the sudden, the stock, which I think had been up sharply, is now down sharply, just because everybody started getting freaked out about how much growth they were going to produce in 2018. But the stock is pricey. It's always been pricey. It's a good business.
Hill: It's nearly tripled in the last 12 months.
Hanson: You never want to short stocks that appeal to human vanity.
Hill: [laughs] For those who may have missed it, what Tim referred to there, Dan Pink, best-selling author, we just had him as a guest at Motley Fool Money, he was here at The Motley Fool, and his latest book is about the science of timing. And one of the great things about his book -- and there are a lot of great things but one of them is, he talks about how there was a point in time where you could survey a 100 people on any given thing and you would get some sort of results, and academic papers would be written from that. Now, in the era of big data, you can throw tens of thousands of examples. And in this case, I think they analyzed something like 26,000 conference calls of public companies, and overwhelmingly, regardless of the results being put up, the ones in the afternoon were more negative.
Hanson: Yeah. More negative speech. More negative tone.
Hill: OK, so, first order of business for Align Technology, move that conference call.
Hanson: Morning conference call next time, guys! You're welcome for that advice!
Hill: And I was telling our friend and colleague down at Motley Fool Asset Management, Charly Travers, and one of the things he talked about with respect to the guidance was, management has been very consistent year after year. This is one of those examples where, we say this from time to time, listen to what management is saying and hold the management accountable for their own targets, as opposed to Wall Street analysts. It sounds like they've been very consistent year after year in terms of their growth projections. So, the fact that they put up 40% growth last year, now you have a bunch of afternoon, their bodies are crashing, they're cranky analysts saying, "Why aren't you guiding to 40%?"
Hanson: Yeah, that seems to be what happened.
Hill: So, as I mentioned, we're just starting to heat up in terms of earnings season. I said that the other day, and I'm curious what your thoughts on this are. It has to do with buybacks. You mentioned the tax plan, and what we saw with Electronic Arts. By the way, we saw this last week with Johnson & Johnson, where the headline on Johnson & Johnson's latest quarter was, they posted a loss of nearly $11 billion. And it's just like, what happened?! And it's like, well, no, it's because of the taxes. Do you think we're going to see a lot more companies, or even just an above average number of companies, this earnings season and possibly even next earnings season, announcing increased buyback plans? We saw that with Lowe's come out the other day and really ramp up their share buyback plan. And for companies that have, all of a sudden, with the new tax law, they have more capital, that seems like the easiest lever to pull.
Hanson: Yeah, the buyback situation is interesting. Obviously, buybacks have been very popular for a number of years now. Some people think these are the largest amounts of buybacks being made in history, though there are a lot of ways to adjust for that. Obviously, I think buybacks are a popular use of capital, but I don't think it's necessarily for the reason why a lot of people think. There's a good research paper that came out at the end of last year called "The Premature Demonization of Stock Repurchases." It's AQR Capital Management, Cliff Asness' shop, put it out. And basically, a lot of people think that repurchases are either one, that means companies are foregoing investment in growth, or two, they're just trying to prop up their stocks or artificially boost earnings per share. I think what the paper shows is, none of that is really true, and maybe the only argument you can make is, in this very low-interest-rate environment, debt financing is cheaper than equity financing, so why would you not take out debt to buy back your stock? You're simply swapping out one more expensive source of financing for another. As long as interest rates remain where they are, there's no reason why that shouldn't continue. It means that, at the end of the day, your financing source is a lot cheaper, so, the company is probably going to end up keeping more of its gains for itself down the line.
Hill: Our email address is firstname.lastname@example.org. From Michael Thomas in San Francisco, "Just letting you guys know that I'm a big fan. I listen almost every day. But I was on a car ride with a friend the other day and put the show on. Halfway through, he woke up from a nap and asked what we were listening to. I told him it was Market Foolery, an investing podcast that I like, and I offered to turn it off, but he said he was looking for something like that and we let it play. We then listened to Chris and Bill Barker talk about silver nests and balls of yarn for 10 minutes. I don't think I succeeded in turning my friend into a Fool. Keep up the good work."
Hanson: Barker has kept many persons from becoming a Fool.
Hill: That's ... that's unfortunate. That's unfortunate. But an opportunity to say we have a bonus episode of Market Foolery coming this Friday. Michael, please do not let your friend listen to that, because we're not going to be talking about investing at all. It's going to be Apropos of Nothing No. 3.
I mentioned the Fool 100 Index, I don't know if it was the last time you were on or the time before that. This was something that you had been working on putting together, and you have an update. But for those unfamiliar, what is the Fool 100 Index?
Hanson: The Fool 100 Index is a rules-based index that tracks the performance of the 100 largest buy recommendations we have here at The Motley Fool. It's 100 stocks we like ranked by market cap. And it's performed, the back-testing we've done, performed great over time. And we're excited to have it out there in the world. You can look at the returns on fool.com. You can track yourself against it. You can see what's in it. All sorts of fun stuff.
Hanson: If you go to fool.com, you can see the returns of the Fool 100 there compared against the S&P 500.
Hill: Right there on the main page?
Hanson: Yeah. And then you can click through to fool100.com, learn about how the index is made, what's in it, when it gets rebalanced, all that good stuff.
Hill: And our colleagues at Motley Fool Asset Management ...
Hanson: Yeah, so the other great thing about the Fool 100 is, because all of the constituents meet liquidity requirements, it can be used by anybody to create an index-linked product like an ETF. And so our friends at MFAM, certain affiliates of The Motley Fool, now offer products that track the Fool 100. Folks can learn more about that at fool100etf.com. But as always, don't buy or sell stocks based solely on what you hear.
Hill: It's like I always say whenever Barker is on, if you want more information, go to foolfunds.com. You want more information on this, go to fool100.com. Tim Hanson, investor at large, thanks for being here!
Hanson: Thank you, sir!
Hill: As always, people on the program may have interests 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. That's going to do it for this edition of Market Foolery. The show is mixed by Dan Boyd. I'm Chris Hill. Thanks for listening! We'll see you tomorrow!
John Mackey, CEO of Whole Foods Market, an Amazon subsidiary, is a member of The Motley Fool's board of directors. Chris Hill owns shares of Amazon, Johnson & Johnson, and Walt Disney. Tim Hanson owns shares of Amazon and Walt Disney. The Motley Fool owns shares of and recommends Align Technology, Amazon, Johnson & Johnson, Netflix, and Walt Disney. The Motley Fool recommends Electronic Arts and Lowe's. The Motley Fool has a disclosure policy.