On this episode of Market Foolery, Chris Hill is joined by Million Dollar Portfolio's Matt Argersinger as they discuss the state of the market. Stocks are trending upward, which should have most investors feeling optimistic -- but what is driving this train?
And for the latest news, Caterpillar (NYSE:CAT) blew out expectations, while Netflix (NASDAQ:NFLX) has at last filled in the biggest remaining hole in its global reach with a deal that puts its content in front of Chinese audiences.
A full transcript follows the video.
This episode was recorded on April 25, 2017.
Chris Hill: It's Tuesday, April 25. Welcome to Market Foolery. I'm Chris Hill. Joining me in studio today, from Million Dollar Portfolio, Matt Argersinger. Thanks for being here.
Matt Argersinger: Yeah, glad to be here.
Hill: Jason mentioned this yesterday, how many companies there are on the Million Dollar Portfolio, either on the watch list or actually in the portfolio, that are reporting earnings. I always appreciate when you're in the studio, but I particularly appreciated this week, because I know how busy it is. A lot of companies reporting earnings today, but I think we have to start with the market in general. You have the Nasdaq hitting 6,000, which is of course making headlines because it's a big round number. But how about this for a list of companies: Home Depot, Lowe's, McDonald's, John Deere, Honeywell, UnitedHealth, 3M, Mastercard, PayPal, Adobe, Electronic Arts, Activision Blizzard, Microsoft, Alphabet, and Facebook, they are all, all of them, hitting all-time highs today.
Argersinger: That's pretty much everything, I think.
Hill: Yeah. That's not just tech, it's healthcare, it's home improvement, it's restaurants.
Argersinger: Across the board.
Hill: It's across the board. And I'm wondering, how problematic is this for someone in your position, whose job is to go out and look for companies -- we talk about upside, and yes, these companies are hitting all-time highs today. Let's go ahead and stipulate that all of them will go up from here, which means this is not the only all-time high they're going to have.
Argersinger: It shouldn't be.
Hill: But, for someone in your position, I don't know, this seems like a little bit of a problem.
Argersinger: You feel two ways about it. One way, you're saying, this is great. You are an investor, you like equity --
Hill: This is why we invest.
Argersinger: This is why we invest, we invest for companies to hit all-time highs, we invest for the stock market as a whole to hit an all-time high, we invest for the Nasdaq 6,000 and 7,000 and 8,000 and beyond. The other part of me is an analyst, an equity analyst, and I'm constantly looking for those excess returns. And if everything is going on and hitting all-time highs, it gets really hard. Especially if you look at the overall market, we're using certain historical measures at really high valuations. You don't want to get excited when you look at companies -- and, we'll talk about one that I think is overvalued -- we look at a lot of companies that are maybe going to grow revenue in the single-digit range, which is fine. But they're trading at 20, 25, 30 times earnings multiples. It's hard to get excited about companies like that. The other thing, I think, that's working, and we've talked about this on the show, how the really big secular shift that we've seen toward passive investing, ETFs, what that's done is sent a lot of money to very broad indexes in the market that are essentially, because capital is coming in, they have to keep buying. I'm not surprised that a lot of the blue chip companies you named out are hitting all-time highs. That's sometimes a function of the fact that money is coming into the market, it's coming into these passive strategies, it's coming in through people's 401(k)s, all various sources. Until that changes, until there's some kind of major dislocation in the market that changes that, or changes people's perception, it's very hard to keep up with all these companies.
Hill: Some of the companies we just went through, particularly Facebook, Alphabet, Microsoft, those are three of the five or six biggest companies in the public markets. Do you think that, as these stocks rise, as the big get bigger, does that increase the likelihood of buyouts of smaller companies? If you're Facebook or Mastercard, are you taking your all-time high stock and putting it to use in the form of buying out smaller competition -- not necessarily competition, but like, "We could use our all-time high stock to go out and buy that company over there."
Argersinger: I think that's a great point. If you're a capital allocator -- that's what a CEO is, at his or her core, a good capital allocator. As a capital allocator, if I saw my stock trading at what I thought was a very lofty valuation, I wouldn't be buying back my stock, I would absolutely be either issuing stock, if that was the cheapest form of capital, or like you said, I would be looking at competitors out there and saying, "Wow, if I could use my equity as a cheap form of capital and buying power, I'm going to go buy a competitor." The big getting bigger is a great point as well. I think, if you look at Facebook, Alphabet too, the amount of capital that these companies can put to work, it makes it very hard. As big as Snap is already, Facebook can go in there and pour $1 billion. Amazon is another example of a company that's pouring something like $3 billion in India, whereas Flipkart is a company that's been operating in India for a long time, over a decade now. Amazon can go in there in a few years and probably knock them out of the market, just because of their sheer size and access to capital. The big getting bigger is a pretty interesting thing to watch.
Hill: Let's talk about one company that's helping to push the market up today, certainly pushing up the Dow, because Caterpillar is one of the Dow 30 stocks. Caterpillar's first-quarter report was fantastic. This is not a beat-by-a-penny situation. Their profits came in more than double what Wall Street was expecting, their overall revenue was solidly higher, they raised guidance for the full fiscal year. And the stock, this is one of those tried-and-true, steady blue chip performers, their stock is up nearly 7% this morning. I get that this was a great quarter, but I'm assuming this is what you were referring to when you were like, wow, 7%? That seems lofty for a company like Caterpillar.
Argersinger: It does. The earnings picture looks great for them. But that's because Caterpillar, like a lot of companies, has been doing a lot of restructuring lately. If you look at Caterpillar, for example, they've had restructuring charges every quarter going back to the end of 2012. Just last year, they had about $700 million of restructuring costs. This is just them shuttering old facilities, moving a plant somewhere else, or shifting capital from one segment to another, and shutting down operations.
Hill: And that whole problem they had in China.
Argersinger: That whole problem they had in China. The problem with me, though, is that when I see a company that restructures this often, I don't believe management when management comes out and says, "These are one-time expenses that we're taking out of our earnings. Here's our real earnings." That makes me very uncomfortable. With a company like Caterpillar that's doing that, I tend to count those charges. And if you do, the earnings per share don't look nearly as good. Then, if you just look at revenue growth overall, it's up 4%. I know they saw some strength in the resource business and the energy transportation business. Those segments have really struggled over the past few years with commodity prices and oil prices. But the fact that those are bouncing back is a good part of the story. I would just say, be very careful of Caterpillar. We talked about lofty valuations. You have a company growing revenue 4%, gave great guidance for this coming year, but is this a company that should trade at 32 times earnings? Those earnings, by the way, are the adjusted earnings. They're already restructuring more this year, and they're taking those out of their guidance.
Hill: I didn't realize the multiple was that high.
Argersinger: 32 times! That, to me, I think Caterpillar is a great company. It's an industry bellwether, it's very diversified, but I'm not paying that multiple for a company like this.
Hill: And you hit on a key word there, which I think is part of a small sliver of the enthusiasm that we're seeing today, and that's bellwether. I think any time -- Caterpillar is on that short list of large companies that, when they do well, it's like a Rorschach test, but a Rorschach test where every institutional investor sees something positive. When Caterpillar puts up a really good quarter, I think you have a lot of people on Wall Street saying, "Oh, this means great things for housing, this means great things for infrastructure."
Argersinger: "Energy is great, mining is coming back," yeah, all those things, you're right.
Hill: I know we talked about Netflix yesterday raising $1 billion in financing, but they're back in the news today. Netflix has struck a deal in China with iQiyi, which is one of the leading video-streaming platforms, it is a subsidiary of Baidu. We see the stock up 2%. This is going to be interesting, to see where this deal goes from here. Netflix has been trying for a long time to get into China. They're not the first U.S. company that's tried to do business in China.
Argersinger: And it won't be the last.
Hill: It won't be the last. And they've decided to go this route, which I think is a smart deal. It's a licensing deal, it's one of the biggest platforms. As of late last year, iQiyi had 480 million monthly active users. In terms of getting Netflix original content in front of a very large and new audience ... we don't know what the terms of the deal are but just in terms of the audience, it seems like a win.
Argersinger: I agree. I think it's a win for both. Netflix, as you hinted at, it's been an enormous challenge to get into China directly. In fact, I think in October, they gave up. Reed Hastings, on the conference call, said, "We've run into a buzzsaw trying to get into China, so we're going to pursue some deals, some joint ventures and licensing deals," and this is the first major one. I like the deal because for iQiyi, they were called the YouTube of China for a long time, and they have a lot of free content, but they did shift to a subscription model last year or the year before, and they've slowly grown that business. But what they've struggled with is content, they've had to pay a lot for content. With the deal with Netflix, you bring in a lot of curated content -- because I'm sure the Chinese government is going to have a lot to say about what kind of content Netflix is able to get into iQiyi's platform, but at least for iQiyi, it gives them great content. For Netflix, it gets them that foothold in China. If Chinese consumers like a lot of the Netflix content, it opens the path for them to get more and more content in. I think, eventually, you could see Netflix saying, "If this is working, maybe we'll do a joint venture with iQiyi, where we're supplying a lot of the content, they're handling all the distribution, and we're splitting the subscription revenue 50-50 or something like that." It's a bit of a long game that Netflix is playing, but if you are shareholder, I think it's a positive move. It's the foothold you've been looking for. I don't think it will be that accretive to revenue. I think Netflix has said these licensing deals aren't going to be a big uptick to revenue. But, down the road, lead to big things.
Hill: I want to hit on a couple points there. One, before I forget, you had mentioned the content in China, and what's going to be allowed and what's not. I think it certainly works in Netflix's favor that they have a pretty large portfolio of original content. This is not four or five years ago, where they basically had a couple of shows, and that's it. They have a lot of original content. And we'll find out in the coming weeks and months what exactly is the content that's going to be available in China, because it's not going to be everything. We know there are movies that are made in the U.S. that are altered to be shown in China, they are edited in some ways. We also know there are directors in Hollywood -- Quentin Tarantino is one who comes to mind -- I don't think any of his movies have ever been shown in China, because he said, "I'm not changing my movies, I'm not going to edit them for the Chinese government or any government." You're right, it's not going to be accretive to revenue. I think it does probably help them down the line when they are making a pitch to content creators. Robert Roy, who's the VP of content acquisition, he's the guy at Netflix that's in charge of going out to content creators. We've talked before how, if you're a content creator right now, it's your market. It's a seller's market. You have Amazon, you have Hulu --
Argersinger: You've got bidders.
Hill: You have bidders. You have YouTube, and obviously Netflix. I think if you're Robert Roy at Netflix, now, you get to go to content creators and say, "Oh, and by the way, we can get you in front of an audience in China in a way that some of these others can't."
Argersinger: Right. And it's an audience that's about 1.4 billion people large. Very compelling. I think, yeah, you're exactly right. They now have the access. Now, we can make movies that we're 95% sure will get into China, as opposed to saying, "What do we have that we can alter or edit?" It's a great point.
Hill: One of the things we were talking about earlier this morning, you read these stories about this deal, and you start to gain some insight into just how competitive the video-streaming industry is in China. iQiyi is a Baidu subsidiary. Alibaba has their subsidiary. Tencent has their subsidiary. Just like we have the clash of the titans here in the U.S., that's absolutely playing out in China.
Argersinger: It is. China is an interesting case, too, because unlike the U.S., there really wasn't this linear TV market that we've had in the U.S. for decades. In China, they were so quick to move directly to streaming on my computer or my mobile phone on my tablet. It's amazing to see, unlike us, where we had the cable networks and things like that, no, these are the players in China, and they've already grabbed significant turf. It's going to be a clash of the titans. I think iQiyi, Netflix deal, it's a bit of a leg up for them today.
Hill: Are you watching anything on Netflix right now? Are you bingeing anything?
Argersinger: My wife and I just finished watching the two seasons of Daredevil. And I have to say, I'm a Marvel Comics fan, the movies have been great, Netflix has done a great job with a lot of those Marvel properties like Daredevil, Luke Cage, Jessica Jones. I'm liking that universe right now.
Hill: I'm about halfway through Luke Cage and very much enjoying it. Although our man behind the glass, Dan Boyd, he's a fan of the Marvel series on Netflix. Dan, can you jump on mic and share a word or two? For those unfamiliar, there's the Marvel Universe in the theaters -- Iron Man, Thor, Hulk, etc. Then, on Netflix, you have Daredevil, Luke Cage, Jessica Jones. The most recent one is Iron Fist.
Argersinger: Yeah. I haven't watched that one yet.
Hill: I haven't watched it. Dan, you've watched Iron First. You watched the others. I know you're a big fan of Luke Cage and Jessica Jones. Iron Fist, I'm getting the sense, not quite up to snuff.
Dan Boyd: I unfortunately have had the extreme displeasure of watching all 12 episodes of that pile of dreck.
Hill: At any point, maybe episode three, did you think, "I don't think this is getting any better and I'm going to stop?" Why did you keep going?
Boyd: Probably the sunk-cost fallacy. I gave it about four or five episodes to see if I was enjoying it, and I wasn't, but I'm kind of the completionist, so I was like, "We're just going to get this done as quick as I can."
Hill: Did you switch over into hate-watch mode? Have you ever hate-watched a show?
Boyd: No, I don't think that's a good idea for anybody's psyche. But, listeners, real quick, never watch the show. It's bad. Finn Jones is terrible. He's laughably awful in the role. I don't know what they were thinking about why you would make this show in 2017, but they went ahead and did, and it's garbage. Hot, hot garbage.
Hill: You heard it here, from Dan Boyd. Netflix, when it comes to the Marvel series, is batting .750, three out of four. They got three out of four.
Argersinger: Let's hope the next one is good.
Boyd: I don't want to count the first season of Daredevil as a hit there.
Argersinger: Really? The second season was better, but ...
Boyd: I like Vincent D'Onofrio a whole lot in that, but that was really the only good part.
Hill: At least there was that good part.
Boyd: Yeah, that's fair.
Argersinger: I get the sense that Dan likes bad guys, like the Kingpin. What did you think of Punisher? Punisher was good, I thought the guy who played Punisher was pretty good.
Boyd: Jon Bernthal is a Washington D.C. native, and a big fan of D.C. sports teams, so he's pretty much my best friend.
Argersinger: [laughs] There you go.
Hill: All right, Matt Argersinger, thanks so much for being here. I'll let you get back to work.
Argersinger: All right, thanks Chris!
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!
Suzanne Frey, an executive at Alphabet, is a member of The Motley Fool’s board of directors. Teresa Kersten is an employee of LinkedIn and is a member of The Motley Fool’s board of directors. LinkedIn is owned by Microsoft. Chris Hill owns shares of Amazon. Matthew Argersinger owns shares of Activision Blizzard, Amazon, Baidu, and Netflix. Matthew Argersinger has the following options: short December 2017 $800 puts on Amazon. The Motley Fool owns shares of and recommends Activision Blizzard, Alphabet (A shares), Alphabet (C shares), Amazon, Baidu, Facebook, Mastercard, Netflix, and PayPal Holdings. The Motley Fool recommends Adobe Systems, Electronic Arts, Home Depot, Lowe's, and UnitedHealth Group. The Motley Fool has a disclosure policy.