In this MarketFoolery podcast, host Mac Greer is joined by Motley Fool director of Small Cap Strategy, Bill Mann, and Matt Argersinger of Million Dollar Portfolio to discuss a couple of well-known companies: home-improvement retailer Home Depot's (NYSE:HD) latest outperforming quarter and the retail apocalypse, as well as the extremely appetizing private equity bid that's being bandied about for Buffalo Wild Wings (NASDAQ:BWLD) and the unique issues facing chain restaurants.
But for followers of The Motley Fool and its individual stock-picking ethos, the most interesting chatter of the day may be that a Nobel-winning economist is afraid index funds and passive investing are undermining the way the stock market is supposed to operate. Does he have a point? The guys weigh in.
A full transcript follows the video.
This video was recorded on Nov. 14, 2017.
Mac Greer: It's Tuesday, November 14th. Welcome to MarketFoolery. I'm Mac Greer, and joining me in studio, we have Motley Fool director of Small Cap Strategy, Bill Mann, and Matt Argersinger from Motley Fool Million Dollar Portfolio. Guys, welcome!
Matt Argersinger: Hey, Mac!
Bill Mann: Hey, I was in your neck of the woods yesterday. I was in Houston.
Greer: Is that right? Celebrating the Astros?
Mann: It turns out it would have been a really good idea to go into the Astro gear selling business, because everybody ... I'm so happy for your city.
Greer: I'm very happy too. I bought three copies of Sports Illustrated, I brought them home, and my son said, why did you buy three copies? And then I realized I had probably bought too many copies.
Greer: Because I got one for him.
Mann: I don't mean to jump on it right out of the gate, but as you were winding up, I thought, yeah, I was in Houston yesterday, and it was glorious. I have such a soft spot for teams that have historic futility.
Greer: Yes. That's our motto, historic futility.
Argersinger: Now, Mac, you got three copies of the Sports Illustrated Championship issue.
Argersinger: Did you get a copy of the 2014 issue that predicted the 2017 --
Greer: I did not. And those are collector's items now. I know, I need that one, those are going for big bucks on eBay. But I made a deal with myself that I was not going to make any gratuitous Astros or Costco references today, and I've already blown it.
Mann: No, it's not your fault. I wanted to say --
Argersinger: It's Bill's fault.
Mann: It was my fault. I am a fan of teams that have historically not done very well, which means I'm generally unhappy. So, I'm really happy when folks who have also shared sports unhappiness get a little taste of happiness.
Greer: And it's a weird place to be. I have to tell you, as someone who has lived his life with his teams losing, I don't quite know how to act. It's thrown me completely off. I need to find a Cubs fan or a Red Sox fan and get some advice. OK, on today's show, guys, lots to talk about. We have a Nobel Prize winner who's sounding some alarms about passive investing and indexing, and we're going to get to that in a minute. But let's begin with Home Depot. Better than expected earnings. Matt, we have same-store sales that are way up, crushing expectations. And the numbers seem to be helped by the bad weather. But, you look at the stock today, not doing a lot.
Argersinger: Yeah. I'm not surprised. You have to remember, Home Depot was up more than 20% this year. It's had a great year. And you said, the same store sales, up almost 8%. There might be a handful of retailers in the country that are putting up that kind of number. You mentioned the hurricanes. According to Home Depot $282 million in additional revenue from hurricanes. So, obviously, very few retailers can benefit from hurricanes the way Home Depot has. 14th straight quarter that Home Depot has surpassed expectations. In this retail environment we're in where it seems like nothing is working, nothing really isn't working as well as Home Depot.
Mann: What you're saying is that people are terrible at expectations.
Argersinger: That's part of it, yes.
Mann: Like 14 straight quarters of complete futility.
Argersinger: You're either really underpromising, or something's happening there, you're right.
Mann: Yeah. It's definitely been a good quarter. We're going to talk about this in a bit. In an environment where people think that Amazon (NASDAQ:AMZN) is going to crush everything, Home Depot is fine. And there are lots of businesses that are like that, but Home Depot, I think, has the secret sauce.
Greer: Bill, let's talk about that. You were just mentioning, I know we passed around a Bloomberg story, the title, a great, ominous headline, America's Retail Apocalypse Is Really Just Beginning.
Mann: That's brutal.
Greer: It is brutal. And when we've talked about problems facing retailers, we have talked a lot about Amazon and the effect that Amazon is having. But it's much bigger than Amazon, right?
Mann: Yeah. Amazon, I don't have the statistic off the top of my head, but Amazon is still something on the order of 2% of all retail sales in the U.S., which is, let's just say, phenomenal, because you're talking about 2% of a really, really big number. But it's not just Amazon. The thing that you have to realize -- I was recently in Silicon Valley, and I was looking at all of the different amazing businesses, and I realized that Silicon Valley came from the death of the military industry in that same area. There was a renewal. And I think we're going through the same thing in retail. There are lots of areas where the big department stores, which used to be enormously relevant, you just don't need them anymore. But that's where the space is pointed to. The big malls, it's just not the type of things that are needed anymore, and it's not where the trends are or are going. But you have that, and you also have these stores, a lot of which have been taken out by private equity, absolutely larded with debt. So, I'm not sure that the retail apocalypse is driven by Amazon. Obviously, that's part of it, and it's very specifically hurting some segments, but it's not everything.
Argersinger: Yeah. Bill mentioned it, Amazon is part of the story here. E-commerce in general is part of the story. But it really is a balance sheet story more than anything else. The amount of debt that's going to come due over the next several years as pointed out by this Bloomberg report is staggering. Tens of billions of dollars' worth of debt from companies --
Mann: Yeah, this year was nothing compared to what's coming in 2018.
Argersinger: Yeah, it's a sliver. Especially if you look out to 2019 and beyond. It's staggering. And I think, one thing that the Bloomberg study didn't point out, Credit Suisse came out with a report early this year looking at the sheer square footage of retail space that we have here in the United States. Bill was getting at it --
Mann: Eventually. [laughs]
Argersinger: The number here is amazing. We have 2,000 square meters for every 1,000 people in the U.S. 2,000 square meters of space --
Greer: Don't use the metric system. Come on!
Mann: [laughs] I was about to say ...
Argersinger: They did it in meters! I can't help it.
Greer: Credit Suisse. What are you, Canadian? [laughs]
Argersinger: What's the number in Germany? For example, in Germany, obviously a very advanced country --
Mann: It's also meters.
Argersinger: 181. So, we have 2,000 here. In Germany, it's 181. In China, it's 39. So, that number alone says, to Bill's point, there's just too much retail. We have too much space that we don't need anymore. So, I think those three things, Amazon, balance sheet, too much square footage --
Mann: And it's shifting. A really interesting conversation that I had with Kent Taylor, who's the CEO of Texas Roadhouse, Texas Roadhouse loves putting their restaurants on mall properties, in the middle of the parking lot. And he said, yeah, there are a lot of malls that are out there that are going away, but a lot of them are shifting. There's a fantastic new development in the western part of this metropolitan area called the Mosaic District, and they have taken office space, they've taken residential, and they've got retail, and it's all mixed together. So, there, you have a very vital retail environment, and it's just because it's shifted to how people are shopping now.
Greer: The Target there has an escalator that will bring your cart up and down. It's like voodoo magic. I would go there just for the escalator at Target. Is that wrong?
Mann: No. My son, the first time we went, we tried to follow the escalator up that glider thing. I was like, "Son, you might not survive this experience."
Greer: [laughs] So, let's underline it for investors. Bill, I know you're a big fan of asking the question, when you read the newspaper, what does this mean for investors? Where's the opportunity for investors? So, given this whole shift with retail, the Amazon effect, too many stores, too much real estate, too much debt -- as an investor, what do you do with all that?
Mann: It's a great question, and I haven't really cracked the code yet. But I think some of the answer is going to actually be some of the real estate development companies. We're talking about Jones Lang LaSalle, which primarily deals in office space. But a lot of office space now is being integrated into, this is where the growth is. So, I think those types of consultancies are probably areas of opportunity. And then, also, the Amazon apocalypse is a pretty known story. I think companies like Home Depot really do actually offer a little bit of opportunity.
Argersinger: There's when company that comes to mind, and I think it's a recommendation in at least one of our services, it's called STAG Industries, it's a REIT. Their specialty is really looking at --
Mann: Why isn't it pronounced "right?" I mean, we're German, right?
Argersinger: [laughs] But, they specialize in warehouses, distribution facilities, light industrial stuff, stuff that's trending that way with the e-commerce world that we're getting into. They own a lot of those properties. And that's an interesting way of playing this potential.
Greer: STAG Industries?
Greer: We'll keep an eye on it. Guys, shares of Buffalo Wild Wings up big on Tuesday on news that a private equity firm had made an offer to buy the chain. According to reports, Roark Capital had made an offer, more than $150 per share. Bill, that's some good cash, given BWLD is trading around $117 per share. Or, was.
Mann: Immediately moved up to nearly the price.
Greer: So, what do you make of that?
Mann: What I make of it is, given the fact that Sally Smith, the longtime CEO who's really been the driver behind Buffalo Wild Wings' growth up until now, and it really has been a phenomenal story up until about the last two years, the market is saying that this is an offer that's likely to be taken. It will certainly be meriting a consideration in the boardroom. And maybe it's a good deal. I have a hard time with the fact that Sally Smith has been essentially pushed out after years and years of outperformance. This is just another one of the signs of how hard it is to be a CEO of a public company, or to be a public company in general.
Greer: And restaurants in particular seem to have, it's a tough business. Is there more of a sell-by date when it comes to restaurants? As an investor, if you own a restaurant, do you keep it on a much shorter leash? Because we can all think back to the Boston Markets, you think of Chipotle's (NYSE:CMG) recent problems. Obviously, stocks go up and stocks go down, but restaurants seem to be a particularly fickle business.
Mann: Matt may have a slightly different take on this, but I think with restaurants, brand and experience is everything, but really, the brand is so powerful with restaurants. But you can't put too much power into the brand, put too much value into the brand. Chipotle is a great example. A few years ago, I don't know if you all remember this, but suddenly Chipotle had no access to the pork that they used to make carnitas, and they just put a sign up at all the stores saying, "Sorry, we have no carnitas." And that was maybe the canary in the coal mine for Chipotle, the fact that their supply chain was stretched enough and weak enough that a little problem is going to cause big problems for them, or, a little challenge, I would say. So, yes, you have to be very careful in putting too much value into the brands of restaurants, because they can disappear [snaps] like that.
Argersinger: That's such a great point. I had totally forgot about that pork issue from several years ago. If you'd really dug into that, you would have realized that Chipotle spreading out across the country with their supply chain was going to cause a lot of unforeseen challenges that they hadn't dealt with before.
Mann: Yeah. It's easy to get an amount of product from one farm. But as you grow, you need more and more suppliers. And it's really hard. It's an enormous challenge. And the thing that I take from Chipotle, which I appreciate, and I still do appreciate, is that they take a lot of pride in their supplies and their food and everything else, but it hurt them. And that's a hard reality with restaurants.
Greer: Do you have a favorite restaurant stock, or a restaurant you would like to see go public that may not be public yet?
Argersinger: We live in the D.C. area, and one restaurant chain, I don't know why it's called a chain, because I think there's only half a dozen, but there's Matchbox, which is --
Greer: It's so good.
Argersinger: -- really great, I think it's local, I think they don't have any restaurants outside the DC area, but it's great food, great atmosphere. It's way too small to probably consider going public. But if there was one I would like to see go public in the future ...
Mann: To me, the obvious answer is Chick-fil-A.
Argersinger: Oh, yeah.
Greer: Love Chick-fil-A.
Mann: Chick-fil-A is so, so, so good!
Greer: They have one at Reagan National Airport now, and I am willing to pay the $6 parking to go to the Chick-fil-A at the airport. Is that a cry for help or what?
Mann: [laughs] It used to be a Dulles, and maybe this is a sign of the times, Dulles had, inside of the security area, the only Starbucks that was on my commute to my old business. So, my friend and I would drive, he would drop me off, I would go in through security, buy Starbucks, come back out, and he would have done a loop, and we'd get in the car and go to work. So, yes, I understand you perfectly.
Greer: You have topped me. That's outstanding.
Mann: Well, this is before 2001. That was not as much of a challenge as it is now. You weren't de-belting and things like that to get your coffee. Yeah, so, Chick-fil-A would be fantastic. There's actually a restaurant, it's a Taiwanese restaurant, they just started opening shops in the West, it's a dumpling place called Din Tai Fung. And for a while, it was the cheapest Michelin starred restaurant in the world. And they've begun opening additional stores. And it's phenomenal. And not only is it phenomenal, but the price point is such that, because it's dumplings, they're all pre-made, so you can literally sit down and eat and be paid and done in 20 minutes.
Greer: I like that.
Mann: So, as a customer, it's fantastic. But as a business, that's pretty awesome, too.
Argersinger: As we talked about restaurants we would like to see go public, I would say, the one thing that this Buffalo Wild Wings deal emphasizes for me, and we talked about the challenges that Chipotle has faced, what Bill said earlier, it's so hard to be a public company nowadays, especially if things aren't going your way, the scrutiny you have to deal with. And I worry that this might become a trend. Either more companies go private, or less companies go public. And as public investors, that's not something we'd like to see, but it's probably a trend.
Greer: Guys, let's close by talking about the oh so sexy world of passive investing and indexing. One of my favorite economists -- if you can have favorite economists --
Mann: It is kind of a geeky opener. [laughs]
Greer: I know. But we've interviewed him, I really love Robert Shiller.
Mann: He's a great interview, isn't he?
Greer: He is. And he's won a Nobel Prize. We should probably mention that. On CNBC yesterday, guys, he had some ominous or cautionary things to say about passive investing and indexing. To put it all in perspective here, in 2016, investors invested more than $0.5 trillion in passive funds.
Mann: That's kind of a lot.
Greer: It's a big number. Here's what Robert Schaller has to say. He says, "The strength of this country was built on people who watched individual companies. They had opinions about them. All this talk of indexes, it's a little bit diluting of our intellect. It's become more of the game." Bill Mann. Indexing, bad for the market? What do you think?
Mann: It's a tragedy of the commons. And it's a little disingenuous for us -- we're stock guys. "Yes, passive investing is bad!" [laughs] But it does expose certain risks that you don't otherwise have, and I think people need to know about them. The market is a price discovery instrument. If everyone is going to passively invest, nobody is doing the research by which discovery happens. And I think about the fact that, we were just talking about Buffalo Wild Wings potentially going private. It's been a pain for them to be public the last couple of years. It can't be a good environment in which passive investing is such a huge thing, to think about going public as a company. Why would you? You'd have to hope to end up in some index constituency. You might not be there. So, it's expensive, and it's a hassle, and nobody's watching.
Argersinger: I agree. What it does is, it eliminates the distinction between quality companies and companies of lesser quality. As Bill said, you could be a bad company, but if you're lucky enough to be in part of this Dividend Aristocrat index, money is flowing your way and your stock price is probably high as a result, whereas a company that's not in that index that might be performing better, might be an interesting opportunity, it's not getting that "love" from the market. So, I agree. I think the discovery aspect of, not just the price discovery, but distinguishing between companies that should be valuable, or more valuable or less valuable, it's become harder when money is flowing blindly into the market with these indexes. And some indexes are very specifically targeting what kind of asset classes they target. And whether or not your stock is in one of those targeting areas determines what kind of value it's going to get in the market. It's kind of a strange place to be.
Greer: So, it sounds like it's a bit of a paradox, that indexing is more effective as long as you have a critical mass of stock pickers.
Mann: I think that's well put. You have to, you have to have people, at the end of the day, doing some analysis to set the price. And I think they are very interesting areas. Do you know how long it's been since the S&P 500 has had more than a 5% drawdown? Not in a day, just from its peak. 5%.
Argersinger: Early 2016?
Mann: Yeah, it's been a while. It's been more than a year. In the same year in which $0.5 trillion have gone to passive investing, and a lot of that goes into index funds that are tracking the S&P 500. So, I think there's something meaningful going on. And when it breaks, and it always does break, it will break in a way that might be very, very uncomfortable for people.
Greer: And on that happy, upbeat note ... [laughs]
Mann: The Undertaker is back! But, we do still think index investing is a great vehicle for people. But I don't think it's something that is without risk. And I think that's what Shiller is saying, too.
Argersinger: Right. And what I said earlier, too, companies that aren't in those indexes can also become values. They become opportunities for us because they're misvalued because they're not part of those indexes. So, it also creates opportunities as well. And when everything starts selling off at some point, which it will, inevitably, everything is going to be selling off, because so many people own these funds. And, again, more opportunities for the active investors.
Greer: So, you need your active investors, and you need your indexing. Without one, the other doesn't work as well.
Mann: Yeah. It's funny, when I was a fund manager, we were managing funds in a lot of emerging markets. And in some countries, like in Egypt, for example, the index fund makes up about 50% of the trading volume every single day for the stocks. And it's a situation that will break. And, at some point, you're going to have the same situation here. I don't know what the percentage is here. Obviously, it's a much more dynamic market than Egypt, it's a broader market. But, at some certain percentage, you're no longer tracking, you are pushing.
Greer: 50% of the market in Egypt?
Greer: There you go. So, if you want to win a bar bet and you're listening to the podcast right now, there you go. I would have had no idea. Impress your friends.
Mann: [laughs] Here's your random fact.
Greer: [laughs] You're going to be the life of the party. Or not! OK, guys, thanks for joining me today!
Argersinger: Thanks, Mac!
Greer: 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 it for this edition of Market Foolery. The show is mixed by Dan Boyd. I'm Mac Greer. 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. Bill Mann has no position in any of the stocks mentioned. Mac Greer owns shares of Amazon, Chipotle Mexican Grill, and Costco Wholesale. Matthew Argersinger owns shares of Amazon, Chipotle Mexican Grill, and Starbucks and has the following options: short December 2017 $900 puts on Amazon. The Motley Fool owns shares of and recommends Amazon, Buffalo Wild Wings, Chipotle Mexican Grill, eBay, Starbucks, and Texas Roadhouse. The Motley Fool has the following options: short January 2018 $170 calls on Home Depot and long January 2020 $110 calls on Home Depot. The Motley Fool recommends Costco Wholesale, Home Depot, Jones Lang LaSalle, and Stag Industrial. The Motley Fool has a disclosure policy.