Happy earnings season! In this episode of the Market Foolery podcast, host Chris Hill talks with Total Income contributor Ron Gross about earnings out of Facebook (NASDAQ:FB) and Microsoft (NASDAQ:MSFT), and the importance of conference calls.
Facebook dropped after reporting its fourth quarter and then rose to a new all-time high after investors had a chance to digest the report. Microsoft is taking a big hit from the new tax plan, but its metrics are fantastic and its future is promising. Also, the guys discuss why CEO transparency is more important than frequency of earnings reports, and why we're not seeing conference calls by video just yet.
A full transcript follows the video.
This video was recorded on Feb. 1, 2018.
Chris Hill: It's Thursday, Feb. 1. Welcome to Market Foolery! I'm Chris Hill. Joining me in studio today, from Total Income, Ron Gross. Happy February!
Ron Gross: Hey! It's February already.
Hill: It is. How about that? Just like the calendar predicted.
Gross: Have you written 2018 on a check yet?
Gross: Do you still write checks?
Hill: Every once in a great while I write checks, and if someone is nearby watching me, they make fun of me.
Gross: [laughs] That's funny.
Hill: It's Earningspalooza.
Gross: Thank God!
Hill: Before we get to Earningspalooza, three quick housekeeping items. Usually I do those at the end, I'm going to get them out of the way right now.
Hill: Because, in the wake of yesterday's episode, I've already gotten emails, questions and tweets from listeners about the Fool 100. Just go to fool100.com.
Gross: Everything you need to know.
Hill: That will answer far more than I can tell you. As I mentioned, it's Earningspalooza this week on Motley Fool Money. There are so many companies reporting earnings just in the last 24 hours.
Gross: It's a plethora.
Hill: It is. We couldn't get to them all today. PayPal, eBay, we're not getting to those today. We will get to them on Motley Fool Money. Otherwise this would be an hour-long show.
Gross: No. I have to go.
Hill: Speaking of hour-long shows, my third announcement is a reminder that, tomorrow, Friday, Feb. 2, there will be a bonus episode of Market Foolery. It is our third Apropos of Nothing episode.
Gross: Great name!
Hill: And it has nothing to do with investing! Nothing! On the Twitter profile for Market Foolery, it says, "Analysts discussing business investing news and occasional tangents." Tomorrow's bonus episode, it's all tangents. There's no investing news. So please, if you don't like tangents, that's one to skip.
Gross: If you'll have me, I volunteer for one.
Hill: All right.
Gross: "I Digress." I would like to change the name to that.
Hill: [laughs] We can work that out afterwards. Let's get to the earnings. We'll start with Facebook's fourth quarter. Another great reminder that it's good to be an individual investor and not a computer algorithm that just trades automatically on what the earnings announcement says, because right after the earnings came out yesterday afternoon, shares of Facebook down about 5%. One of the big headlines was about the lower user hours. We'll get to that. As we tape this, however, the stock is up 4%-5%. It's hitting an all-time high in part because, do you know what Facebook can do? They can charge more money for ads.
Gross: Which pretty much is the business model, right? Yeah, really interesting. As you said, if you trade on headlines -- which, as a Fool, I hope you never do -- you probably would have gotten this one wrong. The metrics in and of themselves, a lot of good ones. Forty-seven percent increase in revenue; significant increase in profits; average price per ad rose 43%; they were able to extract nearly $6 more revenue per user, which is a 26% increase. Lots of stuff for those folks that are into metrics and want to measure where Facebook is growing.
The headline, as you mentioned, and why the stock sold off was this big, time spent by users had fallen by about 50 million hours a day. First of all, 50 million is a big-sounding number. And it is, we shouldn't sweep this under the rug. This is an important thing to discuss. It translates to about a 5% decrease in time spent on Facebook during the quarter. That translates to a little more than two minutes per day per average user. Two minutes, OK. But I think it's more important to understand why, and it's because Facebook has been making this very concerted effort to change its News Feed to prioritize more on what friends and family are sharing, and less on news, videos, and other type of content that does typically perform well in the News Feed, but encourages the passive use of the platform that Facebook is trying to get away from. And that has an impact. It certainly has an impact in the short term and perhaps the medium term as people adjust their viewing habits.
But as you mentioned at the top, the more important news is they're able to actually increase their ad revenue. That's what's going to really drive this business. The company made it a very important point on the conference call to say that they thought the lower time spent would be compensated for by higher quality time. Now, we'll see if that's actually true. Any trimming of ad loads, as they call it, would be compensated by higher ad pricing. And I think we will see that. So, all in all, I think the company is doing what it needs to do to be around and be relevant for the next five, 10, 20 years, even if they take a short-term hit on some of the metrics that investors watch so closely.
Hill: And Mark Zuckerberg said -- or, if he didn't say it, it was one of the executives on the call; I think it was Zuckerberg -- that this drop in hours, they don't think that's a trend. They think that's a blip. We'll find out the answer to that in three months. And I think unlike Elon Musk, Mark Zuckerberg is a CEO who gets held accountable for what he actually says --
Gross: [laughs] Is that important?
Hill: -- in terms of the business performance. So that will be interesting to watch.
Gross: For sure. One other metric I want investors to keep an eye on is, the company had their first ever quarter-to-quarter decline in the number of users who log on daily in the U.S. and Canada markets. That number was down about 700,000 daily users. Although the number was up 33 million globally. But, U.S. and Canada are ever important, so let's just keep an eye on it.
Hill: Yeah, it's absolutely something to keep an eye on. But I want to go back to the ad pricing. Average price of ads up 43%.
Gross: That's a big number.
Hill: That's astonishing. If you're a company that regularly spends money on Facebook's platform, you go to them in the summer of 2017 and make your ad buy, and you come back in November and, "Oh, by the way, it's going to be a higher price." "How much?" "Forty-three percent higher." And you're going to pay it, because what are you going to do? You're going to spend that money, where, Snapchat?
Gross: [laughs] God forbid. The company doesn't need to keep putting up those 43% numbers, in my opinion, for the stock to still be one that you would want to own. But that's an incredible number. And they will have to prove to advertisers that, not only are people coming to the site, but they are staying for a fair amount of time and consuming those ads. But I think the company has proven and will continue to prove that that is the case.
Hill: So, we have a tech giant putting out this report, stock drops after hours. Once people can digest it, the stock up and hitting an all-time high. Which brings us to Microsoft, which basically had the exact same story with their third quarter report. Profit and revenue came in higher than expected. The cloud computing division raking in more than $5 billion. And that stock -- as amazing as the run of Facebook has been over the last 12 months, Microsoft being up 50% in one year is astonishing.
Gross: Yeah, it's astonishing, and really, the credit goes to Satya Nadella, the CEO, who truly has transformed this business over the last several years into a cloud computing business. And it's not easy to turn a ship the size of Microsoft and focus on something else. As you said, that cloud computing business, really solid. The Azure business jumped 98%. Office 365 grew 41%. The overall Intelligent Cloud segment was up 15%. They're really basically the No. 2 cloud company now behind Amazon (NASDAQ:AMZN). Really impressive numbers. Now, we can't forget what they call the More Personal Computing segment, that includes Windows, and that is the largest segment of Microsoft still. But it is, of course, the slowest growth segment as well, if we get growth in a particular quarter, only up 2%. But still, growth is better than decline. And let's remember, it's the largest segment, so it still remains important.
But, this is a cloud computing story. That's what the stock, I think, trades on. That's why the stock was up 50%. And I think they've done a great job. Like many other of these huge companies that have done business overseas for years, they've accumulated a large cash hoard of overseas profits, I want to say around $143 billion. So, of course, they had to take around the $14 billion charge because of the new tax plan because of that, as we're seeing across the board, not a problem there. They haven't said when they'll actually bring that cash back. But, as they've done in the past, they've done a pretty good job of returning cash to shareholders, both through their dividend as well as stock buybacks. They've had to do that largely through debt, because they've been somewhat cash constrained, which is funny for a company with billions of dollars. So, they've done it through debt. Now they probably will not have to do that if they choose not to once they have more cash in the bank here in the U.S. I think that's great for shareholders. The company is not as cheap as it once was, let's face it, it just isn't. Twenty times EBITDA is not a cheap stock. But if they keep this transformation going and keep the growth numbers coming in -- I'm an owner, and I have no intention to sell anytime soon.
Hill: It's interesting, because Alphabet is going to report after the market closes today, and that'll probably be one of the lead stories on Motley Fool Money this weekend. If you think about Facebook, Microsoft, and Alphabet and how those companies have performed, it's not like you can look at all three of them and say every single part of their business is crushing it. And that, to me, is part of the counter to people who look at, in the case of Facebook and Microsoft today, both stocks hitting an all-time high and thinking, "Gosh, I really don't like buying at the high," I just look at that and go, OK, but it would be one thing if they were hitting all-time highs and they were maximizing every single part of their business. That doesn't appear to be the case. Certainly, in the case of Facebook, if they're turning on some sort of cash machine with WhatsApp, they're keeping that a secret. Microsoft, LinkedIn is in the Business Processes segment of Microsoft's business, along with Office, and that did nearly $9 billion this last quarter. That's great; that was a little bit higher than expected. But I don't think Microsoft looks at what they're doing with LinkedIn and says, "That's exactly where we want it to be."
Gross: For sure, no.
Hill: And with Alphabet, it's YouTube.
Gross: Right. There's growth in things that are not doing well, there's growth in things that are doing well and will continue to do well, and there's new business lines. And you can't look at a stock and say where it is on its 52-week high or low and make an investment decision based on that. It's much, much more important to look at the underlying fundamentals of the business.
Hill: So, you're saying, don't just look at the headlines.
Gross: For sure do not.
Hill: Unless you're a trading algorithm, in which case you should have your pay docked because it hasn't worked out.
I wanted to get your thoughts about conference calls. It struck me this morning as I was watching CNBC and they were playing audio clips from Facebook's conference call, where Mark Zuckerberg was reading from a prepared statement. It got me thinking about how different companies approach conference calls. At one end of the spectrum, you have Berkshire Hathaway and other companies that say, "We're not doing this. We're not doing quarterly conference calls. We're going to do an annual one. That's it. We're not doing a conference call." Obviously, they do the quarterly reports, but they don't do the call. You have Facebook and a lot of other companies that say, "We'll do the quarterly report and we will have a phone call." But that was the thing. I was watching the TV and they have a picture of Mark Zuckerberg and I'm hearing his voice and I just thought, why aren't they doing a Skype call?
Gross: Have you ever had a Skype call with more than four people?
Hill: I haven't, no. But I'm assuming Facebook has the technology to pull that off. And then, at the other end of the spectrum from Berkshire Hathaway, you have companies like -- and I don't know that they do this every quarter, but they've certainly done it for the last few quarters in a row, you have the Walt Disney Company, where CEO Bob Iger, the quarterly report comes out, he sits down and does a live one-on-one interview on CNBC and then he goes to the quarterly conference call.
Gross: Right. That's a lot of good information coming out of that company.
Hill: First of all, do you have a preference? Or do you not care?
Gross: I have a lot of thoughts here. Let me try to organize them. First of all, conference calls were originally designed for Wall Street analysts and institutional investors. It would be very rare for an individual investor or a news media outlet to be on a conference call. That's what they were put in place for, for the company to disseminate that information, and for analysts to ask questions.
Hill: And by the way, lest anyone listening think Ron is referring to way back in the Dark Ages, like this is how it was in the '50s -- no, that's how it was in this century. At the beginning of this country, I'm going to take a victory lap on behalf of our company, The Motley Fool was instrumental in helping to push the SEC to approve what was referred to as Reg FD, Regulation Fair Disclosure, which said, "We actually think that individuals have the right to this information, too."
Gross: Right. So, now, not only can most individuals actually listen live to a conference call, but for sure, there's replays, there's transcripts, and there's much more access. And it's much less done behind the scenes, like you said, where analysts used to call up companies and ask questions and companies would answer them. Now, Reg FD has said, basically all important public information needs to be disseminated equally to all investors. Which has been great, maybe not great for analysts, but certainly great for investors in general.
But back to your actual question, I think it's really more about transparency than it is about frequency, and Berkshire is the perfect example. The frequency that you hear from Warren Buffett himself is not quarterly -- although, like you said, there is a 10-Q and there is a press release. But, the transparency coming out of that company, I think most people would agree, between the annual report and the annual shareholders' meeting, is pretty extensive. And as an individual investor, you can ask Buffett questions, and certainly analysts ask him questions, and he does go on CNBC occasionally, and Rebecca Quick gets an interview here and there with him. But, you could talk to investors all day long, if you're just reading boilerplate financial data and not answering questions, that's not as helpful as the transparent CEO who really wants to help investors understand what's going on in the business.
And I think where companies get into trouble is when they forget that they're public companies owned by the shareholders. And that's actually where you'll see activist investors come in, as I used to be. When companies start to act like private companies and say, "Shareholder, you can come along for the ride if you want, but this is the way we're doing it." They forget that they're no longer private, they've gone public for whatever reason they chose to do so, and that they owe a certain amount of transparency to the shareholders of the company. That's where activist investors will come in and start making noise, very often. Again, frequency, we can haggle with. Transparency is essential.
Hill: I think, if nothing else, you get a better sense of how management is feeling if you can actually see them, and hear their voices, but particularly if you can see them. To me, every once in a while, I'll talk about having stocks on a leash, how much leash do you give a given company or a given CEO? And I tend to give a longer leash to companies and CEOs that are, to your point, more transparent, and I have a better sense of how they handle tough questions. When everything is great, when it's all sunshine and rainbows --
Gross: That's easy, right.
Hill: -- anyone can be running the company. It's when they hit a couple of speed bumps, that's when I really want to see, what is their body language like? How prickly are they under tough questioning? What's their level of confidence? Because ultimately, that's one of the things I want. Not blind confidence, not Ricky Bobby confidence, unearned confidence. But, "Yeah, we're in a tough patch, but we're going to make it out of this."
Gross: It's interesting. I would imagine someone will be brave enough to move a conference call the video at some point, and maybe that will get traction. There's thousands of people on calls sometimes, so, especially if there's going to be questions that are asked, you have to get the technology right. But, I always picture the management team sitting around a desk with a speakerphone on, and I picture the CFO scribbling something down quickly and sliding it to the CEO, or maybe somebody covers a microphone and says, "What's the answer to that question?"
Hill: "You can't say that!"
Gross: And on video, that gets a little bit more dicey, because you can't do things behind the scenes. So, you have to have your stuff down a little bit more. But, how could it not move to that at some point, right?
Hill: I hope so. Thanks for being here!
Gross: My pleasure!
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 on Monday!
John Mackey, CEO of Whole Foods Market, an Amazon subsidiary, is a member of The Motley Fool's board of directors. Suzanne Frey, an executive at Alphabet, is a member of The Motley Fool's board of directors. Teresa Kersten, an employee of LinkedIn, a Microsoft subsidiary, is a member of The Motley Fool's board of directors. Chris Hill owns shares of Amazon, eBay, PayPal Holdings, and Walt Disney. Ron Gross owns shares of Alphabet (C shares), Amazon, Berkshire Hathaway (B shares), Facebook, Microsoft, and Walt Disney. The Motley Fool owns shares of and recommends Alphabet (A shares), Alphabet (C shares), Amazon, Berkshire Hathaway (B shares), eBay, Facebook, PayPal Holdings, Twitter, and Walt Disney. The Motley Fool has the following options: short March 2018 $200 calls on Facebook and long March 2018 $170 puts on Facebook. The Motley Fool has a disclosure policy.