Fans of The Motley Fool can't help being aware that it's practically impossible for Wall Street pundits and writers to communicate without letting some obscure terminology slip into the mix. It's not their fault, of course: The purpose of specialized argot in any arena is to provide folks with shorthand, so they don't have to keep repeating long phrases to describe things like "employer-sponsored, tax-advantaged investment accounts whose funds are intended only to be withdrawn in retirement." So much easier to just say "401(k)."
But if you want to play the game, you have to comprehend the conversation, so in this week's Rule Breaker Investing podcast, Motley Fool co-founder David Gardner is bringing in a trio of special guests to explain six terms that investors might not know as well as they think they do, or as well as they'd like to. Three will be relatively basic, and three will be more advanced. Listen in and find out if you know them all.
Also, one year ago, Gardner offered up "5 Stocks the World Really Needs Right Now," and he checks back in to see how that mini-portfolio is performing so far.
A full transcript follows the video.
This video was recorded on Feb. 21, 2018.
David Gardner: And welcome back to Rule Breaker Investing. A delight to have you with me this week. Thanks for joining in here toward the end of February.
Well, that was a really fun last week's podcast with special guest, Kevin Kelly, whom I interviewed at Motley Fool ONE San Francisco. What a wonderful opportunity to speak to somebody who thinks deeply about your future and mine, where the world is headed, and especially for us as Rule Breakers, let's try to get our dollars in alignment with that as best as we can see. So, thinking forward with your money is very Rule Breakery, and it was a delight to circle back with a great, I'm even going to say a Fool. I do think Kevin Kelly was very Foolish, himself, last week.
This week, now for something completely different.
We're going to go to a series. I'm going to call this the third in the series. The series is kind of "Gotta Know the Lingo." Investment lingo. It's about the educate part of The Motley Fool's credo to educate, to amuse and to enrich. It is my delight, every week, to try to do all three but in particular, this week, we're going to go with the Educate part by looking at some of the terms.
That's what we do in the series -- look at some of the terms that you might hear about and not fully understand. Or some new oncoming terms to get you thinking about the language of investing, business, and maybe technology, as well. To get you smarter about these concepts.
Now, I have three special guests. If you're a Motley Fool podcast fan, you'll recognize all of these voices as regular performers in front of the public. As we set up the stage every week for all our Motley Fool podcasts, you're going to recognize these stars, and I'm delighted to have each of them join me.
Each has prepared two terms, so we're going to go through six terms this week on Rule Breaker Investing, and for each of my guests they've brought one simpler one and one more advanced one. We're going to go with the three simpler, first, have a halftime show, and then we'll come back with our three more advanced.
Now, I guess it wouldn't be one of my podcasts if we didn't have some light game element. We have to gamify this a little bit, so please keep score of your performance as you listen to this at home, or while jogging, or driving. For each of the simple terms, give yourself two points if you already knew it, and one point if you're just learning it. If you've listened and learned.
And then for the advanced ones, it's going to be five for already knowing it and two if you're just learning it this podcast. So, feel free to keep score. Tweet it out, maybe, at RBI Podcast. Let us know your score after this week's podcast.
I should mention, since this is the third in the series, if you're interested in going back and hearing the first two, "The Language of Investing." That's what we called our podcast on Feb. 3 of 2016, "The Language of Investing." We didn't have the Gotta Know the Lingo name at that point but that, definitely backward, is Volume I. And then last year, March 8, 2017, Gotta Know the Lingo. That will be Volume II. So, this is Volume III.
I also want to mention that we have a special delight. At the end of this podcast we're going to review five stocks that I picked on this podcast a year ago -- "5 Stocks the World Really Needs Right Now." So, hang with us and you're going to find out whether the world needed these stocks or not. How they're doing one year later.
All right. Without further ado, let me introduce my first guest. My good friend, longtime Motley Fool co-conspirator Robert Brokamp.
Robert Brokamp: Hello, David!
Gardner: Robert, what a delight to have you. Of course, a lot of us know you from Motley Fool Answers, but I know you for your outstanding work for two decades on behalf of all kinds of investors at Fool.com and, in particular, people who are getting started, or people who are getting ended. And without being too silly about that, you have an outstanding way of speaking to people who are just beginning to get started investing, but also running our Rule Your Retirement service and a lot of articles about retirement, as well. Robert, thanks for joining!
Brokamp: It's my pleasure, David!
Gardner: What is term No. 1 this week?
Brokamp: Term No. 1 is "529 savings plan." It's a term some folks probably heard. It's named after a section of the tax code, an exciting way to name your various things. It's sponsored by states, but usually run, or at least co-run by a financial services firm. It's usually meant for saving for college, but there's a new twist that we'll get to in a second.
You don't have to participate in your own state's plan, but if you do, you might be able to get some sort of a benefit. Thirty-five states offer a tax deduction on the state income tax return if you participate in your state's plan, so that's definitely the first place to look if you're interested.
The great benefit of a 529 savings plan is that the money grows tax-free as long as you use it for qualified higher education expenses, meaning college, but thanks to the new tax law that was just passed, up to $10,000 can be taken out for qualified elementary or secondary school expenses tax-free. A lot of people are very excited about this.
One thing we should note, though, is that the new tax law just said you can do that in terms of federal free taxes. Not all the states are onboard, yet, with this, so before you take money out to pay for elementary or secondary school, check with your state to see what the tax status of that is going to be.
Gardner: And when I check with my state, am I just basically googling my state's name and "529 savings plan?"
Brokamp: Yes. Really, the best resource for information about 529s is a website called SavingForCollege.com. They're pretty good at updating the rules, but you definitely want to google your state treatment of 529 savings plans. Do it as Google News, because then you'll get the most recent article on that.
Gardner: And Robert, is 529 something that you put into play with your own family?
Brokamp: Yes. Each of my kids has a 529 savings plan, and now that I have three kids who are teenagers, we're getting to the point where I'm going to have to tap these accounts...
Gardner: It's becoming all too real.
Brokamp: It is becoming all too real, and there's a whole art to that in terms of how you invest it.
One of the potential drawbacks of a 529 savings plan is that when you participate in a plan, it's sort of like your 401(k) at work in that you only can choose from among a selection of mutual funds. You cannot invest in individual stocks in a 529 savings plan, which I know is disappointing for a lot of Motley Fool listeners. For those who really want to pick individual stocks, I would suggest that you consider the Coverdell Education Savings Account. It's got a much lower contribution on that. Only $2,000 where you...
Gardner: Are you previewing your more advanced term later? Is Coverdell coming back, Robert?
Brokamp: Well, no. I think the Coverdell is a good supplement, because you can do both. The good thing about 529 savings plans is they virtually have no contribution limits. You can pretty much put in as much as you need to pay for a kid's college savings.
Gardner: All right. Robert, would you use that term in a sentence?
Brokamp: Yes, and here it is. "If as soon as your child is born you open up a 529 savings plan, contribute $200 a month, and earn 8% a year, the account will be worth approximately $100,000 by the time your kid turns 18."
Gardner: Robert, I was thinking you would bring a silly sentence, but that one was pretty straightforward and educational.
Brokamp: Well, it's very surprising for such a thing to come from me, but yeah.
Gardner: OK. Thank you very much, Robert Brokamp, for getting us kicked off on "Gotta Know the Lingo, Vol. III." There's 529 savings plan. Again, fellow Rule Breakers, if you feel like you already knew that one, give yourself two. If you learned something from what Robert just shared, give yourself one.
And next up, my friend Abi Malin. I know Abi from my Motley Fool Stock Advisor team, but also Motley Fool Hidden Gems and a lot of other work throughout the company. Abi, how long have you now been at the Fool?
Abi Malin: It's about two and a half years, almost three.
Gardner: That's pretty awesome. A delight to have you and thank you for rejoining with me. You've been on Rule Breaker Investing before. You're a familiar voice to anybody who listens to Motley Fool podcasts. Is Chris Hill really as nice a guy behind the scenes as he purports to be in front of crowds?
Malin: Yes. In front of crowds, he always manages it very well.
Malin: Behind the scenes, he's a little bit more of a jokester.
Gardner: A little bit more of a jokester. OK. Well, that's good to know. These are the kinds of insights that I think each of us tunes into each week to this podcast to hear. Thank you, Abi! Slightly more seriously, what is term No. 2?
Malin: Term No. 2 is "customer lifetime value." We use this term a lot around Fool HQ, both internally and when we look at companies. It is the present value of the projected revenue attributed to the entire future relationship with the customer.
Gardner: LTV is the acronym a lot of people use in the field. Lifetime value. Roughly, Abi, when is this appropriate to use or look at? What kinds of businesses?
Malin: Certainly, subscription revenue businesses, but also businesses that aren't necessarily subscriptions, but have high order frequency and repeat orders.
Gardner: Now, for companies that are subscription businesses, if I'm listening to a quarterly earnings report or conference call, would this typically be a phrase that I would hear?
Malin: Occasionally you will hear this, typically because companies tend to highlight it when it moves in a positive direction, not necessarily a negative direction. It definitely influences a lot of decision-making.
Gardner: What are a few companies that you follow that would typically be using lifetime value? It's not necessarily my consistent experience that companies would put it right out there, like what the number is...
Gardner: ... but what are some companies that you think make good use of this tool?
Malin: I think one that's maybe not necessarily so explicit, like you said, but definitely something to watch would be Starbucks (SBUX 3.76%). They have a high margin, high frequency of orders, and really long customer relationships, which sort of offsets that really low price per drink. I think it's one to watch, there, that's kind of interesting.
I think conversely, on the flip side, somewhere you maybe wouldn't see, or wouldn't want to look at this metric is maybe like a mattress company. People only buy mattresses every five to 10 years, and it's not really so relevant there.
Gardner: Because we talked earlier about how lifetime value is typically used by subscription companies, it might almost be fair to say I do subscribe to Starbucks with the frequency and regularity of my visits -- maybe you, too -- but it is not technically a subscription company.
Do you think that Starbucks is sitting back there with their computers dialed in and knows exactly how much you and I have ever spent at Starbucks? And projecting forward, you're significantly younger. You look like a more attractive candidate as a lifetime value Starbucks customer than I am. Do you think that they're that numerical about it?
Malin: I absolutely think that they are, and when you look at their app for the phone, that is a perfect way to track all those frequencies and values, especially over time.
Gardner: So, lifetime value is a tool that enables companies to make probably better and better decisions about how to allocate their dollars. To whom to advertise, or what areas, or what times of life and not to, all focused on LTV.
Gardner: Abi, do you feel prepared to use LTV in a sentence?
Malin: Yes, I could use this in a sentence.
Malin: One company that I think uses lifetime value very strategically would be The New York Times (NYT 2.51%). We've seen them have a tremendous comeback in the past one or two years. I think this is one where you've seen their customer lifetime value grow for the past year as they institute higher prices and continue to increase their value per customer.
Gardner: That was an amazing sentence. That definitely had a semicolon or two, and I think it was off the cuff, which was most impressive, Abi. And I agree. Not only that, but you've previewed one of the five stocks that a year ago I said the world really needs right now, so we'll be reviewing later in the podcast how The New York Times stock has done. Abi Malin, thank you very much! We're going to have you back with the advanced term in a little bit. That was term number two!
All right. So, term No. 1, 529 savings plan. Term No. 2, customer lifetime value or LTV. Again, if you feel like, "I already knew lifetime value. I work every day slogging through LTV numbers," then go ahead and give yourself two points. If you're just learning it for the first time, give yourself one point.
Now there's a little bit of a controversy, already in this podcast, because my producer, Rick Engdahl, practically reached through the glass a few minutes ago, off air, and said, "Dave, shouldn't we be giving them more points if they're learning it?" So, for now, I'm going to say, "I don't know, Rick."
I'm going to say this. Go ahead and give yourself two plus one points, three points, if you feel like it's more important to you to show that you learn and score bigger. Then, yes, it will confuse what's put out there on Twitter after this podcast because I know everyone's going to go right to Twitter and say @RBIPodcast, here's how many points I had, and we might see some inflated scores because of the controversy, but this one may not get resolved this podcast. We might have to hash it out over mailbag next week, or if anybody has a strong opinion.
All right. It's time for term No. 3 and guest No. 3, Sarah Priestley, who a lot of us know if you're a regular Industry Focus listener. I certainly am. Sarah's work in energy and the industrials is a delight every week. Sarah, welcome!
Sarah Priestley: Thank you very much for having me!
Gardner: I'm delighted to have you. This is our first time that we're getting to experience each other in the podcast studio, and Sarah, you've already made a confession. You described yourself as a "consummate over preparer."
Priestley: Yes, I do a lot of efficient productivity time by over preparing, so pretty much everything.
Gardner: And that was like an apology that Sarah gave us. She walked in and I think all of us -- Rick, and Robert, and Abi -- all of us agreed that we don't have enough over preparation at Fool HQ. So, this is maybe the future of our company. Diligent. People who actually work hard and do great work. Sarah, a delight to have you join with me. And what is term No. 3?
Priestley: I'm going to squeeze three terms into one...
Gardner: This is definitely innovative.
Priestley: ... and do "upstream, midstream, and downstream" in the oil industry, because I see a lot of people using it all the time, and often people within the industry don't actually know what falls into these definitions.
Gardner: Now, I might already be one of those that's not going to be able to award myself the two points for being smart about this, because I feel like if even people in the industry don't get this right, Sarah, I don't even want to take a guess at it other than we're talking about how energy reaches us. At what stage it's channeling where it's coming from. Let's start with upstream.
Priestley: Absolutely. Upstream is sometimes called the exploration and production sector, or a factor of E&P. The segment in the industry finds and extracts crude oil and natural gas. They do the geological surveys, they apply for the permits and leases. They search for underground and underwater reserves. They drill the exploratory wells. But they also are responsible for -- once they've found those -- managing and operating the wells so will then bring the crude oil from the ground.
Gardner: Now what is it about the phrase upstream that denotes that?
Priestley: Essentially, the closer you are to the end consumer, the further downstream that you are. Essentially, you're furthest away. You're at the upstream.
Gardner: Thank you very much. I have had some very bad upstream stock picks in the last few years, Sarah...
Priestley: A lot of people have.
Gardner: ... as the oil price -- especially my underwater explorers and others. It hasn't been a great time, although the last six months, it seems like energy and the oil price has been picking up. Around $70 a barrel...
Gardner: ... for a little while, there, so that's been interesting.
Priestley: And there's a lot of opportunity, there, because as you said, people have been fleeing the area, the sector. It's definitely a high-risk, high-reward element of the oil industry. I think if you want a more medium, low-risk, then the midstream, which we're going to talk about next, is definitely where you'd want to allocate your dollars.
Priestley: Midstream is essentially the segment that includes all the infrastructure that's needed to move unrefined oil and gas over long distances. This is pipeline, pumping stations, terminals, rail tank cars, tanks, ships, and trucks. It covers a huge amount, and it also bleeds into upstream and downstream, depending on the kind of company you're talking about and things like that.
And given the commercial success of U.S. shale, which we saw boom 2012, 2014, and we've seen the whole result of that with the collapse of oil prices, midstream has become more important. You've got the Eagle Ford and Permian Basin. They're in Texas, so they're close to refineries, but a lot of the deposits -- Marcellus and the Appalachian Basin, South Dakota, Colorado, and Nebraska -- we're aiming very, very far. You're talking thousands of miles.
Gardner: Did I not read that thanks to shale, the U.S. is poised to become the world's No. 1 oil producer.
Priestley: Absolutely, yes.
Gardner: I couldn't have expected that 10 or 20 years ago when I first started The Motley Fool. Sarah, how long have you been at The Motley Fool?
Priestley: Almost two years. Not very long. I'm still a baby.
Gardner: It's a delight to have you. Let's go to downstream.
Priestley: Downstream refers to companies that refine crude oil and transform that into raw materials which we use for a myriad of useful substances. The one that comes, obviously, straight to mind is petroleum for our cars. Not your car -- much more green -- but they own oil refineries and petrochemical plants. Distributed and retail outlets.
This part of the chain is crucial to a lot of different industries. Petrochemicals are used to make rubber, asphalt, fertilizers -- a lot of things that people don't consider -- and downstream is a margin business, so you're essentially hedging on the difference between what you can sell the refined products for, for what you bought the crude oil for, which means it tends to do well, actually, in a low crude oil environment.
Gardner: Sarah, what's an example... I didn't speak to midstream. I should briefly say I've also made at least one pretty bad stock pick midstream, because Kinder Morgan has been a real underperformer despite an attractive-looking dividend a few years ago when I first picked it. But what is a downstream company or two that is of note?
Priestley: So, Phillips 66 and Valero are two that spring to mind. I can definitely empathize in the midstream sector, but I would say that TransCanada looks great right now with the boom of liquid natural gas. So, if you're bullish on that, then.
Gardner: Awesome. Sarah, are you prepared to use one or more of your three terms that you somehow made one term in a single sentence or three?
Priestley: Yes, I'm actually going to call myself out. I'm completely guilty of not being very accessible, so on last week's Energy show, I said, "Rising profits upstream from crude oil sales but narrowing downstream margins." And what I meant by that was that the extractors are experiencing booming profits because obviously they're getting more per barrel of crude oil.
And downstream they're being pressured because, as I said, downstream tends to do well in a low crude oil environment. As these prices come up, you can't necessarily recover all those costs from the marketplace so quickly. You have to be kind of a slow increase, so, yes, it's pressuring margins of the refineries.
Gardner: Sarah Priestley, that was awesome! Thank you very much! Now, there's going to be more controversy about how to score our own personal performance, because on the face of it, if you feel like you already knew those terms -- and I don't think I could say that I did -- but if you did, you would get two points. And if you learned from Sarah, you would get one, but you've learned up to three terms, arguably, from Sarah, so I'm going to say that you can give yourself three points if you already knew all three, and if you learned, then go ahead and give yourself two points.
But if you're part of the Rick Engdahl school, then go ahead and give yourself three points on top of that, so give yourself five points. And if anybody is even still counting points, then you are a better Fool than I know.
Quite seriously, we're going to keep keeping score. Thank you very much, Sarah!
Gardner: Now, earlier in this podcast I did promise at this point, the midpoint, we would have a halftime show. Robert, what do you have for us?
Brokamp: A wardrobe malfunction. How's that?
Gardner: A wardrobe malfunction. That's something that's really only available for the people watching this podcast on video. I'm going to apologize right now to you if you're only listening to this on iTunes, Spotify, or one of those podcast sites. Robert, a remarkable wardrobe malfunction. Thank you so much for sharing that with our video watchers.
It is now the end of halftime, so we've covered three of our six terms this week on
"Gotta Know the Lingo, Vol. III." We're now moving to our more advanced terms, so for each of these, and each of my guest stars, they're going to be bringing a little bit more lumber. Go ahead and give yourself five points if you already felt like you knew these terms, or two points if you're learning them along with me. Robert, what is term No. 4?
Brokamp: It's "asset location." So, not asset allocation, but asset location.
Gardner: I feel like you're either being cute with the planned words, here, or this is a hardcore phrase.
Brokamp: This is a real thing.
Gardner: OK. I think a lot of us would say we know asset allocation. Where you're putting your dollars. How you're doling them out, some to this stock, or some to bonds and not stocks. Or whatever it is, it's how you're allocating your assets. Let's talk about location, then.
Brokamp: So, you've decided how much to have in various assets. Which investments you're going to buy. The next decision you have to make is in which accounts. You might have a taxable brokerage account. You might have a traditional IRA. You might have a Roth IRA. You might even have a Coverdell or some other type of account. Each different account has different tax characteristics, and each of your investments has tax characteristics.
Gardner: I see where you're headed here.
Brokamp: So, determining which investment should go in which accounts is the art of asset location.
Gardner: So, Robert, this immediately begs the question. How many accounts, either, do you have or do you think we should have? Or, what is the average number of accounts held by an American, if you know something like that answer?
Brokamp: The last I heard, the average person has between four and eight accounts. And that depends on, first of all, whether you're single, or if you're married, and if you have kids because, as we discussed, if you have kids then you probably have some other accounts. But you probably have your 401(k) at work. You probably have an IRA. You might have a 401(k) at a previous job. Then you have your spouse's account. So, we have multiple accounts that you have to make these decisions about, and which investments they should go in.
Gardner: Robert, what would be a typical example of an awesome asset location, and then what would be a typical mistake made by people who don't listen to this podcast and learn important concepts like asset location.
Brokamp: There are a few key principles of it, and one is basically to rank your investments and investment strategies according to tax inefficiency, and then you take the investments or strategies that really would cost you a lot in taxes and make sure those go in your IRAs and 401(k)s.
As an example, let's say you own an actively managed mutual fund that has a lot of turnover. In other words, the fund manager is doing a lot of buying and selling generating a lot of taxes. It happens.
Gardner: I probably don't want to own that fund, but it does happen.
Brokamp: Right, so if you have one of those, you should put it in your IRA or your 401(k). Compare that to a stock that you plan to hold for decades, and it doesn't pay a dividend. You can own that stock for 30 years and you'll never pay a penny of taxes on that until you sell. And then when you sell, you'll pay long-term capital gains, which is a lower rate than what you'd pay if you were taking that stock out of your traditional IRA. That's one example of how you would take a look at your investments and decide in which type of account they should go in.
Since you asked for a mistake, one mistake people make is they think OK, I'm just making the decision between the taxable account and the IRA, but they then don't compare whether what they should put into the traditional IRA and the Roth, assuming they have that. What you should do is take a look at your investments and think which investments have the highest potential return. Of course, you never really know, but generally speaking you might think that this collection of stocks is probably going to outearn this other collection of stocks.
Gardner: Maybe, for example, five stocks the world really needs right now.
Brokamp: A perfect example, David! A perfect example.
Gardner: All right, good. I'm with you now.
Brokamp: You would put the ones that you think have the highest potential in the Roth, because the Roth is the account that when you take the money out in retirement, it's tax-free. That's the best account, so that's the account you want to grow the most, and you'd use your traditional 401(k) IRA for investments that still will be growing, but that you don't expect to grow as much. It might be just your standard index fund, or it might be your bond fund, or something like that.
Gardner: All right. Robert, before I let you go, I want to make it clear. Plus five points if you already felt like you knew asset location and, in this case, practice it well, because I don't think you should give yourself five points if you knew it, but you're not doing a good job with it. Two points if you're learning it for the first time.
Robert, before I let you go, would you please use that in sentence?
Brokamp: Yes. According to one study, investors can increase their after-tax wealth by as much as 15% by practicing smart asset location.
Gardner: Excellent. And speaking of smart, I think the Motley Fool Answers podcast makes a lot of often new Fools, but sometimes dyed-in-the-wool Fools smarter every week. Robert, there's an unlimited opportunity, right now, to promote something about the Answers podcast that maybe is up-and-coming or gives us a little insight into Alison's personal life that you would never do so. Throw us a bone, Robert Brokamp, is what I'm trying to say.
Brokamp: Alison is an open book. She does not hold back on the show. Let me tell you that much. I will say what we used to do is answer a listener question in the beginning of each show, and then get into what we call the meat of the podcast. We've now switched it so that the first three episodes of every month we cover the latest. Some things we've read about in the news, as well as some media topic, and then the last episode of each month is our listener mailbag. That will be our next episode. The last episode of every month -- that's where to send in your questions and we'll try to answer them on the air.
Gardner: Awesome. Thank you very much, Robert Brokamp, for your and Alison's wonderful work with Motley Fool Answers. Now it's time for Abi Malin. Abi, welcome back!
Malin: Thanks for having me!
Gardner: You are going to bring a term, here, in our more advanced portion of the show that does relate to the initial term that you brought. Briefly reviewing, term No. 1 was 529 savings plan. Term No. 2 was customer lifetime value. At No. 3, Sarah bringing upstream, midstream, downstream. Robert just threw down asset location as term No. 4. Abi, what is term No. 5?
Malin: Term No. 5 is "customer acquisition cost." This relates pretty well to my first term, which was customer lifetime value. Customer acquisition cost is the amount that the company spends to attract one new customer.
Gardner: Now LTV is an acronym that people often use for your first term. Have you seen CAC out there? Do people say "the cack"?
Malin: I don't see it as commonly, but I know in my own notes I abbreviate it that way. I don't know if it's an industry standard.
Gardner: So, customer acquisition cost is, again, often in there for subscription businesses like The Motley Fool. That's something that we use here at The Motley Fool. We ask how much does it cost us to find a new Fool, whether we're advertising on the internet, or baking in all the costs of any given business. Now, we used Starbucks earlier as an example. Do you want to use Starbucks as an example of this one, or do you have another company or insight in mind?
Malin: I think one that's interesting -- a lot of new IPOs have sort of centered around these subscription businesses. So one that jumps to mind is Blue Apron. And I think at the time they filed their IPO, management estimated that customer acquisition cost was about $94 per customer. And we've seen that stock really struggle since they went public, and analysts have said that they think that number is more around, like, $400.
Gardner: I have to admit. I'm aware of Blue Apron. I haven't followed it that much. I have heard some, I think, appropriately bearish commentary, maybe from you, but certainly some Motley Fool analysts about that. It's not a stock that we've picked in Motley Fool Rule Breakers or Stock Advisor. But the company may have undershot its own estimate of the acquisition cost of its customers by 4 times?
Malin: It's a little bit more complicated than that. The general formula for calculating customer acquisition cost is sales and marketing expense attributed to new customers divided by net new customer count. So, it really depends what they consider a new customer vs. actives vs. inactive. It can vary based on what you consider a new customer vs. just retaining or re-enticing customers to order another box.
Gardner: Now, I have to believe that for digital businesses, it's going to be a little bit easier to make this calculation. I think at The Motley Fool, we have a pretty clear sense of what it would be for any given quarter or, more importantly -- who cares about our company -- how about Netflix, a great stock for a lot of us. Netflix, it seems, does a pretty good job talking about its acquisition costs and measuring that. Is it fair to say that digital businesses probably have it easier?
Malin: I definitely think digital businesses have it easier. I would think internally most companies have this unlocked, but it's a matter of when you're an analyst and you're reading transcripts, or 10-Ks or 10-Qs or whatever it is, sometimes you have to make a little bit of assumptions.
Gardner: Awesome. Abi, are you ready to use "customer acquisition cost" in a sentence?
Malin: Yeah, I can do that.
Gardner: Go for it. Now, is this going to be one that you've written down ahead of time, or are off the cuff just killing it with another long, but educational sentence?
Malin: To be honest, all of my sentences included my examples of companies, so this is off the cuff, but I can wing it.
Gardner: Awesome. Go for it.
Malin: I guess connecting my two ideas, oftentimes when we think about subscription companies, we like to look at ratios, so, customer lifetime value to customer acquisition cost. So LTV divided by CAC, typically that's a ratio that we like to look at, especially as it trends over time. Our goal is that that ideal ratio should be about 3-to-1, so lifetime value of a customer should be three times the size of the acquisition cost. If it's less than that, it means the company is spending too much and if it's more than that, it means they're spending too little.
Gardner: Period. Full stop. Again, good uses of semicolons. But much more seriously, Abi, that's really helpful, so that ratio, 3-to-1, is kind of what you're shooting for as a business.
Malin: The golden ratio.
Gardner: Golden ratio. Abi Malin, thank you very much! Would you like to promote any aspect of your own work coming up in the next month? Are there any stocks that you're researching that you can talk about behind the scenes for our services? Or, maybe you're going to be on Market Foolery and you're going to say something later this week.
Malin: Our Hidden Gems rec is coming out on Thursday, so I'm excited for that.
Gardner: Awesome. Thanks, Abi!
Malin: Thanks for having me!
Gardner: All right. As we get ready for our final term, term No. 6, do tot up your score in your mind. Remember -- plus five if you'd already known customer acquisition cost. Maybe even knew Abi's golden ratio. Give yourself one more if you knew Abi's golden ratio -- six. I didn't. If you just learned that term for the first time, please go ahead and give yourself two points, although if you're in the Rick Engdahl school of scoring, that actually might be worth seven, not just two or three. So, I know you have a specific idea of your score in mind, and that's going to be important because Sarah Priestley, you've got term No. 6 for us. What is it?
Priestley: "Inventory turnover."
Gardner: Inventory turnover. The way that you said it with your British accent, it sounded almost like "infantry" turnover, which...
Gardner: ... would be a very bad thing, don't you think?
Priestley: Yes, probably I don't enunciate. Inventory.
Gardner: No, you do great, but infantry turnover would be troubling.
Priestley: It would be very troubling.
Gardner: That's something that we're not looking to promote, or do, or make happen on this show. More seriously, Sarah, inventory turnover. I got it. Define it.
Priestley: It's an efficiency ratio. It measures the rate a company purchases and then resells products to customers. In its most simple form, that's what it is. And you can work it out one of two ways. One is market value of sales divided by ending inventory. Or cost of goods sold divided by average inventory, and this is what I would say is the preferred metric because average inventory accounts for seasonal fluctuations. So, if you're Canada Goose, for example, which is heavily reliant on the winter season -- it sells big parka coats -- then you're going to want to rule out, you're going to want to flatten some of those peaks and drops.
Gardner: So, you've already given us two ways to think about or calculate it. I want to take a step back. For those of us who didn't have an accounting course, or don't work in this field full-time, this is a more advanced term or concept. Sarah, when we talk about inventory turnover, why would we bother measuring that? What is the usefulness of that if you're looking at financial statements or thinking about a business?
Priestley: I like to use it, especially within the industry that I cover. On the Industry Focus show we look at a lot of industrial companies, and it's hugely important to see how well, especially in manufacturing, your production planning is. So, a low inventory turnover implies weak sales.
This could be due to a poor performing product line, bad marketing, production bottlenecks; but, the issue with this is it leads to excess inventory, so for any business that handles any physical item, excess inventory is a bad thing, because there's a holding cost to old inventory. In manufacturing, it's work in progress, and that capital could be better allocated. Elsewhere in retail, especially fashion retail, once you've gone past the season those items become obsolete, and you have to reduce the margin.
So, high turnover, conversely, generally implies good sales and efficient production planning. It also means that the company is at less risk of being stuck with a load of inventory and that they're replenishing their cash quickly. These tend to be the companies that are more responsive to changes in customer demand. They tend to be more nimble.
Gardner: I know we have a lot of entrepreneurs listening to this podcast, and a lot of you, obviously, are familiar and thinking about inventory turnover. A big story over the last 20 years has been that you have to have more inventory if you have a bricks and mortar store. If you have a physical presence, you're required to have more inventory. And if you do -- if you're Walmart or somebody else -- you want to get as good as possible at identifying what should be on the shelves and turn it over as fast as possible.
Again, I know a lot of entrepreneurs are going to be familiar with this concept. But for those who aren't, Sarah, I know that you came to us from Rolls-Royce, right?
Priestley: Yes, absolutely. We used the metric a lot. It was something that I was driven to on the shop floor to make sure that we had, they call it turns. You want as many turns per possible per quarter per year.
Gardner: And what would it be for an automobile company?
Priestley: For an automobile company -- I was actually looking at these figures before I came in for my example -- a great example is Ford (F 1.71%). I think they had 10.9 turns per quarter. That equates to something around six days. It takes them six days to take one item from nothing, create it, and ship it to the customer.
Gardner: Which sounds remarkable to me. It makes me think my Ford shares should be doing better than they have over the last five years.
Priestley: Yes, it's all that debt. But the important thing, as you mentioned, is Walmart would want extremely fast turnover, and then it's slightly different for automobile manufacturing companies. You have to apply it to the context of the industry. It has to be apples to apples, so don't compare automotive to grocer if you're trying to make an investment decision.
Gardner: It is all relative. Looking even more broadly, like over the last century, is it a fair generalization to say that inventory turns have gotten faster in business because of all the logistics we have today and the digital?
Priestley: Absolutely. Definitely. And in manufacturing, which I keep on harking on about, but in manufacturing, particularly, the rise of just-in-time, lean six sigma has really revolutionized how quickly we can extrapolate things out to the customer. And as you quite rightly said, digital. The thing that it has enabled us to do is just get so quick with the supply chain.
And one thing to really focus on with this -- if you're looking at inventory turnover and it seems like they have an exceptionally good inventory turnover, so they turn over a lot of stuff very quickly -- is that could be a bad sign because it could mean that they have poor purchasing planning, so if they're leaving money on the table by essentially every time that they supply the end retailer it sells out straight away, then maybe we need to address that, too.
Gardner: I see that. If the shelves are bare because people keep buying the stuff and they're not supplying enough, it might look great from an inventory turnover standpoint, but not a very good business.
Gardner: Sarah, are you prepared to use this in the final sentence for this week's podcast?
Gardner: Is it going to be like one of Abi's sentences with semicolons, or is it a consummately over prepared, beautifully written English sentence?
Priestley: I don't know that I would say, but I'll do my best. Judging on inventory turnover, Ford stock looks slightly more efficient than Tesla (TSLA 1.24%) stock, as Ford has six days. Tesla has 20 days.
Gardner: Wow! That's really interesting. We hadn't preplanned this, but Tesla is also arguably one of five companies the world needs right now, which is where we're headed next, so that was a perfect transitional element. Sarah, before I let you go. Industry Focus. I'd love to know what you're thinking about, either with your next podcast or in the month ahead or so. Where are you headed with Industry Focus -- Energy and Industrials?
Priestley: Not to over-inform people, but yesterday they were telling about Tesla's earnings. They had a really interesting quarter and we're going to kind of break that down. And then the following week, we're hopefully getting in a guest speaker to talk about the changes, the legislation that's coming through on infrastructure spending, which could be revolutionary for a lot of companies in the U.S. There's been a buying up of a lot of infrastructure companies in preparation for this, so it will be interesting to see what happens.
Gardner: Fascinating. Well, I really enjoy your work, Sarah. Thank you to all the Industry Focus podcasts we have. Sarah Priestley, this week, but each of the days of the week has a different host with a recurrent industry or theme, and it's a delight to have you this time. Thanks, Sarah!
Priestley: Thank you!
Gardner: All right, and now as promised at the close let's review five stocks the world really needs right now. Now, that's a podcast. You can go back and listen to it since I'm proud of the work. Feel free to go back. It was last February. You'll see February 2017 when we were talking about the world and trying to match stock picks to where the world was headed, which is arguably what I try to do every week on this podcast or in our work at Motley Fool Stock Advisor and Rule Breakers, but very explicitly a year ago picking five stocks toward that. We're going to review them right now really quick because we're near the end of a fun show that had its center elsewhere.
Here are the five companies in alphabetical order and how we are doing. I want to mention that each of these was picked for the next four years -- I was saying four more years at the time -- so this is just the end of year one. Let's see how they're doing.
First of all, the S&P 500 -- our bogey, our competitor, our arch rival -- what the academics tell you, you can't beat. It would just be luck if you were to be beating the S&P 500 over any given period. The S&P 500 over the last year, since that podcast, up 16%. So, each of these will be compared against the S&P 500.
The first one up is Alkermes (ALKS 2.48%). Now, Alkermes is a company that made itself famous, buttered its bread on drug delivery systems partnering with other drug companies, and getting that drug from that drug company to your bloodstream or to your organ drug delivery systems. Began making its own drugs recently, focused on the life of the mind. Things like depression. Opioid, the epidemic. Alkermes is working that space. That's why I said the world really needs this stock right now.
A year ago, the stock was at $56.89. At the close of the day this podcast published, happy to say it's up to $67, now. That's an 18% gain. So, against the market's 16%, that's a plus-2% for ticker symbol ALKS.
A stock the world really needs right now, No. 2, was FactSet Data Systems (FDS 2.50%). FactSet in a world where there are a lot of questions about facts, and what's factual, and what's not. And talk about fake news, which was a recurring theme in this list of five companies. I really favor a company like FactSet Data Systems which puts the facts on the table for lots of companies.
You know, it's a lot easier when things are quantifiable. When you can put numbers to see what's fake and what's not. The things that are less quantifiable. The things that are based on words or suppositions -- that's a lot more possible to fake. But fortunately, ticker symbol FDS working within the numerical field bringing facts to the world every day.
The stock was at $179.82. Today it is tipping the scales right at about $201. So, not a bad year for FDS. Up 12% but unfortunately 4% behind the stock market over the course of that time, so of my five picks, here, this is the only loser to foreshadow where we're headed. Minus 4%.
The stock the world really needs right now No. 3. In alphabetical order the ticker symbol is GOOG. The company is, of course, Alphabet (GOOGL -0.21%) (GOOG -0.27%). Now Alphabet a year ago was at $818.98. Really happy to say it's just short of $1,100 as we tape here this week of February 2018. A year later it's up 34%, more than doubling the market's 16% gain. So, a nice plus-18% in the win column for Alphabet.
Alphabet, of course, the crown gem of Alphabet is Google. I like businesses where you can use them to find out the truth. Now, I realize Google sometimes gets blamed, because if somebody writes fake news out there and you use Google to find it, they might be getting paid for the advertising behind that, but that is a real minority of most of what Google does on a daily basis worldwide.
Google, as I said a year ago, its moonshots benefit humanity. This is a company, Alphabet, that is doing lots more than just Google, and I think it's a great company. In particular, I think it's probably the most innovative company of our time and innovation is something I think the world will always need right now. So, really happy to see that performance by one of the most widely held companies in all Fooldom.
Stock No. 4 that the world really needs right now, I said a year ago, was The New York Times Company. Especially its digital offering becoming more and more popular. Sometimes getting some criticism from people in the presidential administration which arguably has worked to The New York Times' benefit.
What I favor about The New York Times is that whatever you think of its politics or its brand -- and I respect it, even though I don't find myself always agreeing with it -- I like the efforts that they make to fact check, and "all the news that's fit to print." Again, while I may not agree with all of it, I respect the process by which The New York Times goes through and does what it does every day, increasingly digitally.
That's why I'm happy to say this stock, which was at $15.95 a year ago when we did the podcast is today at $25. Of the five companies, this is the No. 1 performer. NYT is the ticker symbol. Up 57% over the last year. So that's a plus-41% in the win column. I'll total all these up right at the end.
And finally, stock No. 5 that the world really needs right now. Sarah mentioned it briefly at the end of her presentation, and that would be Tesla. The ticker symbol is TSLA. The stock was at $279.76 a year ago, as we closed out the podcast, and today it's up from $280 or so to $335. That's a gain of 20%.
Now, of course, Tesla has made itself something that the world needs, not just through the production of its beautiful Model S cars, or the Model X, or the Model 3s that are increasingly starting to show up, but also has distinguished itself with SolarCity and, in particular, the Gigafactory as the company that dropped the name Motors from its name a year or two ago. Now it's Tesla, and it represents a wonderful, progressive thinking about where the world's headed using technology to better our lives. I think Tesla, indeed, has proven itself as a company that the world really needs right now.
All right, so some numbers here at the end. We've been scoring. This has been a gamified podcast throughout. I forgot to mention. At the end of those six terms if you listened, and are still listening to this podcast at the end of that, give yourself 37 points on top of what you were already scoring just for sticking with us all the way through.
And then my producer, Rick Engdahl, has suggested one additional scoring innovation, and that is if you bought any of these five stocks reacting to last year's five stocks the world really needs right now podcast, go ahead and give yourself... Rick's calling it the Golden Snitch. Go ahead and give yourself 150 points. So, tot up your scores and let us know how you scored on this week's podcast.
Now to close, those five stocks that we just reviewed. Again, each of them being compared to the market. The market was up 16%. These stocks were up 61% when you net their alpha together. What that really means is that each of them average outperforming the stock market by 12%. So not a bad first year. This group averaging a 28% gain against the S&P 500 16%.
Maybe I will humble brag. I'm not sure that I've ever once yet -- this is really lucky -- underperformed with any of my five-stock samplers in the two and a half years of this podcast. So, really glad to see this list of five once again beating the market and inspiring you and me to save more money and darn it, get it invested in stocks the world really needs right now.
After all, as I've often said, make your portfolio reflect your best vision for our future. And that's what you're doing, I hope, when you invest in companies like these, or whatever you think are the stocks the world really needs right now.
That was a fun podcast. Thanks for joining with me and my talented special guest stars this week. Next week it's mailbag, so send us your questions, RBI@Fool.com, or your comments. I love reading them. Rick and I read through all of them. We pick our favorites. We'll share them with you in our February mailbag next week.
In the meantime, Fool on!
As always, people on this 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. Learn more about Rule Breaker Investing at RBI.Fool.com.