iRobot Loses a Fifth of Its Market Cap -- but It's Fine

On today's Market Foolery podcast, Motley Fool analyst Ron Gross joins host Chris Hill to talk about a few of the market's biggest stories.

iRobot (IRBT -6.91%) tanked after earnings, despite a respectable quarter and its long-term horizon. Domino's (DPZ -0.48%), on the other hand, had some comparatively slow comp growth but popped 10% after their report.

Tune in to find out why, and which highlights to focus on in these quarterly updates. Plus, the guys dip into the Fool mailbag and look at the connection between the approximately 823 companies that IPOed last week and what might be a frothy market -- one that might remind some of us a little too much of the year 2000.

To catch full episodes of all The Motley Fool's free podcasts, check out our podcast center. A full transcript follows the video.

This video was recorded on April 24, 2019.

Chris Hill: It's Wednesday, April 24. Welcome to MarketFoolery! I'm Chris Hill. Joining me in studio today, for the first time in a long time -- for me, anyway -- Ron Gross is in the house!

Ron Gross: I'm here for Mac more so than for you. But I'm here for either of you. 

Hill: I appreciate that! We're going to talk restaurants. We're going to dip into the Fool mailbag. We're going to start with iRobot. This is, ladies and gentlemen, the latest lesson in always look past the headline. Always look past the headline! One of the headlines I saw this morning on iRobot, which is the maker of the Roomba vacuum cleaner, was this: "iRobot Tops First Quarter Earnings Estimates, Ups View on Tax Gain." Well, that's good! That sounds good!

Gross: [laughs] Yeah, well, but...

Hill: But, top line revenue was light, and shares of iRobot are down 20%. 

Gross: Yes. Everything that goes up must come down. This has had a fine run. It went public back in 2005 at $24. Reached a high of $130 in late February. Here we find ourselves a little bit back to Earth at $105, still very respectable. As you say, the big reason for the sell-off was just the fact that they were light on revenue as compared to analyst expectations. But overall, it was a fine quarter. There's nothing to freak out about if you're a fan of iRobot. Domestic revenue, up almost 7%. Stronger than expected demand for the high-end I7 and I7+ Roomba models. I don't have one. You don't have one, do you?

Hill: No. 

Gross: I don't, but they seem pretty cool. Interestingly, they were able to get away with price increases that they really had to implement to offset the impact of tariffs. Interesting to see how those tariffs actually flow through a business and create consequences for the consumer, actually, in this case, because of higher prices. International revenue, interestingly, up 12%. Japan, China, Europe, Middle East, and Africa all strong on the I7, I7+ sales. Really, a strong quarter. They continue to invest quite heavily in R&D, which is expected. Earnings per share up 10%. But now, here's where you need to look through the headline -- because of that tax benefit, that's really the reason we saw a nice increase in profits. If you strip that out and make adjustments, earnings per share were actually down 8%. But, again, nothing to panic about because they are investing heavily in the business. 

Overall, I think it's a fine quarter. They reiterated guidance. That should be an indication to investors that even though maybe revenue was somewhat light as compared to expectations, the company thinks everything is on track. Earnings per share guidance was actually increased -- but, again, just because of that tax benefit.

Hill: It sounds like a lot of this was due to the valuation. As you said, it's a fine quarter. Yeah, they were little light, they weren't dramatically light. They weren't "let's punish the stock to the tune of 20%" light, unless you look at this and you say, "This thing is trading at some insane multiple and it doesn't deserve it."

Gross: Right. It's actually not, it's only trading around 30 to 32 times earnings. 

Hill: Well, that's today. Yesterday, it was probably trading a little higher.

Gross: [laughs] Right, a little bit higher. But it's actually still not that bad. However, even at 10% earnings growth, giving them the benefit from the taxes, that doesn't support a 32 P/E. And if you strip that out and you actually see net income contracting, that certainly doesn't support a P/E that is somewhat significantly higher than the market's overall P/E. But it's not one of these crazy 100, 200-times high-tech companies. It's a consumer technology company with quite a strong installed base. They do need to keep coming up with better iterations, because this can get stale and growth will slow over time, for sure.

Hill: Interesting morning for Domino's Pizza. Same-store sales for Domino's in the first quarter came in at 3.9%. Let's face it, there are a lot of restaurants out there that would love to have that kind of same-store sales growth. 

Gross: For sure.

Hill: However, in the case of Domino's, that's the slowest comp growth they've had in more than five years. What happened this morning that the stock is up nearly 10%? It was a good quarter, but this has been such a great operator for so long, I was surprised to see the bump in this stock.

Gross: You nailed it on the head right in the question. Folks were concerned about the slowing same-store sales growth. That is bound to happen over time to almost any restaurant or any retail store. In this particular case, they actually weren't as bad as I think investors and analysts were expecting. You had global retail sales up 4.6%. U.S. same-store sales up 3.9%, as you mentioned. International same-store sales growth up 1.8%. Not knocking the cover off the ball, but certainly still positive. This is the 101st consecutive quarter of international same-store sales growth, and the 32nd consecutive quarter of U.S. same-store sales growth. That's very, very impressive!

They continue to open up new stores. There's always a concern about cannibalization. If you open too many, it's going to hurt the business. They opened their 16,000th store during the quarter. They think they can get to 25,000 globally by 2025. Still, if they're right, a large growth runway ahead of them. The way retail stores and restaurants make money is the combination of open more stores and have those same-store sales grow. In this case, Domino's continues to do both.

Hill: They're going to grow their store base by 50% in the next six years? That's their goal?

Gross: Yeah. It'll be largely overseas. There's a saturation in certain parts of the U.S., but they think they can get that done. And they'll kind of have to, probably, to really support the stock. We're at $295, high of $305, so it's a little bit off its high. What a run it's had, as we've spoken about many times, going back all the way to revamping their pizza and their menu. But at 30X earnings, they're going to have to continue to put up that earnings growth, especially when the median restaurant multiple right now is more like 24X. They're selling at a premium, which they deserve to do; but they've got to continue to put up the numbers to deserve that.

Hill: When Patrick Doyle stepped down as CEO of this company, he had such a phenomenal run, I think it was 10 years he was in the corner office. Did such a great job. Really turned this business around. One of the things we said at the time was, "Well, good luck to whoever comes next, because that's a really, really tough act to follow." 

Gross: For sure. 

Hill: And Rich Allison comes in as CEO, and he's off to a really great start. He said something on the call this morning that caught my eye. He was being asked about all the different delivery platforms that are out there. He said, and I'm quoting here, "I don't see any need for us to go onto third-party delivery platforms. It's not clear why I would want to give up the franchisee's margin or data in the business and give it to someone who would ultimately use it against our business." First of all, good for him!

Gross: Yeah, I agree. 

Hill: That's absolutely the right move for them because they do have not just the installed base of franchises, but the delivery system as well. I don't want to say they can afford to do that, but they've earned the right to do that. It really seems like the smart move.

Gross: Smart move. He's really brought the company into the digital age. The former CEO got the company from a franchisee perspective on the right path, from a menu perspective on the right path. Now, the company has done a fantastic job digitally, whether it's mobile or online. Now, they just have to make sure that the delivery experience is appropriate. Make sure that those drivers don't get into car accidents, as literally was happening 20 years ago because they had that 30 minute guarantee. You had to be careful about that. But they want to make sure that the delivery times are appropriate, that the customer experience is a strong one, that the ordering experience remains easy. So far, they're doing all those things.

Hill: You ever order Domino's?

Gross: Yeah, sure. Actually, Papa John's in my household -- not for me, for my son -- is more prevalent. As we've spoken about, they have their own issues. Starboard Value is attempting to turn those guys around right now. Don't sleep on that, because Starboard really has a great track record of coming in, especially with restaurants, and getting things done. I'm a New Yorker, those pizzas don't necessarily do it for me, but they're both very easy. 

Hill: [laughs] I do like the thin crust that Domino's offers. We don't order it that often, but when I do, that's what I go with. 

Our email address is [email protected]. Question from Dr. Clifford Roads in Maui, Hawaii. 

Gross: Good for you, Doc!

Hill: Let's just go hop on a plane, we'll answer his question in person. Just because. The good doctor writes, "The market is up dramatically and so are IPO offerings. Is there any historical correlation between market tops and an increase in IPOs?"

Gross: Correct. We've had a flood of IPOs. Mostly strong ones -- Levi's, Pinterest, PagerDuty, Jumia, Lyft, which was good and then not so good. We've got Uber coming. But I don't think it's really a cause and effect thing. I think what happens is, behind the scenes, investment bankers want to take companies public when the time is right and when they will go well. That often happens during strong markets, sometimes market bubbles, or in this case, I think late-cycle bull markets is what we're seeing. A lot of these companies could have probably gone public last year, but then the markets got really weak in December, and I think some of them were probably put off. Now, you see a flood of them trying to get in under the wire. By the way, investment bankers are really like to go to the Hamptons in the summer, so you're not going to see a lot of IPOs happen in the summer, either. 

You want to try to get most of these in either before or after the summer. It's just the way it works. [laughs] 

I do think it's probably somewhat of a contrarian indicator when you see investment bankers and companies trying to quickly get their IPOs in because they're fearing that a slowdown could be coming. That could be a reaction to December being a mess, and everyone saying, "Oh, gosh, I'm never going to get my company public. I missed the window." And now that the windows back, we won't miss it this time around. So you see people flooding the markets. 

Hill: We did see reports at the very end of 2018 and early in 2019 about some of these IPOs that you're talking about being moved up, in terms of their timetable. The front half of 2019 was going to be a bit more loaded than originally scheduled. I will say, to his question, it does make me a little nervous. 

It's like, look, market tops are great. It's great to see your stock at an all-time high. It's great to see the market at new highs. But the combination of market highs and... and I understand it. I understand why, strategically, it makes sense for these companies to go public when they're going. But it does lead me to actively fight against a little bit of nervousness because I so vividly remember 2000. [laughs] 

Gross: I think that's perfectly fair. What's also interesting is, when you see these big 50% increases on day one of these companies, it means the investment bankers are underpricing these IPOs. The investment bankers see the supply and demand for the stock before they price the stock. Sometimes even, they'll go higher than the price rating indicates by a couple of bucks. But they know that they're going to get a huge increase on day one, or at least they should know, or perhaps they see softness, occasionally, as well. So, these companies are actually leaving a lot of money on the table when they go public, and then after the fact see a 50% pop. It's still good if you're an insider and you own tons of shares, but as far as the company raising as much money as possible, it's not necessarily that great to see a 50% pop on day one. But it does speak to, once again, the only reason that stocks go up and down, supply and demand. Right now, there is still quite a strong demand for these IPOs.

Hill: Is there an optimal number when a company goes public that makes everybody happy? The investment bankers are happy, the company is happy. A 15% pop? 20%? What is it?

Gross: Fifteen percent used to be the rule of thumb -- 15% discount keeps the stock strong. You don't want a stock to break its IPO price anytime shortly thereafter the IPO. That's a weak job by an investment banker --

Hill: Hashtag-Lyft. 

Gross: You'll often see even investment bankers and traders in the market supporting a stock, buying a stock and taking a stock into inventory, that is perhaps weakly trading because you don't want to be the investment banker who takes a stock public and then sees the price break the IPO. I think 15% is nice. These high-tech companies, typically the ones that are strong, go up significantly more than that.

Hill: By the way, you mentioned the low -- maybe not the low, but certainly the Christmas Eve low. [laughs] The volatility in December. Since the Christmas Eve low, S&P 500 up 25%.

Gross: Strongest first quarter in 10 years, and it continues. It's wonderful to see. I'm not going to complain. I like to see my brokerage account go up as much as the next guy. We know these things don't last forever. And as Fools, we should be OK with that because we know as long as we're long-term buy and hold investors, it always comes back. It always has, anyway.

Hill: Ron Gross, thanks for being here!

Gross: Thank you!

Hill: As always, people on the 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. That's going to do it for this edition of Market Foolery! The show is mixed by Dan Boyd. I'm Chris Hill. Thanks for listening! We'll see you tomorrow!