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This Investment Lesson Proves the Value of Disruption by Simplification

By Motley Fool Staff - May 14, 2019 at 9:57AM

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When it came to building a better gym company, Planet Fitness showed that subtraction is the best addition.

That which humans collect, we have a natural urge to categorize. Books, rocks, baseball cards, whatever -- and stocks are no different. Some we classify as "growth stocks," because their revenue -- and, hopefully -- earnings are rising relatively rapidly. Others are viewed as "value stocks," because based on the fundamentals, they look underpriced. If the business has been in the habit of distributing solid, often rising dividends, it might get called an "income stock."

And then there are "story stocks" -- the ones that are trading less on their current numbers, and more on the narrative that investors and the media have built to describe why eventually, the revenue and earnings will surely arrive. Paint a compelling enough picture, and investors will bid your company up on hope and faith.

But Motley Fool co-founder David Gardner sometimes takes a different view of the "story" concept -- he prefers to think about the way occasionally, an addition to your portfolio creates a story that's unique to you, and that clarifies a specific nugget of investing wisdom.

In this episode of Rule Breaker Investing, he invites several of his colleagues into the studio to share some of their favorite "stock stories" and the lessons they learned from them. For this segment, his guest is analyst Rick Munarriz, who recognized that the gym chain Planet Fitness (PLNT 4.25%) might just be on to something with a business model that dumped most of the stuff that rivals were using to attract customers.

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 May 1, 2019.

Rick Munarriz: The title of my story is "Subtraction Is the Best Addition." And the story starts with a guy by the name of Chris Rondeau. And he's a college student. He loves to work out, he had his first gym membership when he was 16 years old. So he starts working at the front desk of basically an old gym that was failing, it was bought out by two brothers. And it's sort of fashioned as the very first Planet Fitness. This is in rural New Hampshire, a city called Dover, population of about 30,000. They want to differentiate themselves from every other gym. Even in a town with just 30,000 people, there are a lot of places to work out. So they basically say, "We're going to work on price because that's always been a pressure point for people. We don't want to be just for die hard gym workout people. We want to go in and give them a good price." So they get a low price.

But then they found in just a matter of time that instead of becoming this popular mainstream gym, they wound up attracting all the cheapskates at the other gyms. So they said, OK, we don't want that. It's not that we don't mind the lugheads, as they say, the guys and women that really like to work out and pump iron and grunt while they're doing heavy workouts. But that really wasn't what they wanted to be about. So they got rid of the heavy weights. Then they got rid of the smoothie bar. Then they got rid of the day care center, which was going to be controversial. But at the same time, they also got rid of the fitness classes. So all the stuff that your LA Fitness and whatever major fitness brands value with the traditional gym/fitness center, they said, we're not going to do it, we're just going to have great exercise equipment, it's going to be awesome, and we'll just charge $10 a month for it.

And right away, it resonated. It just started picking up steam. It's not one of these costly things, it's not a hard sell. They're not trying to set you up with a fitness trainer or some long interview. They don't tour you around the place, trying to sell you stuff. There's no smoothie at the end of the day, though they do have free pizza days every once in a while.

And then along the way, this Chris Rondeau, he becomes a club manager, then he becomes a regional manager, then a VP. And in 2013, 20 years after he was checking memberships at the store, he becomes a CEO.

David Gardner: How about that?

Munarriz: Planet Fitness went public two years after that. They went public in 2015. I always look at new IPOs, and this is company that intrigued me, even though I'll admit, I'm an LA Fitness member, only because they're about two blocks away from me. I'm know I'm speaking from the wrong side of this argument. But I really enjoy what they're doing. And most impressive to me was how fast they were growing. They have a couple of company stores, but it's mostly franchisees who are pulling the weight here. That was in '16, and they paid out like a $2.78 a share dividend just a year later to distribute stuff as things went out.

But then the company, when we discovered it on the Rule Breakers end on the Supernova side, the stock was actually just about where it was when it went public. So this wasn't some scintillating hot stock out there, I think was actually below the IPO price when we first recommended it. Ever since then, the stock's been on fire. I mean, this is a stock that's basically more than quadrupled since going public. It's at $75 now. This was a stock that was at $16 four summers ago, and even lower than that. It was a broken IPO for a while, and it's clearly done everything right.

The most impressive thing to me about Planet Fitness is their comps. You're thinking, comparative-store sales, it's a term you usually see with restaurants or with retail stores. But it's important for gym memberships, because this is an industry where people say, "Oh, it's fickle. People sign up over the holidays. They overeat, in January, they have a New Year's resolution." In Time Square, Planet Fitness was a sponsor there right when the ball dropped, there was a big Planet Fitness billboard over the New Year's this year. But it's not the case with Planet Fitness. They've had 48 consecutive quarters of comps [growth]. So we're now up to 1,742 Planet Fitness gyms located around the country, and they're starting to expand internationally, on a small scale. But this is the same company, the guy who basically started working the desk at one gym is now running the company that's now 1,742.

And revenue keeps growing. It's double-digit consistently. Last year was its strongest growth in more than four years, with earnings growing even faster. So basically, here's a company that could disrupt the gym system to make it accessible to the 80% of people that wouldn't be caught dead in the gym or signing up for these $60-a-month memberships that are high-pressure, and you're just looking around and saying, "I don't feel good about myself, everyone here looks so much better than me." They have posted across all their gyms "judgment-free zone." They basically try to police that. They know that they're cashing in on young people that are very health-conscious and self-conscious about what they look like, the Instagram selfie generation, and the older people who just want to stay fit. But they don't want people bragging about it or anything like that. So it's just a cool company that has struck a great core, cashing in in rural America, and urban American, basically the whole country, finding their pockets in these strip malls in the suburbs where big retailers are moving out and there's a lot of space for them to come in and get in cheap and basically move over with their 10,000 square feet of heavy equipment.

Gardner: And growing they are. Rick, you brought this stock to Motley Fool Rule Breakers. I'm seeing right now, the publishing date of that was January 27th, 2016. We're talking about just over three years. And yeah, the price that day was $11.93. I had forgotten that the company IPO-ed higher than that. Turns out, you don't have to buy every IPO in those first few days or even months. But it's remarkable to watch that ascent, from about $12 a share to about $75, as you mentioned, today. I know it's exceeded your expectations. Mine as well. It's a six-bagger. But a company that illustrates a lot of what we're talking about in Rule Breakers, which is finding companies that improve the world, brands that you recognize, often driven -- and I love the story that you told of Dover, New Hampshire. These are real people, flesh and blood, our fellow Earthlings, who are coming up with ideas and building great companies around them and helping out the world. I think Planet Fitness is a lot of what we're about, a lot of what you do as a great stock picker for Rule Breaker Investing.

Rick, let me ask you in closing, what's a one-line takeaway that I as a listener should remember from the story of Planet Fitness?

Munarriz: Sometimes the best way to step up as a disruptor is to take a step back. If you want to revolutionize an industry, you don't have to make things more complicated. In the case of Chris Rondeau and everyone at Planet Fitness, they just basically scaled back to the essentials of what a gym is all about. And sometimes that's enough.

Gardner: Companies and brands that democratize the world make it simpler. Think about how simple Apple has made computers or Netflix made finding good entertainment. You don't have to go down to the store anymore, pay late fees, it's all just a click away, and it keeps getting better seemingly. So these are some of the great companies of our time. And darn it, these are all active recommendations that we have in Motley Fool Rule Breakers and Stock Advisor, thanks in part to people like you. Rick Munarriz, thank you for your story about Planet Fitness!

Munarriz: Thank you, David!

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