Advance Auto Falls Behind

In this episode of MarketFoolery, host Chris Hill talks with senior Motley Fool analyst Jason Moser about some of today's business news. Advance Auto Parts (AAP -0.49%) dipped on its quarterly report, even with higher-than-expected profits and revenue -- investors want more than what Advance is putting up, and the competition is providing. Snap (SNAP 1.29%) popped on news that it's releasing a new version of Spectacles. Jason explains why investors shouldn't buy into Snap for its social media or ad dynamo potential, if they buy into Snap at all. Plus, the guys draw from the listener mailbag -- should investors buy into more than one index fund, or is one enough? Tune in to find out more!

To catch full episodes of all The Motley Fool's free podcasts, check out our podcast center. To get started investing, check out our quick-start guide to investing in stocks. A full transcript follows the video.

This video was recorded on Nov. 12, 2019.

Chris Hill: It's Tuesday, Nov. 12. Welcome to MarketFoolery! I'm Chris Hill. Back in studio, Jason Moser. Thanks for being here!

Jason Moser: Had so much fun yesterday, I thought hey, let's do it again! Right?

Hill: Well, I did mention it last week, we've got the annual meeting for The Motley Fool this Thursday and Friday. That just means we're recording everything in a shorter amount of time. Today, we're going to be recording Thursday's episode. It's all hands on deck. It's Foolapalooza, we're excited!

Moser: We've been at this for like 10 years, man. When I'm making that list of priorities out, Chris, let me tell you, you and MarketFoolery are right there at the top. Every day.

Hill: Don't tell your manager!

Moser: Don't you doubt it!

Hill: We're going to talk augmented reality. We're going to dip into the Fool mailbag. We're going to start in the automotive world. Third quarter profits and revenue for Advance Auto Parts came in higher than expected. It is the sixth consecutive quarter of new sales growth for Advance Auto Parts. Why is this stock falling 8%? This is a good quarter and continuing a pretty nice trend for them.

Moser: You say it was a good quarter. It wasn't really a bad quarter. Maybe I'll start with that. I think it was more of the same of what we've seen from this company over the past several quarters. I think the market is probably reacting. There was a little bit of a tightened guidance there on the comps numbers, their expectations on comp sales. Whether it's restaurants or auto parts, when it comes to retail, comps is obviously a metric that matters a lot in. I think they lowered that high end on the comps guidance by about 50 basis points. The market's probably a little bit concerned about that, along with the fact that there are some challenges that the business continues to witness. Now, let's talk about some of the positive trends, first. Their professional side of the business is continuing to show progress. Their e-commerce channels are continuing to show progress. They're making a lot of investments in their loyalty program, the Speed Perks loyalty program. Like any retailer, you're putting together a loyalty program to bring people back, to get more data, to sell them more stuff, give them rewards. It really creates that nice virtuous cycle and a long-lasting relationship. That's good. It does seem like, though, the headwinds, the problems, or concerns, maybe, outweigh the good. Transactions were down. There's still some traffic concerns there. No pun intended. Store traffic. When you look at the investments they're making in the business, they're trying to stanch this gross margin compression. When you stretch it out over further periods of time, when you look at it over the last five years, you can see they're having some issues, there really getting that gross margin stabilized. And that ultimately flows all the way down to the bottom line. Speaking of the bottom line, while they were able to grow earnings per share 11%, net income was only up about 6.5%, and a lot of that really is due to just managing the business, managing the cost side of the business. So they're repurchasing shares, that's helping boost that EPS number. So it's not all really that bad, it's just not that great. And when you look at the competition in this space, when you compare the five-year charts between Advance Auto Parts, AutoZone and O'Reilly, Advance is the clear laggard in. The problem is, over all that time, while O'Reilly and AutoZone have continued to make progress and separate themselves, it's really tough to gain that ground back. It's such a competitive space. That race down on the pricing side just continues to accelerate. It really is more difficult for them to make up that ground in. So you get to where we are today. Is it a value play or is it a value trap? It's hard to say, but I kind of feel like I'm leaning for the latter at this point, just based on the numbers that we're seeing today. 

Hill: You mentioned the loyalty program. I think it's worth mentioning, loyalty programs for national chains, once upon a time, it just seemed like this nice bonus thing. Now, it seems like table stakes. Whether you're selling auto parts or coffee or whatever, if you don't have a loyalty program, you almost need to explain yourself. I have to believe that if you don't have a loyalty program that you are actively trying to grow, it's reasonable to assume that you've got cash flow problems. That seems like an investment worth making.

Moser: Yeah, and I think another challenge with loyalty programs, I find myself falling into this trap often, you go to any store and they ask you, "Are you a loyalty member?" And half the time, it's like, no, I'm not. "Do you want to sign up?" "No, I don't, I just want to buy my stuff and get out of here." A good example, I like to paint. So I go to the local art store. I get my stuff from time to time. I don't do it that often. Sometimes I buy stuff from there. Sometimes I buy it from somewhere else. But whenever I go to this store, they're like, "Hey, are you a member of the loyalty club?" And I'm like, "No, I'm not. I just want to pay for my stuff and get out here." Is it worth the extra 10% or 20% to me? Typically, it's not. I'm starting to value my time a little bit differently as opposed to when I was 20 years younger. I'm losing out on a little bit of savings, and that's my choice to make, but the store is really missing out on a lot of data that they could get from me, and they could really start catering to the specific things that I'm buying there. I feel like retailers need to figure something out there. There's a point of friction that they've not fully figured out in many cases. 

Hill: Some of them have. 

Moser: Some of them have. I don't know specifically what that is. Maybe it's the nature of what you're buying. When you use Starbucks' loyalty program, for example, it's pretty easy because you're going there on a daily basis. With a one-off purchase or the more infrequent purchases, it becomes a little bit more difficult to fully figure that out. I'm not saying I have that solution, but I think that's something that they need to work on. The more they can reduce that friction, the more data they're going to get, the longer the relationship they can create, and the better that works out for everyone.

Hill: Snap has launched Spectacles 3, the latest version of its glasses, now with augmented reality. For just $380, you can buy a pair, record video, apply 3D effects, and then post it to your Snapchat account or other social media networks. Shares of Snap, I should point out, are up a little bit today. Is there a reason for optimism for Snap's business based on this latest launch?

Moser: Maybe. I would say maybe. I think if you're looking for an investment in wearable technology, Snap is not it. I defy you to give me one reason why Snap is a better bet here as opposed to something like Apple or Microsoft or Alphabet. It's not. If you say it's because they're smaller and nimbler, and they can move faster and break things more quickly, that's not the case there. That's not an advantage here. That's actually a disadvantage. They don't have the same resources to devote to this kind of stuff. Frankly, I don't think they have the same talent. When you look at companies like Microsoft and Apple and Alphabet, they are working on that headset, augmented reality, mixed reality. They have more resources, they have more talent, they've been at it for a lot longer. Then you look back to what Snap ultimately is, it's an ad play. On its own, that's fine. But it is a niche social ad play. That, to me, makes it far more difficult to get behind as an investment. Contrary to popular belief, I really do want to like this company. In its last earnings call, management used the phrase augmented reality 21 times. That's right up my alley, in regard to the augmented reality service and the ideas that we're looking for. Founder and CEO Evan Spiegel said, in 10 years, he believes that consumers will widely adopt augmented reality glasses. I tend to agree with that. I just don't think it's going to be theirs. And that, perhaps, is the problem. I think really, when you look at this particular line of Spectacles, these Spectacles are geared more toward the creators that are using Snapchat. I think at the end of the day, this is really an investment in engagement. It's not something that you or I would necessarily buy. I think it's something that's meant for the high dollar creators that are giving Snapchat content on an ongoing basis. From that perspective, it's an investment in engagement. That probably makes sense for them. Again, we get back to that point where it's an ad play, it's a social niche ad play. They need to create engagement. This is going to be one way to do that.

Hill: To the point we were discussing earlier regarding money that you can invest when you're a business, you namechecked Microsoft, Apple, Alphabet, companies with really deep pockets. We were talking the other day about the Apple Watch. First iteration, not that great. Latest version, much better. Apple has not just the money to devote to improving their existing devices, but they've got the time because they've got the money. Snap, by their own admission, the first version of this didn't really work out. Presumably, version three is significantly better. You would hope so, if they're charging nearly $400 a pop for them. But they need this to be something that moves the needle more so than Apple does, in a shorter amount of time.

Moser: There's absolutely no question. Again, we go back to what is their main source of revenue today? It's advertising, plain and simple. So, for them to figure out a way to diversify that revenue stream, I applaud them for being on that now. I like the forward-thinking nature. But when you talk about companies like Apple and Microsoft, and let's throw Amazon in there, Alphabet, these are companies that not only have the resources and the talent, but they've got all the time in the world. They've got the fundamentals working in their favor. These are businesses that are clearly profitable. They make a ton of cash. That affords them all the time in the world. Right now, Snap is not there. Now, that's just because it's a younger company, still getting its feet underneath it. But when you look at the estimates out there in the analyst community, GAAP profitability is a really long way out for this company. GAAP profitability isn't going to happen until 2023. That all just goes back to, we've got a company here that's valued on excitement, it's valued on potential, it's not valued on fundamentals at all. It's got a leader that I don't think has proven himself yet, and he's in full control of this company and the direction in which they go. I think, as an investor, if you look at Snap and you think this is just some massive upside potential social play, that's a bit naive. I think we've seen the massive upside in social shake out. I think what you have here's an opportunity for a company to continue growing, develop its own identity, start embracing more technology, help steer us toward this new mixed reality technology space. One day, they'll be profitable. They'll have some fundamentals that we can value the company on. And it could continue to grow. And then maybe it makes sense as an investment. But this to me is clearly one where I would rather buy it after I've seen demonstrable success. Not, "Well, I think that they're going to do well down the road." We've seen a lot of those already. We hit Twitter like that every quarter, it was the potential, and that just doesn't always work out.

Hill: Shares of Snap up 150% this year.

Moser: Yeah. I mean, it's been a great year, no doubt. It's coming off an extremely low base and major pessimism. They really had nowhere to go but up. So, that, to me, is a sensible reaction. It's not been a good investment if you got in at the IPO. Again, I feel like it's one where it's more sensible to buy this thing once it's proven that it can succeed, that it's sustainable. Doing anything before that is going to be your higher-risk holding in your portfolio.

Hill: Our email address is [email protected]. Question from [...] Hope I'm pronouncing the name correctly, sorry about that. "I'm new to the investing world. You always say that investors should begin by first investing in index funds. After some research, I bought some shares of a broad market index fund ETF. While continuing my investment in index funds, is it preferable to continue buying more shares of my existing investment? Or, should I seek other investment fund opportunities as well? Thanks for all your help."

Great question! We do say that all the time, that it's such a great first step when you're starting to invest. Just get that exposure to the broad market. I am not one of those people who invests in multiple index funds, although there are people who do very well just looking at, once they start with a broad market fund, then they say, "I'm going to focus on a small-cap ETF, a small-cap index."

Moser: A lot of people are really only invested in funds. If you look at it from the perspective of just investing in your 401(k) or whatever your retirement vehicle may be, in most cases, you're choosing from funds in how you allocate your money. From that perspective, the short answer is yes, you can absolutely invest in more than one fund. You can reinvest in the fund that you own already. People can be very successful just investing in ETFs. I think that really, that gets to the greater point here of making sure that you understand what the ETF that you're invested in represents. When we consider this email, for example, and the fund in which he's invested, it's the Schwab broader market funded, ticker SCHB. I did a little research into that particular fund to get a better idea of, what does this fund actually represent? This is a really big fund here. This is a fund that holds essentially 2,500 U.S. stocks. For context, we talk a lot about the S&P 500. The S&P 500 is, surprise, 500. This particular fund owns a really big basket of stocks. So then you have to ask yourself, if you want to invest in another fund, you probably want to invest in that other fund to get exposure to something that you don't have exposure to already. Otherwise, maybe it just makes more sense to add to the fund that you already own. This fund itself is highly rated by Morningstar. It's reputable. It's Schwab, so costs are low, turnover is low. There are low frictional costs involved with it. It's a market cap weighted fund, so it skews toward the bigger companies. One argument for that could be that the bigger companies keep on winning, they keep on getting bigger, and you want to own those companies. 

Generally speaking, yes, you can own as many index funds as you want, or ETFs. You want to just understand what is in the ETFs that you currently own, and then try to figure out, do I need to buy something else to get exposure to something else that I don't currently own? In this case, with SCHB, this is a fund that owns a lot. Most of those companies are probably represented by other funds that you would have access to anyway. So maybe in this case, you don't need to own another index fund. Maybe this is all you really need from that perspective, and you can just keep on adding to it. I own one index fund, the S&P 500. And I just keep adding to that every time I get paid here at work. I don't feel the need to go any further than that because I've also got individual stocks and I've got some real estate and other ways to diversify my portfolio. Hopefully that sheds a little bit of light on it. It really boils down to just understanding what's in that fund that you own. A lot of different ways you can find that out. If you just go to your trusty Google and type in the name of the fund, typically, that'll bring you either bring you to the homepage of the company that sponsors the fund, or it would take you to something like a Fool site or a Morningstar site or something where you can find the components of the fund. Just, understanding what is in the funds, that can help dictate where you put your future investment dollars.

Hill: Real quick before we wrap up. We talk about entertainment pretty frequently on this show. I came across in my Twitter feed a lot of entertainers tweeting about Rick Ludwin, who was an executive at NBC. Died the other day at the age of 71. I'll put this out on the MarketFoolery Twitter feed. A very nice obituary. All of these tributes about, sounds like, for someone who spent his life in the television industry as an executive, a pretty soft-spoken guy, a pretty mild-mannered guy. A lot of wonderful tributes being paid to him. From a business standpoint, Rick Ludwin is the lone executive in NBC who believed in a show that was originally called The Seinfeld Chronicles.

Moser: [laughs] He was that one guy.

Hill: He was. There were all these other executives who were like, "I don't know about this show. It seems like it's too New York. I don't think it's going to play well," that sort of thing. And Rick Ludwin believed in the show so much that he had money in a budget -- they did one episode, showed it to executives, they were like "Eh, I don't think so," they all turned it down. And he had money in a budget that was for specials. So, just, like, "Hey, we're going to do a concert special," any kind of primetime special that he wanted to do. He had money set aside in that budget. He took all of that money for four primetime specials and said, "I want four episodes. I'm going to get four episodes of The Seinfeld Chronicles. We're going to put it on TV." And that got the whole thing started.

Moser: That's an amazing story! When you think about, I mean, you talk about shows that have changed the world, I think Seinfeld is certainly one of those shows. That's one of those shows that continues to, I think, hold true in a lot of ways today. It has developed, obviously, a rabid fan base. Frankly, I think social media has only fueled that fire. That only happens every once in a while. We talk a lot about data, Netflix, Disney, all these companies using data to make decisions -- at the end of the day, these shows are art, and art is not so easily figured out. That's why they're special. 

Hill: Right. We were talking before we started recording about reviews. Some people rely very heavily on movie reviews, TV reviews. Ultimately, it's the people who decide what they want to watch.

Moser: Precisely!

Hill: Thanks for being here!

Moser: 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 MarketFoolery! The show's mixed by Dan Boyd. I'm Chris Hill. Thanks for listening! We'll see you tomorrow!