5 Questions Investors Should Ask Themselves in 2021

Should investors buy with margin? What's going on with bitcoin and China? What 2021 IPOs should investors have on their radars? And how should we keep our investments grounded for the next year? In this episode of Industry Focus: Wildcard, join The Motley Fool's Asit Sharma and Emily Flippen as they answer five questions investors should ask themselves as they enter the New Year.

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This video was recorded on Dec. 30, 2020.

Emily Flippen: Welcome to Industry Focus. Today is Wednesday, Dec. 30, and I'm your host, Emily Flippen. Today, as we head into the new year, I am joined by Asit Sharma. We're going to be talking about five things that we think investors should ask themselves heading into 2021. Asit, thanks for joining.

Asit Sharma: Thank you for having me, Emily. This is one of my most favorite days of the year, because it's too late to get anything done on those resolutions from last year, but it's too early for me to make resolutions for the new year. [laughs]

Flippen: Well, before you get into today's conversation, I have to say I didn't think about this as a New Year's resolution purchase, but I suppose it could be perceived that way. Maybe an hour before we started taping this, Asit, I have decided to take the plunge. I'm a walking, breathing, living hypocrite, because I have decided to buy myself a NordicTrack bike, some home exercise equipment for me. Somebody who has long said that you are the Peloton's of the world are going to have a hard 2021. I had my membership to Planet Fitness. All of that now down the drain, because it's expected to get here on Sunday.

Sharma: [laughs] Emily, I have watched you on our live show for Motley Fool subscribers. Do exactly this, diss the very equipment that you just bought. [laughs] I think that's great. I think we should all be looking to keep healthy and safe next year. I can't diss on you too much, but that is a little funny. [laughs]

Flippen: I almost painted it up as a win-win scenario for myself here, because on one hand, if I like the equipment, then I'm getting healthier, and I didn't just throw away a pretty sizable amount of money on some useless equipment. But at the same time, if I dislike it, then I feel that much more vindicated in my rather strong previous opinions about the usefulness of home exercise equipment. This was the psychology that I had talked myself into when making this purchase.

Sharma: I think that's a great rationalization. I have a feeling you'll do well with that purchase. [laughs]

Flippen: I typically, pre-COVID, enjoyed working out, so I'm hopeful that I'll actually make use of it. But history says that your home exercise equipment will typically become a place where you just hang your clothing, and maybe my cat will get more use out of sleeping on the seat than I will. I hope this isn't the case. But I have to say, I still have that in the back of my mind a little bit.

Sharma: Well, if I had a better memory, I could just fast forward to ask you at the end of next year what you did with that piece of exercise equipment. But I'm sure I won't remember, so it's all good.

Flippen: [laughs] Let's hope not, just in case it's bad. If it's good, I'm sure I'll be going out of my way to remind you about this exact conversation.

Sharma: There you go.

Flippen: But needless to say, one of the five things investors should know about 2021 is not to buy themselves home exercise equipment. But if that is something you choose to do, better for you. I know the first topic that we have here, the first question investors should ask themselves is one that I imagine we see pretty eye to eye on. That's a big question. Which is, should investors buy with margin? We're seeing reports now that individual investors especially are becoming more prone to purchase equity, so stocks with money that they may not necessarily have. Maybe pointless to say this and repeat this, but Asit, can you tell us why that is maybe not the best idea?

Sharma: Absolutely, Emily. Just a brief overview of what buying on margin is. When you have an equity's account, you can use the stocks that you own as collateral to buy other stocks, and it's a really common practice. Many new investors are pleased to discover that they can maybe choose their gains by borrowing some stock. We saw an article in the Wall Street Journal. The title was "Investors double down on stocks, pushing margin debt to record." If you think about all the money that's borrowed to buy stocks, that's measured on an aggregate basis. It's at a record. This has been a really crazy year in the stock market. Many more people are trying this method of investing.

Now, for the overview or the recap for those of you who are familiar, margin or buying a margin, it sounds like a great concept. Let's just walk through a really quick example. A great concept, I should add, if you're [laughs] only considering the upside. Suppose you buy $1,000 worth of stock and you decide to borrow $1,000 alongside that from your broker. Now, let's look at a great scenario. The stock that you have invested in rises 50%. After you sell the stock and repay your broker for the $1,000 you borrowed, you'd actually have $1,000 gain on your investment. Now, suppose the same stock loses only 25%. You're actually down 50%. Because remember, you borrowed as much as you invested in that stock.

The way the math works is either you can run into a very nice scenario, which in a rising market might be easier to come by on a day-to-day basis. Or you're going to be in a situation where you look at your own capital and that's just been eaten into because you've leveraged your performance. This is something that, for me personally, I have traded on margin when I was younger, earlier on in my investing career and investing journey. I religiously avoid it now, because you don't need it to do well in the market over the long run. In fact, I think it can impact your returns. What are your thoughts on margin, Emily? I sort of know what your perspective is, but I'm curious to hear if you've ever invested using margin and how you feel about this as an investing tool.

Flippen: Perhaps I'm overly risk averse for my age, but I've never really been interested in investing on margin. I've been debt averse, you could say as well. The idea of taking on what is essentially a form of debt to leverage equity purchases never appeal to me. I tend to focus on the investments that I have. While I may not be high-accuracy, great companies performed really well. When you're going out of your way to leverage up your investments, accuracy rate is much more important. Because when you lever up an investment in equity that goes down, you lose significantly more.

Because of that, I tend to be a long-only, no margin, no leverage investor. That's been my background. But I think perhaps an overly simplistic way to look at it, is almost like borrowing money. Going out to an external lender and asking them, "Hey, let me borrow some money, I'll pay you an interest, which in this case is the margin rate. Then, I will pay you back within a certain period of time," and then take the money that you've borrowed to buy stock. The reason why it's a good way to think about it is because it reminds investors that margin, in some ways, it's just a fancy word for saying debt, which I think people forget about. But the reason why it's actually even worse than going out and taking a loan is because you can have something that's called a margin call that you don't get with a regular lender. Which is essentially that the brokerage that you're borrowing from, in this case the lender, can come back to you when the value of your equity falls below a certain amount and say, "Hey, now you have to pay up. You have to put more money in, or I'm going to force you to sell these investments at a loss." In that case, it's almost even worse than going to an outside lender to borrow money because you could be forced to pay it back, even before those gains or losses have been truly realized.

Sharma: I think that's such a great point, Emily. For the long-term investor who is looking to buy really awesome companies that are going to generate a lot of operating cash flows and have rising revenues over the long term, those can also be really volatile stocks. If you're trying to lever up your return, the longer you're out, the longer that you do this, there's going to come a day where either you realized that margin interest is eating into your turns or, because of natural volatility that happens with great companies, Netflix, Amazon are two great examples, you'll get margin call that takes you right out of that position. You won't be able to realize the same long-term phenomenal gains that an investor who is purely just cash invested in that security would realize, I think it can be a red herring type of investment as well, just with its ability to pull you out of great stocks, because the best stocks tend to be volatile over the long term. There's a growth curve for every company. As a company gets more mature, its volatility decreases. But in the early years, where often the maximum gains come from a growth company, stocks can move all over the map.

Flippen: Perhaps a good way to sum it up is that old investing adage, which is don't invest money that you can't afford to lose. I think it's fair to say a large majority of people who are investing on margin are investing money that they can't afford to lose, because they may not even have it in their accounts. Just making this full circle here, if you have to have a rule of thumb here, never invest what you can't afford to lose, and margin will allow you to invest a lot more than most people can afford to lose. But that was a sad place to start off in 2021, which will hopefully be a more compelling year than 2020. I like the second question that you've posed to investors here, one that I think it's a lot easier to make a case on either side of which is, "Are you a believer in bitcoin?"

Sharma: Yeah. This is interesting for so many of us. Emily, it's been hard to ignore the surge in cryptocurrencies, bitcoin in particular, over the past several months. I just did some research before we came on for this podcast. I was looking for bitcoin's all-time high before this year. It was back in mid-December of 2017, that was the peak [laughs] of the first wave of bitcoin frenzy. It hit $19,100 per bitcoin that year. Then just fell away from those highs and gradually dwindled down. This leader of cryptocurrencies was trading around $9,000, $10,000 and actually went as low as $5,100 in mid-March, which is the same time the stock market reached its big low this year. As we tape today, on December 30th, 2020, it is trading at $21,800. [laughs]

Man, I guess we should talk about why bitcoin is rising so much. There's a few reasons. One is that investor risk appetite is just higher at the end of this year after everything investors have been through in this spring, with the peak of the pandemic, and all the money that's rotated into high-flying tech stocks, which are benefiting from this remote, work-at-home economy, investors have become a lot more willing to look at other assets, alternative assets, and take the same type of risk as they're taking in stocks like Zoom, which is a really wonderful company, but trades at a very, very high-priced sales multiple. Another, I think, well-known or well-acknowledged reason that bitcoin is rising is that both Square and PayPal are opening up bitcoin to new purchasers. Now, Square has been offering bitcoin or the ability to use bitcoin through its service for a while and PayPal has just jumped on-board really this fall. You have two major fintech companies with enormous platforms of users, who now have a really easy avenue to buy cryptocurrencies, which can be tricky if you haven't had any degree of familiarity before in trading this or investing in them.

Then, I guess, there are two more quick reasons. One is all the stimulus that came through this year in the face of the pandemic has increased the U.S. money supply. What that means is there's just a lot more money that the Federal Reserve has injected into the United States monetary system, which tends to decrease the value of the U.S. dollar. When there's more supply, then the value of a thing decreases. This often is accompanied by people buying up traditional inflation hedges like gold and silver. bitcoin has been off-again, on-again [laughs] type of inflation hedge in some investors minds. That first peak that we talked about, Emily, in 2017, it was also seen as an inflation hedge that maybe it's value will rise if the value of the U.S. dollar was falling, and we're seeing a little bit of that again.

Then fourthly, there is this phenomenon called the bitcoin halving, so that's H-A-L-V-I-N-G, as in cutting something in half. bitcoin has a periodic mining halving, I think it's every four years, and this affects the amount that people who mine bitcoin, that is people who are working to ensure that the blockchain that bitcoin rests on is valid, they get fewer bitcoins for doing the same amount of work. What this ultimately does is to decrease the supply of bitcoins that are in existence and available in the open market. That has a tendency, every time this happens, to push bitcoin up. If you could take all these four big waves together, I hate to hype things up, Emily, but they've lit a fire under this leading cryptocurrency this year. Now, having settled that, [laughs] I'm curious, do you own any bitcoin and what are your thoughts on this?

Flippen: I do not personally own any bitcoin. I generally avoid what I perceive to be commodities, which are items that you can buy that don't have any value beyond what other investors attach to them. When I buy equities, when I'm buying businesses, I understand the value of the tangible or in many cases, intangible assets that I've just purchased with my money. I believe that there's value there that admittedly can only be realized when I sell it to somebody who perceives that there's a different value attached to that business. But in my mind, there's a tangible asset backing that produces, in most cases, cash. Whereas a commodity is something that never produces any value, no cash, no money beyond what another person attaches to it. That has been the reason why I don't purchase gold, I don't purchase commodities, and in this case, I don't purchase bitcoin.

Now I'm coming to see that I think I may have a wrong perspective is such a blunt way to put it, I think my perspective on bitcoin may be changing. You talked a lot about the U.S. money supply and that's true, but it's also true on a global level when you look at the currency crisis is happening in many countries across the world and the limited supply of bitcoin in combination with its perception as a store of value, that could change over time to make it a global hedge against currency crisis. There's potentially value here that I'm throwing away. I think a good example is probably a company called MicroStrategy. I'm not sure if you know this business, Asit. It's relatively small and they made a lot of news earlier this year when their CEO decided to take, I think it was $1 billion of cash that they had sitting on their balance sheet, or $650 million, something around there, and put it into bitcoin. They decided to buy bitcoin with their excess cash. The CEO is an interesting person to listen to, the stock's up something like 150% as a result of this decision, so it's not without its own little cashiness. But that is to say long-term, maybe there's more value in bitcoin than there is in other commodities or what I perceive to be other commodities. But right now, I still think there's a lot of speculation that goes into the value of a single bitcoin. We're seeing that with the hype that comes from investors. When bitcoin rises in value, more people are likely to jump in and feel the need to buy. The accessibility of bitcoin going up, I'm sure has also increased as you mentioned.

Sharma: Yeah. I find that really fascinating that your perspective is changing a bit. I've also been a skeptic on bitcoin because I feel that if ultimately this is a unit of value that people are going to use to do primarily economic exchanges, then you want a stable currency. You don't want that value to be changing my leaps and bounds every day. That makes it harder for it to be this medium of exchange. Emily, there are so many other competing cryptocurrencies. I always feel that at some point, one of these cryptocurrencies that is more geared toward the banking system, like a Ripple or a Stellar, might become a currency with more investment behind it in terms of money that flows in. But at the end of the day, again, you want the same thing, you want the currency to be stable. Not that any kind of cryptocurrency expert, I just dabbled in this more out of intellectual curiosity than anything else.

Bitcoin is speculative because it's an inefficient medium of exchange when you compare it to some competing technologies of much, much smaller cryptocurrencies and tokens that are available. They just don't have the weight of the public behind them. Ultimately, I think there is some place for cryptocurrencies that can be maybe not a medium of exchange, but an investment for the kinds of characteristics that you're talking about. Maybe they help with leveling out or making the playing field equal in cross-border transactions, where one person operates in one currency, the other person in another part of the globe has another home currency. There's a place for a cryptocurrency to even out that transaction so that neither party loses as much in the exchange. Yeah, I think that this is just something we're going to watch in 2021. Quick prediction, Emily, do you think that bitcoin will come back down to earth by the end of 2021, or do you think it will be higher than it is today, this all-time high region that it's sitting in as we speak?

Flippen: This is getting into Motley Fool Money, reckless prediction here of course.

Sharma: [laughs] Yes, it is. Isn't it?

Flippen: I could make a case for it to be lower, given the fact that it would be natural that what is perceived to be a hedge would increase during the global pandemic that we're living in today, the unpredictability and uncertainty that exists in the world. But I'm actually going to say I think it will be higher by this time next year and I don't have much of a basis for that opinion, other than to say that I think there's maybe value and maybe I'm agreeing with the MicroStrategy CEO here. But I think there is value in having a currency that is not attached to any country. It's purely attached to a tangible value that we haven't seen since the gold standard days. I think it's interesting, I think it's appealing. I'm not buying, but I guess if I was a betting woman, I would assume a year from now, it'll be at the same or higher. What about you?

Sharma: Yeah. I actually agree with you. I think that the frenzy is going to settle somewhat as the U.S. economy rebounds and you have more of a balanced rebound from COVID around the world. Some of the factors that are pushing it now will cool off some. I think also investors will relook at all the sectors that went up in 2020 and take alternative investments in that as well, and rotate to other things. It's natural for investors to do after really a peak-type of year, as we've had at least in the U.S. stock market. But I think it's going to be higher. Does it mean it might be 29,000 or 31,000, somewhere in that range? That would be my most likely guess. I think it will be volatile but probably settle a little higher. But I would have been one of the last people to tell you, at the beginning of this year, that it would almost triple, I guess, from where it was at the beginning of the year. That just goes to show you and to warn viewers that my predictive acumen isn't that great. Maybe this is a signal for folks to run out and buy bitcoin [laughs] I don't know if it's going to up that much.

Flippen: When I look toward 2021, I like this other question that you posed. I'm going to broaden it a little bit though. That's a question I think all investors should be asking themselves which is, what is going on with China and in particular, Alibaba (BABA 0.64%), Jack Ma, Ant Financial? It feels like an unadulterated mess over there. [laughs]

Sharma: It does, Emily, and I'm curious to hear your thoughts on this because you lived in China and really got to see firsthand this economy. I know you're interested in certain Chinese companies as investments. Well, maybe if you could walk us through Ant Financial and Alibaba, and we can pull out a bigger picture on what's going on with Chinese companies and their government in general. Explain to me what is happening, all these headlines about Ant Financial, Jack Ma, and Alibaba?

Flippen: Investors may remember a month or so ago, there was a lot of hype heading into what was going to be huge IPO, a $34 billion IPO of Ant Financial, which is a Chinese business run by Jack Ma, the founder of Alibaba, which owns the Alipay app, among a handful of other things like consumer lending, but really Alipay is what most investors may be familiar with. Even if you don't live in China, you go out to eat, here in the U.S. you go to a shop, you often see the Alipay logo, which is the blue and white sitting on the cash register. This is up there with the scale of businesses like PayPal, even though many investors may not be familiar with the name itself. Regardless, it's a huge IPO, had a lot of hype, was going to be a dual IPO between Hong Kong and Shanghai. It was an exciting business, a lot of investor excitement. Then, right before it was supposed to happen, the Chinese government came in and said, "No." I won't try to get into the psychology of the Chinese government because there's already been a lot of speculation, nobody will really know.

But in the end, Chinese regulators started to take a look at Jack Ma, Ant Financial, and by extension, Alibaba, and started to ask themselves, "How do we feel about giant tech companies?" It's a really interesting question because we see it on a smaller scale happening both in the United States and in Europe, other areas across the world, which is how do we deal with tech giants? Are they running a monopoly? In the case of the Chinese government, they have a lot more control and discretion over private industries than the United States may. As a result, the IPO for Ant Financial didn't move forward, but there's been this big crackdown on Jack Ma in particular that's extended over into Alibaba, that seems to be some power struggle between the Chinese regulators and the Chinese government, and these big tech entrepreneurs that almost fly in the face of many Chinese policies, is perceived to be by many investors a very legitimate threat against the viability of Chinese tech businesses in the future combined with the delisting bill that was passed by Congress earlier this year. It's not painting out to be the most favorable pictures for Chinese companies heading into 2021.

Sharma: Yeah, it's so funny from a layperson's perspective, which is my perspective, watching the unbridled just sheer power of Chinese tech companies because they have such a massive user base in China, how the government has really let them grow without too much oversight. At the same time, I think President Xi Jinping has asserted more and more control over the communist party. The authorities are much more conscious today of projecting that they're ultimately in control of China, not this group of swaggering, very capable technology billionaires of which Jack Ma, I think, is the most fearless, I would say, of them all. They also have an interest in just making sure that certain sectors don't overheat.

We know that China has one of the highest debt ratios. If you look at all the debt that's in China, whether on a consumer perspective, consumer debt, personal debt, or even corporate debt, it's an economy that tends to function using a lot of leverage. In recent years, the Chinese government is now trying to pull back some of the companies that have traditionally made a lot of their economic returns through this model. For example, Ant Financial used to be an outright lender, but it didn't have a lot of oversight. In the last few years, they've become more of an agent of lending rather than a lender themselves, just trying to keep in line with what they knew was coming in terms of regulation from the government. But I think, the confluence of all of these is a really strong leadership posture by Xi Jinping, some sensible regulation of the leverage in the economy. Also what you mentioned, Emily, is the same thing that we struggle with here, is Facebook too big? Is Microsoft too big? Should Google [Alphabet] be broken up? That's a very legitimate question once you have these mega platforms that control so many aspects of people's online experience and have so much influence over our lives. I think all these coming together make it so interesting.

The thing that stuck out in my mind was just a fresh memory that some investors will have of when the Chinese government did something very similar with video games, a couple of years ago that hit some really big Chinese stocks like Tencent very hard. Briefly, Emily, maybe you can explain what the Chinese government did and how that just affected the industry, but I think this memory is fresh for some people.

Flippen: Yes, it still feels like yesterday to me even though thinking about it, I guess it was two years ago. The Chinese government came out with policies that wanted to limit the amount of time that young people were spending on video games, spending in front of their computers. They believed it to be detrimental to the health of the Chinese population. In particular, I think they said it caused myopia, which is an eyesight problem, from spending too many hours looking at the screen. While a lot of these claims were relatively unfounded, that didn't prevent the Chinese government from going to Tencent and it happened to a lot of other smaller Chinese businesses, BiliBili, Huya, DouYu, these platforms that rely on video game streaming were also impacted. But Tencent in particular, being the world's largest video game company, if you want to call it that, it's really a conglomerate. But owning a lot of those video games in China, owning their distribution meant that their business was essentially turned off.

For a period of, I think it was eight or nine months, they weren't allowed to release new games. These regulations dramatically impacted Tencent for that year, but then, Chinese government backed off, they had made their point. These are to allow new games to come through and fast-forward to today, it really hasn't helped Tencent or any of those other businesses back long-term. In my unsolicited two cents here, I tend to be perhaps overly dismissive of the Chinese government actions. I admit that so take my opinion with a grain of salt, but historically speaking, we've seen the Chinese government come in, take really strong stances and big moves for a short period of time before eventually letting actions through. I typically see it as a reminder from government officials about who's in power. When they see someone who is influential and rich, not just in China but across the world, potentially stepping out of line with his comments, they want to smack that person back down [laughs] remind them, "Hey, we are the ones making the decisions here. We are the ones who have the power. We control whether or not you could even list your company on our stock exchanges, so fall back in line." I think that's what we're seeing happened here.

I will imagine Jack Ma probably lays low for a few months. We expect to see no news from Alibaba, Ant Financial, or Jack Ma for a period of at least a few months. Then quietly, he will reemerge, except with the perception this time that nobody is above the Chinese government. That's just my two cents, I could entirely be wrong there, but when I see news like this, that's where my mind goes.

Sharma: Yeah, I know that's comforting to me. I'm interested in many Chinese companies and you've lived there, you've been on the ground. Really, you're interested in these markets so what I'm hearing is, it's probably OK to stay the course. There's going to be some volatility from time-to-time with these regulatory postures, but they're not going to kill the cash cows. [laughs] They're going to let them perform because after all, it's driving the Chinese economy.

Flippen: I hope that is true. I know that investors will have different opinions. It's been a number of years since I've lived or even been to China and people who are familiar will know China changes rapidly. As much as I would like to say that my opinion is entirely accurate, it is ultimately just my, maybe, potentially outdated opinion about the situation. But it is something that I think investors should be thinking about into 2021, if they're comfortable holding Chinese companies. While I'm not a direct investor in Tencent, I do own shares of BiliBili, for instance, which is a video streaming company. I feel comfortable holding those shares. When I think about my Chinese investments, what worries me the most is just the value that American investors attach to Chinese businesses given the political turmoil that exists between our two countries, they simply don't deserve or don't earn the same premium that American businesses do because of the perception of increased risk. That to me is a bigger threat to my portfolio. Then what is, you said it well, political posturing by the Chinese government, but full disclosure, I reserve the right to be wrong here. [laughs]

Sharma: Well, it's good. Something I often forget to do is to reserve that right, nonetheless.

Sharma: Interesting, interesting times. I can't wait to fast-forward to the end of 2021 and see what happens on all these fronts, but I guess that brings us to the next one.

Flippen: Yeah. This is an interesting question. I think investors, when we ask you this question, both of our listeners, [laughs] everybody will have different opinions.

Sharma: All three of them. [laughs]

Flippen: [laughs] All three of us will have different opinions about the answer to this question, but I'm going to pose it to you Asit first, which is, "Which IPO, SPAC or direct listing debut are you most looking forward to in 2021?"

Sharma: Emily, at the end of 2019 this would have been an odd question because at the beginning of the year, the IPO market was really good. There were some nice direct listings, and then we had a couple of IPOs that just blew up. There was the WeWork IPO. Let's see, I'm trying to remember the other big one. Uber came out ahead of its coming out party and promptly descended from there. At the end of 2019, I think it was a gloomy outlook for 2020 and then we had the pandemic. But lo and behold, as the market picked up, so much capital poured into initial public offerings, SPACs, direct listings that now this market is perceived as being really hot and there's any number of great issues that may go public in one form or another next year.

Two that I'm looking forward to are Roblox and Qualtrics, and I will briefly talk about each of these. Roblox, this is an expected symbol of RBLX, is actually a company that was looking to go public in December, but because the market is so red hot, and IPOs in November and early December seemed to almost be mispriced because they went up so much on their listing day, their first day investors bid up stock so much that Roblox actually said, "You know what? We'll wait [laughs] until we can get a better gauge on how we should price our stock." They didn't want to leave money on the table. This is a video game platform in which developers have ready-made tools. They can build games in an immersive 3D environment using Roblox's tools and games are free to play. It's almost something of a social platform. You can meet up with friends and play any number of Roblox games, they're continuously being built around the world.

Developers charge players for certain in-game features and that's a familiar model to anyone who's played video games. Think of Fortnite, buying yourself products in game. Players pay for these in-game features with something called Robux. So, like "bux," but with that "ro-" prefix. Roblox generates its revenue from the sale of Robux to players. There are 31 million daily active users on this platform, and revenue is growing incredibly fast. The first nine months of this year, the company had a nearly 70% year-over-year growth rate for that period. It is losing money. The company lost $203 million on $580 million in revenue in the first nine months of 2020, but it is cash flow positive. This is a really interesting company to look into. I know our friends, Dylan Lewis and Brian Feroldi, did a deep dive on this recently. If you're interested, you can look that up on Industry Focus podcasts. Just go to our list on whatever platform you use to listen to us and you'll find that, it's from a few weeks ago. It's one that I will be very interested in when they go public to monitor for a couple of quarters and see if I can understand the business model enough to invest in it. But it certainly has peaked my attention because the number of people who are playing video games on this planet is only increasing day-by-day and it looks like a concept that could scale in the future.

Flippen: I have to admit, while having not done as much of research into Roblox as I'm sure Dylan and yourself have, when I looked at this business, I was talking about it with my boyfriend yesterday and he posed the question to me, "Isn't this just a company that's looking to trick kids into spending money on stuff they don't need?" I didn't have a good response to that because I think the response is probably yes. I spent a few hours embarrassingly making an account, poking around on Roblox and it's definitely geared toward younger audiences who maybe have their parents credit card hooked up to that monthly subscription. But it's been a really successful business model in the past for video game companies and I don't want to let my Javascript days of video games influence my thinking on Roblox because the numbers seem impressive for what it is.

Sharma: Yeah. I think your boyfriend has a great point there, Emily. One thing that I have learned though that maybe takes the edge off of that point a little bit is that these platforms can be really great social connectors for kids. That's certainly true during a pandemic and you want kids to have real-life experiences with each other, of course. But there is some aspect of just social intercourse that goes on. This model was proven out by Fortnite, who's parent company's in my backyard here in the Research Triangle Park in North Carolina. Epic Games also makes money through the sale of in-game features, but Fortnite itself became almost more of a social happening at some point than the game itself and I thought that was sort of cool. Maybe that makes it a little easier to stomach as an investor. There is that positive impact on it, but I can totally see his point. [laughs]

Flippen: It does make me feel better.

Sharma: Moving on to the second one that I wanted to talk about really briefly here. This is a company that's named Qualtrics, expected symbol XM. Now, I know some of you are listening to this and saying what, XM, isn't there a company called Sirius XM? Well, there is. To me, this is a bad choice of symbol. Why call yourself XM now? The answer is that Qualtrics's platform, which we'll talk about in just a bit here is branded as XM, but it is very close to Sirius XM. But do you know what Sirius XM's symbol is by any chance , Emily?

Flippen: That's a good question actually. I don't, not from the top of my head.

Sharma: It is SIRI. [laughs]

Flippen: I guess I should have known that.

Sharma: Like Siri.

Flippen: Like Siri.

Sharma: Which is another weird branding choice, if you think about it. [laughs] Why in the first place would Sirius have that's close to the word Sirius? Why would it have its trading symbol so close to Apple Siri, and why would Qualtrics have its symbol so close to Sirius XM, even though XM is the name of their platform?

Anyway, let me get off that soapbox of [laughs] making fun of companies for the way they choose their trading symbols. This started out as a survey software company that used to focus primarily in the academic arena. The company grew very quickly. Some of you may remember this name because they were gearing up to go public in late 2018. Well, the German giant SAP (SAP -1.58%), the software giant which makes enterprise resource planning products, bought Qualtrics in January 2019. They basically got them to pull the plug on the IPO and SAP spent $8 billion on this company.

In the meantime, it has grown its platform from more taking surveys and providing analysis back to users to being user-experience enhancement platform called XM, in which you gather data and you understand how customers or anybody that your own business is interacting with, how they perceive your product or how they can get information out of what you are serving. It's still at heart a survey software company where you can send out queries to users or customers, aggregate that data and make sense out of the data you get back. Now, SAP has decided to spin out Qualtrics and the expected valuation is going to be between $12 billion and $14.4 billion, so anywhere from $4 billion to $6 billion more than SAP paid for this company just last year in early 2019. Their revenue is growing at a pretty good clip. It's growing at a 31% year-over-year pace in the first nine months of 2020. Like Roblox, it's also losing money. In fact, their financials look similar.

I said that Roblox had generated about $589 million of revenue in the first three quarters of 2020, Qualtrics has generated $550 million in the first three quarters of 2020, and it has lost $258 million on that. If you remember, I said that Roblox had lost about $203 million. Structurally they look similar, except Qualtrics is growing at about half the rate that Roblox is. Nonetheless, it's an interesting company in a really hot industry, data analytics. It should be a capital-light model over time, Emily, except that they have a lot of sales and marketing expenses on their books that's really driving these losses for now. This is another company I'm interested in. They should be going public early next year. Another one to season for a couple of quarters. It's small enough at somewhere between $12 billion and $14 billion that for long-term holders who like this industry, it could potentially do very well if you are patient. I don't think it's going to be a multi-bagger in just a few short years, but it could be a very high-quality name in an industry that's getting a lot of attention. Did you know about Qualtrics by any chance or had heard of it?

Flippen: Only in the name. Everything I know about it is what you just told me and it's interesting. I had no idea that it was growing that quickly for what it is.

Sharma: It's not the most exciting company [laughs] especially if you think of it as spending out of SAP, which itself is sort of a boring company. But I think it's good once in a while to balance out your more aggressive plays that are tech forward and capital light with some better going to be quality but maybe not grow like a weed. Having said that, Emily, is there anything that you're looking forward to out of this market next year, any IPOs coming up that you've got your eye on?

Flippen: Definitely. I think both of those two are really interesting. The one that I was looking at though, is actually Affirm. Affirm is a buy-now-pay-later solutions provider, I should say. If you're familiar with Afterpay Touch, an Australian company, they're similar in business model to those businesses, which just enables customers to make purchases and pay interest-free over a longer period of time. The intent of the business model is really not to collect interest payments from consumers, but to encourage consumers to spend more with whichever platform they're buying on, and then they get a payment from the merchants themselves.

What is different about Affirm versus other buy-now-pay-later lenders is that around 50% of their revenue comes from those merchant fees, the fixed rate the merchant provides to the company for offering service on their platform. But around 50% of their income comes from consumers themselves. They are a little bit more exposed to the credit profile of the person who is essentially taking out the interest-free loan on their platform. But they've done a great job of building brand awareness and loyalty in their consumers. Around 30% of their revenue comes from their biggest customer, which should maybe be no surprise to anybody who has one of these, but it's actually Peloton. Peloton themselves uses Affirm to encourage people to make purchases of the relatively expensive Peloton bike at interest-free over a period of time. It encourages people to make that purchase when they otherwise, may feel like it was just too much money to spend. It's an interesting business model. They work with merchants, not against merchants. They work with consumers, not against consumers. In my opinion, it's something to keep our eye on.

Sharma: Nice. I am really interested in this after hearing you talk about it, because I've been scratching my head for ways to keep participating in this explosion in online retail and just e-commerce in general, Emily. So many of the stocks that I like have soared this year, some of them I own and some of them wistfully I probably should still take a position. But companies like Affirm are a way to continue to participate in this whole sector as it grows, and hopefully, at a somewhat reasonable valuation, and we'll see after the IPO comes out, but we'll keep that one on our radar for sure.

Flippen: As we wrap up this last Wildcard Wednesday of 2020, I like this final question, mostly because I don't really know how you're going to answer it yet and it's a challenging one. Perhaps the most challenging question we've asked during this show, and that question is, "How do you plan on keeping your investments grounded in 2021?"

Sharma: Yeah. How crazy has this been for any of you who are listening today, who are on Twitter and maybe on FinTwit, that's financial Twitter. You follow a few people who are in finance or accounting, and you're seeing people sharing their portfolios and how well they performed. To me, it dawned on me slowly this year, Emily, that everybody's done really well, who's invested in tech-heavy companies. That's why a lot of my portfolio is in growth companies, although I do own value stocks and some dividend stocks as well. But it's becoming increasingly hard to even think about some stocks just because I've watched [...] price to sales multiples go from 15, which is to me, pretty high to maybe in the 30s or 40s or 50s, and these are quality companies [laughs] I'm talking about. Companies I like and admire, they feel almost too expensive to take a position in.

What I'm doing in this frothy environment to stay grounded is a few things, and I'll keep it short because I'm curious to hear how you are going to keep your investments grounded in 2021. I'm going to try to value narratives next year, and also potential when I'm separating out a truly great company from one that's just riding the current momentum. I'm going to pay a lot of attention to the story and try to assess whether that story equals real potential for the next few years. Then I'll be willing to pay up a little bit more because valuations are so high, focusing, No. 2, on a company's ability to grow its cash flows, that never hurts. For me, that's always something that can bring me back to reality even if I think a stock is overpriced.

If I go back and look at operating cash flows, free cash flows and I see that those are rising and have the potential to keep rising, then I can work backward and convince myself that, again, if it's that company with a great narrative, "It's OK, Asit, you can do this. Buy a little bit," you don't have to spend the whole chunk of your cash on this company, but add some to that position. No. 3, back to basics. I'm going to be looking for companies with a strong ability to innovate, ones that have a competitive edge or a really strong market pull for their products or services in times where you feel that everything looks expensive. Those are the types of characteristics you can always come back to, and when you can put them together, companies innovative, it's got that competitive moat, it's still seeing strong demand for what it offers. Again, that's a company that you can begin to believe in.

Then finally, I'm going to be looking in terms of market cap to supplement other indicators or ratios that I usually look at, whether it's a price-to-earnings ratio, a price-to-sales ratio. For those of you who like to look at things like enterprise value to EBITDA or anymore fancy indicators than that. I want to see what the market cap of the company is. Does it have the potential to grow from a $10 billion or $20 billion or $40 billion company to the next level? Or am I looking at a company that might be in the hundreds of billions of dollars in market capitalization already? I think that'll help me figure out how much I want to put in certain stocks that I like when I'm looking at all the growth opportunities that I have to invest in. Those are my ideas in how I'm going to keep myself [laughs] grounded, Emily. What about you?

Flippen: Well, given how formulaic yours are, I think you're going to be way more successful at keeping your investments grounded in 2021 than I will be. My process is similar to your point No. 2, which is oftentimes the best company to own is a company that you've already bought. I tend to lose this mentality when I'm looking at businesses. I tend to want to add a new company to my portfolio before buying something that I already own, but I constantly have to and I should in 2021 more ask myself, is this new business truly better than a business that I already own?

Oftentimes, the best company to own is one you've already bought, and don't let the fact that you already purchase it keep you from doubling down on a really good investment. I think the way that I am going to try to do this with myself in 2021 is that, any time I want to buy a new stock, I have to buy more of a stock I already own. I think I need some hard and fast rules to encourage myself to do it. I'm the type of person where if I don't have a tracking mechanism, then I will just find out. Give me an inch, I will take a mile. In this case, my goal in 2021 is for every new stock I add to my portfolio, I want to add to an existing business as well. If I truly don't feel confident enough to add to any of my existing businesses in my portfolio, then maybe that says to me, "Hey, you should probably sell one of these businesses if you don't really like it that much."

Sharma: Man, I love that [laughs] because it's going to force you, Emily, to sit down and say, "Okay, which of these stocks is working out for me? Do I really want to put money into these stocks? Or this one over here is exceeding my expectations. What is going right with this? Let me look into this because I think this is going to be the one that I will follow my rule and put more in." It's a really great way to fine tune your portfolio, and like you say, it's a natural way to force yourself to add to your winners, which we know over time is the way that you can make some truly great money. It's the hardest thing [laughs] intuitively to do, but it's a really great principle if you can just bring yourself to do it, I love that. I will have to listen to this part of the podcast again, Emily, to take notes and implement your method along with mine. That was awesome.

Flippen: We'll have to circle back in 2021 to see how effective our grounding plan was, and I encourage everybody listening if they don't do stuff like keep an investment journal or writedown your goals for the year. If you don't already do that, definitely do it as a good way of tracking your progress. You'll want that information a year from today when you're looking back and trying to gauge your personal success.

Sharma: Absolutely. Let's do circle back and let's try to [laughs] remember this time next year on the 30th or so of 2021.

Flippen: [laughs] We'll do our best.

Sharma: Right. [laughs]

Flippen: Well, Asit, as always, thank you so much for joining me for this Wildcard Wednesday, and I hope you have an absolutely wonderful new year.

Sharma: It was a great pleasure, Emily. I wish the same of you and all our listeners, and I will see you in 2021.

Flippen: [laughs] See you in 2021. Listeners, that does it for this episode of Industry Focus. If you have any questions, you can always shoot us an email at [email protected] or tweet at us @MFindustryfocus.

As always, people on the program may own companies discussed on the show, and The Motley Fool may have formal recommendations for or against any stocks mentioned, so don't buy or sell anything based solely on what you hear.

Thanks to Tim Sparks for his support behind the screen today. For Asit Sharma, I'm Emily Flippen. Thanks for listening and Fool on!