In this episode of Rule Breaker Investing, Motley Fool Co-Founder David Gardner, and analysts Maria Gallagher and Alicia Alifieri define risk Foolishly and revisit a risk-rating system to quantify the long-term risk your companies may face.
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This video was recorded on May 19, 2021.
David Gardner: Risk. A lot of people talk about it, but especially in the investment world, I've never found that talk very satisfying. First of all, how do you, how do I, how do they define risk? What does it even mean to say that's a risky stock? The definitions are often unclear. Then some analysts in the risk section of their stock report will say stuff like medium, as in this is a medium risk stock. What does that mean? Well, about a decade ago, I developed a 25-point risk rating system that we've used at Rule Breaker Investing ever since. I defined risk, well, at least what that word means to me as an investor, and we went on not just to put a word to the riskiness of the stock, not just a word like medium, but to go on to put a number on that stock's risk. A number to give you a much more specific understanding, and that number is itself based on 25 questions asked of the stock. You know what? We're going to cover the whole thing this week. Joined by my two friends, Alicia Alfieri and Maria Gallagher, we three are going to teach you the entire system, help you rate stocks yourself along the very important dynamic of risk. Only on this week's Rule Breaker Investing.
Welcome back to Rule Breaker Investing. Well, it was a busy week last week, especially on this podcast. It was my delight to bring you A Road Less Traveled in Ten-and-a-half Chapters, which I started writing at 11:00 AM last Tuesday Morning, 9,309 words later. That is, by the way, a 36-page paper. If you're doing 250 words, double-spaced, single page. I didn't know that I was going to write a 36-page paper that I presented on last week's podcast to you about the future. But that was a delight. I was saying to friends that if I had been told ahead of time that in order to do that podcast last week I would need to write a 36-page paper, I would not have done a podcast [laughs] last week. But I'm really glad that I did and I hope that you enjoyed it. I hope that it opened your eyes and I hope you have some measure of understanding. About my excitement about this podcast going forward, we even did a weekend extra last week, Lead A More Interesting Life, and I hope you enjoy that short story for those who gave us a little time on their weekend. But here we are back to brass tacks, back to the business of investing in this podcast. Last month's mailbag, [...] from Chicago. [...], I hope you're listening. You challenged me to do more investing. You said I was doing a little bit too much storytelling and other things, and I agreed with you. I said I think this podcast needs to remember its roots.
Sometimes, admittedly, it's been a very distracting last few weeks. But with that said, I wanted to revisit risk ratings. I told you in that mailbag that we would do with this month, and here I am this week with two friends to go over risk, assessing risk in your investing. Well, in just a few minutes, I'm going to be joined by two of my favorite analysts at The Motley Fool, Alicia Alfieri and Maria Gallagher, and we're going to talk through my 25-point risk rating system. But before we do that, let me just lay down some introductory material. First of all, if you enjoy what we do this weekend, you find yourself wanting more of it, I did a series. It was a risk month, March of 2016 on this podcast. If you want, we did it in three consecutive podcasts. You can google it, Rule Breaker Investing Risk Ratings, and you will see the series of three podcasts that I've done. It was with two example companies, one of which got bought out subsequently. It's not even public anymore. But it takes you through the same material, probably with little different language and with some extra companies. If you find yourself really enjoying this week's podcast and you crave more of it, just google it and you will find that past series, which should still feel pretty fresh. Assessing risk in your investing.
I said at the top, a lot of people don't really define risk. I feel like I owe it to you, my listener, for you to know how I define risks and how I've used it for Rule Breaker Investing over the year. Here's my rather simple definition of risk. To me, risk and equity investing, when you buy a stock, is that you would lose a substantial portion of your capital here, right here, in this stock that you're looking at, that you're thinking of buying, that you've just bought, that you would lose a substantial portion of your capital held over a meaningful portion of time. Let's think of that as a minimum of three years. To me, risks in the stock is that I would actually lose, let's say, get cut in half maybe, I would lose a lot of my money and nevertheless have held it for several years, which hurts even more because you tied that capital up over time and you did poorly with it. That's how I think about risks and what a risky stock is. Our system to measure risk is designed to fare it out, which are stocks that could happen in a more likely way than other stocks, which are the risky stocks and which are the safe ones. I mentioned at the top my distaste for the phrase medium. I've never known what it means when somebody tells me the stock's risk is medium.
From the beginning, I wanted to help investors think not about risk as a word or some kind of continuum that's a label. I far prefer, in this case, numbers. About a decade ago, we hatched a system. I'm going to explain that right now. We're going to do the why, the what, and the how. I'm telling you about the why right now. Why? I think it's helpful to know what is the risk of a stock, especially for you as a new investor. I hope this particular episode will really help the new investors open your eyes to how to think about, really understand why one stock is riskier or not than another. That is a goal. The why should be fairly clear. I think risk is important. You should be able to think about it at a stock by stock basis. You should be able to think about it on a portfolio level basis. When you reduce it to numbers, you really can in a much more helpful way. That was why I was dissatisfied with other people's definitions of risk and by sometimes the sloppy language around it, so we built this system. That's the why.
Here's the what, what is the system? Well, as I've mentioned, it's a 25-point system. Now if you are an existing Rule Breakers or Stock Advisor member of any vintage, you will recognize that every stock that I pick, as we've put them in over the years, you'll see our 25-point risk rating included with that stock pick. There is ample homework for you to do if you'd like to go back and relearn this, run it yourself, or look at the risk ratings for any of our past picks, they're right up there. But let me say a little bit more about this simple 25-point system. First of all, it is simple, really, and I designed it that way ultimately so that you and I could use it. Anybody could use it. You don't need to be a professional analyst at The Motley Fool, as my two talented guests are, you should be able to do this yourself. You're asking yourself a simple question with a yes or a no. You're going to ask 25 questions, and of course they're the same 25 questions for the most part for every stock that you are looking at. You are going to go through the list. That's what we're going to do for the majority of this week's podcast is go through that very list with two example companies with my two analyst friends. Now, anytime the answer to that question is no, that is risky or riskier. As we go through 25 questions, if we end up saying no 10 times in one of these companies, that is exactly its numbers, spoiler alert. I already know the risk rating of both of our stocks. If we say 10 no's, then that means it's a 10 on the risk rating system. The higher the number, the higher the risk. If one stock has a risk of 17, that means we said no 17 times. If another has just five, then we said no only five times, and five is a lot safer than 17. I hope that's simple to follow. The higher the number, the higher the risk.
In general, we don't like risk. I would far rather make a lot of money as an investor taking no risk. I bet you would, too. Again, our definition of risk is that you would lose a substantial portion of your capital held over a meaningful portion of time. That is not good. Yes, the lower the risk, generally, the happier I am holding the stock, and here's a little secret. A lot of people think that risk equals reward. But what I've learned is that that is not true. You can actually find stocks that are lower risks that have greater rewards, and that itself is rule breaking and part of why we do what we do. To close, with the what, it's a 25-point system. We ask the same 25 questions. Every no is a +1, that's bad. The higher the number, the higher the risk. By the way, while you can do this stock by stock, and I would encourage those who really get into this to do that stock by stock, you can apply this to any stock. For people who are really into it, I want to point out, you can actually measure the risk of a group of stocks or your portfolio, dear listener. All you do is take the risk of each of your stocks, then multiply by the percent allocation that you've given of your portfolio to that stock, and you could estimate the risks of your portfolio. Again, if you get really into our conversation this week, there's more for you. Well, with all of that said, I now want to welcome my friends, Alicia Alfieri and Maria Gallagher. Alicia and Maria, welcome.
Maria Gallagher: Hi, Thanks so much for having us.
Alicia Alfieri: Yeah, so glad to be here.
Gardner: As am I, and it's a delight to have you both. Alicia, I believe this is your debut on the Rule Breaker Investing podcast. You and I have done a number of Motley Fool Live events together. Maria, this is certainly not your debut on the Motley Fool investing podcast because you have been a market cap game show star, among other appearances. Anyway, it's so great to see your smiling faces. We're going to have fun this week talking through, I don't know, is this fun risk? Is that fun? Well, before we start, let me turn first to Maria. Maria, could you briefly introduce yourself and the company that you'll be taking through our risk rating system.
Gallagher: Of course. Hi everyone. My name is Maria Gallagher, I've been at The Fool for almost three years now. The company I'm going to talk about, I have been a user of, it's called Chegg (CHGG +4.89%). For people who aren't familiar with it, it was founded as a go-to place for textbook purchases and rentals, and then Amazon came into this space and Chegg did this really great job of pivoting and going into more service offerings: tutoring, citations, math answer help, etc., taking over what a lot of people used Yahoo Answers for in a subscription-based model. They've done it really well, and I'm excited to talk more about Chegg as the podcast goes on.
Gardner: We will certainly be doing that. Maria, thank you so much for joining me this week, really looking forward to it. I'll mention that both of these stocks are active recommendations. Chegg is a Motley Fool Rule Breaker recommendation. Alicia will be mentioning her company in a sec that's a Stock Advisor pick. Our two example companies are active recommendation stocks that I like today going forward for at least the next three years, and we'll find out their risks together this week. Let me now move to Alicia Alfieri. Alicia, a delight to have you with your debut on The Motley Fool Rule Breaker Investing podcast, welcome. Who are you? What is your company?
Alfieri: Well, I'm so glad to be here. I started at The Fool in September, so I'm a pretty new Fool, and I'm working on the Stock Advisor, Rule Breakers, and the Ownership portfolio. I have brought you to talk about The Toro Company (TTC 0.90%). Some people might be familiar with Toro, from the residential lawn and gardening equipment, but they do so much more than that. They also design, manufacture, and market professional landscaping equipment, golf course maintenance equipment, irrigation systems, and underground construction equipment.
Gardner: Part of what I love is the real contrast between these companies. We've got basically an online education company, and the company that gives you your snowblower or your robo mower for your golf course. For those of us who work on golf courses. We have a wide enough listenership, I'm quite sure we have people who are using both Chegg and Toro, possibly more than I am every day. These are very different companies. One of them is a dynamic recent education player, the other, a long-standing American brand that's a leader in its categories, but both tech-savvy. Without further ado, Maria, and Alicia, let's get started. My job as MC is to queue up what each of our 25 questions is, and then you will dutifully give the answer for your company and any color that seems necessary. Sometimes these are simple numbers, not a lot of color, other times, nuance we should discuss, we'll do both. The first five questions are from the category, the company. These five questions are about the company. By the way, some of our other sections are: the financials, the competition, the stock, and a few others we'll cover at the end, but these are bucketed up. The first five are questions about the company. Question No. 1, a yes or no question from our Rule Breaker Investing risk rating system. Turning now, Chegg and Maria, profitability. Maria, was the company profitable during the previous quarter and past 12 months?
Gallagher: The quick answer is no, as of March 2021, Chegg was operating at a loss of about $65 million.
Gardner: I think that a company that isn't making money, is this crazy, is riskier than a company that [laughs] is making money. Unfortunately for Chegg, we have to give a no. Turning now to Alicia. Alicia, The Toro Company; was the company profitable during the previous quarter and past 12 months?
Alfieri: Yes, and yes. For their most recent 12 months, they had net profits at $371 million, and for their most recent quarter, they also had profits. They're at $111 million.
Gardner: Excellent. The question is written as Alicia and Maria just underline not just about like the last quarter did they make money, but also the last 12 months, but both, you can't just have made money the last 12 months, but if you've lost money in the last quarter, that also matters to us. If you can't say yes basically to both of those, then it's a plus one no. Keeping active score here, I see Chegg's a no, that makes it a 1, I see Toro's a yes, that makes it a 0. Let's move to question No. 2: risk rating system. Question No. 2 is about the cash flow. Turning Chegg and Maria. Maria, was the company cash flow positive during the previous quarter and past 12 months?
Gallagher: This is a yes from Chegg. As of March 2021, they had about $140 million in free cash flow.
Gardner: Really interesting, and here we're highlighting the difference between reported profits but then the actual cash flows, and of course, if a company has cash flow, as Chegg does, that makes it less risky than if it did not have cash flow. I can probably guess for this one, Alicia, but did The Toro Company, was it cash flow positive during both the previous quarter and past 12 months?
Alfieri: Well, so I'm giving partial credit here. [laughs] For the fiscal year-end, yes, but for the last quarter, no, they were down a bit.
Gardner: When we actually ran these numbers for The Toro Company, it was a little while ago, I'm not sure we knew that most recent reported quarter. I counted it as a yes, we're going to call it a yes, for our purposes here, which means that Chegg is still at 1, Toro still at 0. But wow, you can imagine a year of COVID, even for big, in this case, more industrial companies, a lot of challenge, and yet Toro has held up pretty well, at least well enough for us to give them a 0 here. Let's move to question No. 3, friends, about the companies. This is about the company's brand. Turning to Maria and Chegg. Maria, does the company's business rely on recognizable branding that is truly valued by its buyer base?
Gallagher: Yeah. For Chegg, that's really important for them because they need to consistently be top-of-mind for students. A pretty interesting statistic I found is that in 2018, the brand awareness for Chegg in college students was about 80%, so it's a really widely known brand and I think that that's one thing that has a strong competitive advantage for it.
Gardner: Really well put, that is a key factor for our thinking about Chegg, and of course this question is important, because if a brand of a company is not particularly known or valued by its buyer base, that sounds riskier to me than if there is an existing brand relationship. Alicia, Toro, brand, is it recognizable and truly valued by its buyer base?
Alfieri: Yes. They have an impressive catalog of several well-known brands. They have a Toro for turf maintenance, snow management, landscaping equipment, ditch witch for some of their underground and utility construction, [...], which is irrigation programs, and lawn boy, for their residential mowers.
Gardner: A bunch of brands, and in different categories, and yes, sure enough, that is a strength, therefore a less risky proposition. Very happy to give yes answers for both of these companies to brand. Let's move next to No. 4. We've had a lot of yeses so far, only a single no, Chegg still standing at 1, Toro at 0. As we hit question 4, which is about diversification, Maria, has Chegg diversified its buyer base so that no single customer accounts for more than 20% of its revenue?
Gallagher: I'm coming back in with another yes. Chegg, because it's mostly bought by students and actually had 5.8 million paid customers in 2019, so they have a very diversified user base.
Gardner: This is a really, again, an important consideration around the risk of an enterprise. I've lived it myself, the Motley Fool has had a few different business models over our 27 years. Once we were a largely ad driven and ad reliant, we were a free website back in the late 1990s, and we only had a few customers, our big advertisers. When all of a sudden 2001 hit, a lot of bad things hit in 2001, and some of our advertisers said, "You know what? We're not in this quarter." Boy, did that hurt our business quite a lot. These days, much later, much happier to say we have a broad, diversified base of subscribers and we hope nobody would ever cancel any of our services, but if you did, it would not endanger our enterprise in the same way that one big advertiser for us back then, or somebody who does 20% or more of your business, well that does add risk back in. Glad to note that about Chegg, I can probably make a guess about Toro, but this is not about guesses, Alicia, this is about truths and answers. Alicia, has Toro diversified its buyer base so that no single customer accounts for more than 20% of its revenue?
Alfieri: Yes, they have. They sell through a network at 68 domestic, and 140 international distributors, and they sell through equipment dealers, hardware retailers, online, direct to consumer. A big yes here.
Gardner: That is awesome. That brings us to the final of our five questions about the company itself. Again, we've reviewed profitability, cash flow, brand, and diversification. Our 5th and final question about the company for our risk rating system, turning now to Maria and Chegg, is about raving fans. Now this one's subjective. A number of our questions are subjective, and how your answer might be different from how I answer, which by the way gives us different risk ratings. Which is I think an important point that I might make later on. But back to raving fans. Maria, does Chegg receive a positive word of mouth from its customers?
Gallagher: For this question, I try to find as much wisdom of the masses as I can, and for Chegg, it landed me in a lot of subreddit groups [laughs] for different college majors, and I would say that a very enthusiastic yes from a lot of subreddit users, specifically in engineering, has a very positive yes for Chegg in that section.
Gardner: That is awesome. Thank you for that. Again, you can imagine why as people rate the risk of enterprise, which is what we're all doing together. This week you can imagine why having raving fans makes a company much more stable in my mind than having the opposite. Let's move now to The Toro Company. Alicia, does Toro have a positive word of mouth overall from its customers?
Alfieri: Yes, they do. Actually, I'm really excited because I think this is going to be expanding for them in the future. They have a deal with PGA Frisco and Pebble Beach Resorts For Toro branded equipment to maintain the golf courses of every major Championship tournament in 2021. Plus they were named the official turf equipment and irrigation provider for the Ryder Cup through 2029. We think we're going to see them to continue with this in the future, which is really exciting.
Gardner: That's wonderful and that'll probably help grow brands as well in addition to the raving fans. We finished our company's section. I count Chegg with one. I count Toro with 0. These numbers are going to go higher, but at least these five questions we aim at the company, we find very satisfying many, many yeses. Let's next move to the financials. Now we have five questions about the financials. The first one, question No. 6, concerns the growth of the enterprise. Maria with Chegg, did the company grow its sales by 10% to 40% annualized over the past three years?
Gallagher: The answer for Chegg is yes, it shifted its business model, like I said earlier, from that capital-intensive textbook rental to digital learning platform, and so you can see that really tick up in the revenue. In 2017 there was less than 1% growth, but then 2018 and on there was over 20% growth with the most recent quarter of up to 59.8% growth as of March 2021.
Gardner: This is again something that intentionally, I'd like to take a little bit of a longer view. Rather than just zoom in on any one year, keep in mind a lot of analysts just zoom in like one quarter, which I especially don't think is that wise, I like to look at the three-year story. Turning now to Toro and Alicia. Alicia, is this company growing its sales helpfully, between 10 and 40% annualized for the past three years?
Alfieri: Well, they're more of a slow but steady grower. When we look at the yearly totals on their own, so 2019 revenue grows, really tip the scales at nearly 20%, but 2018 and 2020 were both below 10%.
Gardner: We have our first no, for Toro which ties these companies 1 to 1 so far on risk. I just want to add before we move to the next one that I like a healthy amount of sales growth. I think that shows companies are innovating often. They're not cyclical, I prefer companies that grow naturally and don't rely on cycles. If companies are either below that 10% or a subtle point, over 40%, where there's a lot of expectations and a lot of crazy sales going. There are lots of exciting sales stories but that actually creates, in my mind more risk as well. If a company has a really high sales growth rate because there are often market expectations baked in that, that will continue and often it may not, so that adds more risk. I hope it's clear why we have that banded number 10% to 40% as that's the safer, less risky band to be growing your sales, which sure enough, we want you to be growing your sales for most of the stocks we're going to invest in.
Let's move on to No. 7. This is about the independence of a company financially. Maria and Chegg, can this company operate its business in the next three years without relying on external funding?
Gallagher: I remember thinking about this one I had a little bit, I wasn't quite sure I put down yes, because it generates strong free cash flow as much more asset-light than it once was. But it is becoming more and more acquisitive, which I think is important to note here, and it conducted two follow-on offerings. It does have it boosted cash position through a follow-up offering and convertible notes issuance in 2018, and new convertible notes issuance in November of 2020. It currently has about $1.8 billion in cash, which should be enough for the next couple of years. But I wanted to note that I thought about it a little bit more with those follow-on offerings as well as they're acquisitive strategy moving forward, which will be more capital and cash-intensive.
Gardner: Well, and thank you very much for that nuance. It's worth pointing out that while we're giving a binary yes or no, in order to arrive at a final score, that's a number which I think is a strength of the system. At the same time, there are subjective considerations and somebody who is smart and knows this stuff, like Maria can look at it and say, well, it's not necessarily a simple yes or no some of the time. You just heard about a company that's grown through acquisition, where sometimes some companies become dependent on that and therefore become riskier because if they don't find a good acquisition or don't do it well, that can hurt the company and your chances with the stock. We're going to give Chegg, a yes there and say, because of that big cash balance and it is cash flow positive, it can operate without needing external funding, but sure enough, it has drawn on some of that as Maria pointed out. We'll give Chegg another yes, let's turn our sites now to the Toro Company, and Alicia, can this company operate its business without relying on external funding?
Alfieri: Yes, but I'll mention here that they did utilize a credit facility which is essentially a line of credit, partially out of precaution during COVID, but they've already paid that back. Which was smart and shows that the company's commitment to paying down debt is really there.
Gardner: Thank you for pointing that out. Both of these are nuanced, and dear listener, if you are more conservative than I am or than we are, you might actually say, "I'm going to say no on that one," which would give you a slightly different score than mine, which I think is the strength of this system. There is subjectivity that you bring. We're going to be very explicit about that in about 15 questions or so. But some of the risks aren't actually about the stock, it's about you, and what you know or what you think. There is subjectivity and I like that about our system, but we're going to stay tied at Chegg 1, Toro 1 as we move to question No. 8, which is about financial disclosure. Maria, does Chegg maintain a high standard of disclosure consistent with SEC guidelines in the United States?
Gallagher: It's a quick and easy yes for Chegg and I don't have much else to add for that one.
Gardner: Let's keep moving then. Alicia, would you say the same of the Toro company?
Alfieri: Yes.
Gardner: Why does this matter? Well, I don't like to read through really complicated financials. I sometimes think I'm going to be the last to figure out things are going wrong if I'm reading really complicated financial statements. I do mention the SEC guidelines in the United States of America because I do think that America is among, I won't say the best sometimes we Americans think we're better than we are, but I will say we're among the world highest standards for transparency and full and fair disclosure. Sometimes we ding some foreign companies, if we feel as if they are not reporting to the same high standards that I demand as somebody who's trying to figure out the financials. We're going to give yeses to both of these companies, but sometimes we give no's.
Let's keep moving. Question No. 9 continues that theme of transparency. Maria, would ant intermediate level investor, that's always how I think of me, and probably a lot of us listeners think there's more we could learn. We're not experts, but we're also not beginners. Would an intermediate level investor find the company's financial statements and management ownership disclosures relatively easy to sift through and understand?
Gallagher: Yes, I think Chegg and I might talk about this a little bit later with their management team. I really respect their management team. Sometimes when you read these disclosures, there's so much jargon, even when the company is pretty straightforward and pretty simple, they say so many words I feel like I'm googling every 3rd word for no reason. That's definitely not the case of Chegg, I really admire the way management is very straightforward and the way they talk about what the company does and their vision of it for the future.
Gardner: Thank you. Alicia, similarly, as intermediate level investors, do we find the financial statements and management disclosures readable?
Alfieri: Yes, and I would say that both their financial statements and their earnings call give really good color to their earnings to help you understand the moving pieces behind the numbers, which is so important.
Gardner: I like that you both have spoken to management here because transparency is the title of this question, question No. 9, for the risk rating system, but a lot of this is about the leadership of the company and their communication ability and willingness, and that really does count for a lot. As you could imagine, since we're assessing risk, companies that you would not be able to say yes to, companies that are not transparent or communicate very poorly, either on their earnings calls or to the world at large, yeah, that would be riskier if companies are like that. Very happy to be able to say yes to both of these, and so far these seem like really safe stocks, Maria and Alicia. I think that's not going to be fully the case, but my running count here is still 1 for Chegg and 1 for Toro.
Let's move to the final of our financials questions. We call this one well-managed. Now, I would love it, Maria, maybe if you'd speak to this a little bit. This is not a ratio, we use that frequently on this show. You don't necessarily have to give us the chapter and verse textbook, but not everybody may know return on equity or what that is. But here's what we're asking for. Well-managed. Over the most recent fiscal year, did the company report a return on equity of 15% or higher? First of all, yes or no for Chegg?
Gallagher: It's a no from Chegg. It was about -7%.
Gardner: You want to throw us any color or explain what's going on there?
Gallagher: Yes, of course. With return on equity, it reveals how much profit a company earned in comparison to the total amount of shareholder equity found on the balance sheet. It's what us, as shareholders own. It's a really good level of profitability and understanding what that looks like for the company moving forward and in the past.
Gardner: Very succinctly explained and without going too deep here. It's in a way, I think of it as well managed. Are you doing well with the resources accorded you? What is your level of profitability off of the shareholders' equity? Again, this is more of an older school ratio, not one I use very actively, but when we're assessing risk, I think this is a good quick look in. That's a no for Chegg. What about the Toro Company, Alicia?
Alfieri: It's a big yes. For the 12 months ending in January, Toro's ROE was 35.5%. This is slightly down from fiscal year 2019, which is 35.9%, and also a little bit down from fiscal year 2018.
Gardner: Well, thank you very much, and let's call it right there for this section, which was the financial. Where are we? While we've gone through 10 of our 25 questions, some of them are quick and easy, some of them are nuanced. It's not always clear, but I hope we're learning. I hope you're learning right along with us. If I've been doing the math right, after 10 questions, I count Chegg at 2 and Toro at 1. We're about to move to our next section. Three questions that are now about the competition. Because surely you cannot know the risk of a company, if you don't understand the competition that that company is having to think about or deal with either every day or in future potentially. Let's move now to the competition. Maria, question No. 11 is entitled underdog. Maria, again, this is the underdog question. Is Chegg free of any direct competitors that possess substantially greater financial resources?
Gallagher: No. Competition is where we will have some conversations about Chegg and where I had a little bit of pause with Chegg, and that it has a lot of competition in this space. You have universities with massive types of endowments and a lot of money, you have Amazon, you have free YouTube videos and online resources, and so you have the whole Internet essentially at your fingertips, and if you can't find a free answer, then you might go to Chegg. But so they have a lot of competition, especially in the space of people who have more resources than them, specifically, I think YouTube.
Gardner: Thank you, and very true. We had to give this one a no, because there is a lot of substantial competition for an upstart like Chegg. Let's move now to the Toro Company. Same question for you, Alicia. Is this company free of any direct competitors that have substantially greater financial resources?
Alfieri: This is also a no. They have competitors including Heavyweight, Caterpillar, and Deere.
Gardner: Maria, in her explanation, gave us a range of a whole bunch of different competitors from the universities themselves to free online answers on YouTube. Alicia, for the Toro Company, it's much more focused around big players, as you mentioned, like Caterpillar. For both of these companies, we give a no, that's in the loss column, boosting Chegg to a 3 and Toro to a 2. Now let's look at competition with question No. 12, from the other direction. Is the company free of any disruptive upstarts that are visibly challenging its business model? We call this the Goliath question. Is this a lumbering giant that could or maybe is being actively disrupted by upstarts? Let's start with, again, Maria and Chegg. What is your take on this one? Yes or no?
Gallagher: This is another no from me. You see so much competition in this space because it's such a wide range. You have competition from your friend's mom who used to be a teacher in this space and you pay her to help you. You also have places online like the Khan Academy, and you have places like Coursera, and so you have different upstarts groups, free study groups that you build with your friends or things like that, so you have so much, once again, just a lot of competition in this space, both with a lot larger of a competition-based and smaller as well.
Gardner: Absolutely, Maria, and especially because Chegg, to its credit, has broken out of an initial textbook orientation and moved much more to adult lifelong learning across a number of different dynamics. We can imagine yeah, YouTube is out there challenging, maybe I should just watch a YouTube video to figure out how to do this or that thing, so there's no question that there is a lot of disruption in the online education space and that certainly has to ding Chegg. Again, do we still like the color? Yes. This is an active recommendation on Motley Fool Rule Breakers, but let's also, eyes wide open, know the risk and understand the competition, which is what we're speaking to right now. Similarly, Alicia, with Toro, is Toro free of any disruptive upstarts visibly challenging its business?
Alfieri: No, they're not. There continues to be innovation in this space, specifically in automation and in robotics. But something really exciting here is that Toro has done a really great job of using acquisitions as a way to broaden their offerings, which we could talk about later.
Gardner: Well, that is true and that's part of our thesis and why we're excited about Toro's, because it is, I hope anyway, amply ready for an increasingly automated robotic world that we may be moving into with its big equipment. It's not going to be disrupted, we hope anyway, because it is making some of the early stage acquisitions to be a leader in that space. We'll see, but for now, we have to give both companies a no for both of our competition questions so far, which has brought Chegg to a 4 and Toro to a 3 as I ask the 3rd and final question about the competition, that would be question No. 13 of our risk rating system, which is entitled moat. Maria, would potential new competitors face high economic, technological, or regulatory barriers to compete with Chegg?
Gallagher: I had another no for Chegg here, but I do think this one is a little bit more nuanced once again. There is an archive of 30 million expert questions, five million textbook solutions, access to 24/7 tutors, and a consistent growth in an acquisition strategy. They have EasyBib, they have Thinkable. They do have quite an expansive category. But I do think that in terms of the way the question is I always go to, if I'm a new competitor, do I have these really high barriers to entry? I don't really think they do, but I do think that Chegg has a head start in all of their offerings. But I think if new companies come in, the textbooks don't need to be exclusive with Chegg. They don't have that incentive. The universities don't need to be exclusive in that way. It doesn't incentivize me to think that Chegg is going to be this exclusive offering. But I did want to note that they do have, I'd say a really big head start, but I do think a company could catch up to them.
Gardner: I really appreciate again, the nuances and your thinking, and I agree with you. I could imagine some people saying yes, that they do have a good moat. All of the existing answers that they have in their databases, in the search ability, in the accessibility is a substantial asset, and yet, I agree with you Maria, that that would not necessarily intimidate or stop anybody else from trying to build something similar. I think that is the spirit of the question. I'm sorry to note it's no because I always want these to be yeses, but I agree with you, Chegg is a no, which means Chegg gets a no for all three competition risk rating questions, bringing its overall score up to 5. Now, The Toro Company, a very different company. Alicia, but what's your read here for Toro, would potential new competitors face a real barrier to entry to compete with Toro?
Alfieri: This is a no as well. Though start-up would have a bit of a hurdle in terms of getting their brand out there and creating partnerships and relationships with distributors that Toro has, but there are no high barriers to entry here.
Gardner: Awesome. I say awesome because I agree with the answer, but I'm always sad to have to give a no. For both of these companies, they get dinged for all three of our competition questions. That brings the overall score at this point after 13 questions. Chegg is at 5, Toro is at 4. Now the next section, three questions about the stock. We're going to go quickly through these because these are just straight numbers pretty much, and a lot of us, especially long time listeners will already know what a market cap is, so we don't have to explain. Let's go to question No. 14, the first about the stock. Chegg and Maria. Maria, does Chegg have a market cap of $10 billion or more?
Gallagher: Yes, barely. It's a $10.7 billion market cap.
Gardner: Excellent. Similarly, Alicia, does Toro have a market cap of $10 billion or more?
Alfieri: Yes, it's $12 billion.
Gardner: Wow. Both are actually quite near that cutoff, and even that number is a big round number. Somebody else might prefer a different one, I like $10 billion. For me, if a company is worth more than $10 billion in the public markets, that feels safer. Like there's half there. There are lots of employees, there are lots of customers. Those are bigger and safer enterprises than smaller, a little bit more fly by-night in some cases. A lot of people invested in very small micro-cap stocks. I almost never do, but I think we can all agree that at a certain point you are big enough that you're a little bit of an Unsinkable Molly Brown. While I can't say that about Chegg as I think about the company, Toro, I do feel that but the market cap for these companies, surprisingly similar interestingly enough. But both over and so yeses. So we're back to yes ville.
Let's go to question No. 15. I will briefly explain what this means and then Maria and Alicia will fill out their numbers. Question No. 15 is about the Beta of a stock. Basically this is the volatility of the stock. One of my criticisms of other ways of measuring risk is a lot of people think that risky stocks are volatile stocks and they equate risk with volatility. I hope that you dear rule breaker, understand that our ideas fly in the face of that. We do include volatility as a consideration right here with question No. 15, the Beta. But a lot of people just think of a stock zooming up and down more than the market, that's risk. I completely disagree. I think risk is about the chances you'll lose a lot of money after you hold a meaningful amount of time. It's so much more about the fundamentals of the business, and these 25 questions we're asking. Now we're going to zoom in right again on the Beta number. This is the percent the stock moves relative to the market's average movement. If the S&P 500 tends to move up, let's say 10% a year, and a company tends to move up 15% a year. When the S&P is down 10%, this company's typically down 15%. That would be a higher Beta. We would say that it has a Beta of 1.5. It tends to move more than the market in both directions, and you can express that numerically. The number that we use here is a Beta of 1.3. We're going to acknowledge as Rule Breakers that our stocks are typically more volatile than the average stock. I tend to avoid cyclical stocks. For these reasons, I like to ask is a stock's Beta rating over the past 12 months, less than 1.3. I'm going to get quick answers first and we could talk about a little bit more. Maria for Chegg, is its Beta less than 1.3?
Gallagher: Yes, it is 0.82.
Gardner: Wow, so it moves less than the market averages. It's less volatile, or at least over the last 12 months has been than the market itself. Very interesting, Alicia, what about the Toro Company?
Alfieri: Yes, as of yesterday, it was 0.77 for the last 12 months.
Gardner: Here again, these radically different businesses are about the same size and are also kind of lower Beta companies. That surprises me, I have to admit. I wasn't speaking ahead and looking at the answers. I couldn't remember, but I'm really interested to know both of these stocks move less than the market overall up and down. Now these are all averages, and this is only over the last 12 months. This is not something you should expect over the next 12 months or locked down in your mind. But the intent of this question for our risk ratings, fellow Fools is that it's going to be riskier if a stock is flying all over the place than one that isn't too much. Maria, would you like to add anything to that or to Chegg?
Gallagher: Actually, I was very surprised by this. I thought because when we initially looked at it, I thought that the year of COVID would have changed that because I think Chegg was a company that people hadn't thought about, and then COVID brought it to the forefront and people thinking about online accessible education. I was actually surprised. I thought it was going to be higher when I looked at it because it's a stock that has moved a lot over the past year or two.
Gardner: I, too, am surprised by that. Alicia I have to say I'm not as surprised that a staunch or more industrial company like the Toro Company, even though there are some hi-tech aspects that interest us, that it would be a lower Beta stock.
Alfieri: Yeah, I would agree with you. I wasn't very surprised either, just because again, they've been around forever slow, steady growers.
Gardner: All right. Let's move onto the 3rd and final question we asked about the stocks, and that is the question about the price to earnings ratio. Now, I'm not going to redefine the P/E ratio. A lot of our listeners will know that like the back of their hand, others are still new to investing. We don't have time to really dwell on this other than to say that we like to see a positive price to earnings ratio because that means the company actually has earnings which will be safer and less risky. But we'd like it to generally be within a reasonable range. We're going to say here below 30. The question that we asked of our stocks as we rate their risk. By the way, is it going to be a good stock or not? We've had some amazing stocks with very high-priced earnings ratios. This is measuring the risks. That's what we're doing this week. Maria and Chegg, does this stock have a positive price to earnings multiple, less than 30?
Gallagher: No. It has 55 times next 12-month earnings per share ratio.
Gardner: Wow, that's a big number. By the way, keeping score at home, and I'm keeping score right here. That brings Chegg up to a 6 on our risk rating points systems so far through 16 questions. Alicia, what about the price to earnings ratio of the Toro Company?
Alfieri: It's not less than 30, but it was positive. When I initially did my research, it came in at 30.6, so just above.
Gardner: Wow, [laughs] so close. Again, you could have fudged that if you want and the whole spirit of the system, I hope our listeners are picking up this week, if any of us can pick up and use this. If you don't like to round numbers, you'd like to drop fractions, then you could say yes for this one. But we gave it a no. Both of these companies have higher-priced earnings ratios, which adds in an element of risk. Sure enough it will because if companies trade at high multiples, if they stub their toe or if something shows up, I don't know like COVID, for some businesses that can really hurt them, and if they have high valuations, high multiples, then you could expect that stock to get hit harder, sometimes for longer. That is always going to be true of higher P/E stocks, even though I favor a lot of them. Of course these are both active recommendations. Keeping score at home, we're into our final nine questions. A couple of them are very subjective. We'll have some fun in a sec, but we have Chegg at 6 and Toro at 5. Totally different businesses, but somewhat similar. Interesting to note that. Let's move onto our next two questions. This is about management. We're looking for the founders, we're looking at the people of this enterprise in the eye. Question No. 17, founder. Maria, do any of the founders of Chegg still have at least a 5% stake in the company?
Gallagher: No. The founders are no longer involved and the current CEO has 1.6% of the shares outstanding and everyone else on the management team and within the board has less than one%.
Gardner: Wow. We'll talk about that in a sec. But Alicia, the Toro Company, do any of the key insiders, still have at least 5% stake?
Alfieri: I'm glad you left out founders because the companies started back in 1914, I believe, [laughs] so none of them are still involved. [laughs] Also sadly, none of the named executive officers have at least 5% share, unfortunately, they have about 0.42%.
Gardner: All right. Again, does this mean they'll be good stocks or not? No. This one question, this one factor is among many others and what we're doing now, is we're estimating the risk of our companies. I would say it is riskier if there's not a lot of skin in the game at the management level or to Alicia's point, among key insiders. Because sometimes even though a company may have started a long time ago like Walmart, there might still be substantial family ownership, which in my mind reduces the risk of companies. I like to see multi-generational succession, some of our best stocks, I think of Old Dominion Freight Line is a great example of this on the public markets. A trucking company, a market bidder for us in Motley Fool Stock Advisor. In one of those comments, you could say that even though it started a long time ago. I think it's fair to say, Maria and Alicia, that typically companies where you can say yes to this, the founder, like Jeff Bezos, is still going to be active even if he's not going to be CEO later this year, he still owns a big stake, which makes us feel a little bit safer about our own. So sorry to give no's to both of our companies there. Bringing Chegg up to a 7, Toro to a 6. We have one other question about management in our risk rating system and it's about the experience of the top three officers. Maria, do the top three officers at Chegg have more than 15 years of combined leadership at this company?
Gallagher: Yes, and I just wanted to talk a little bit about Dan Rosensweig, who is the CEO. I really admire him and I talked about this a little bit earlier, but he's been at the company since 2010. He came from leading the Guitar Hero part of Activision Blizzard and history at Yahoo! He led them through their shift and their business model has led through a lot of successful acquisitions. He earned a 92% approval rating on Glassdoor and the whole company gets 4.2 stars, an 87% recommended to a friend. Just listening to him on conference calls and reading interviews with him, I think he's really passionate about where Chegg can go. I think he's really honest and I think he's had a really impressive track record of saying, "What we've been doing hasn't been working. We're not going to compete with Amazon the way we maybe could have in 2005. So let's do something different and let's do it well." I really admire him, so that's a big yes for me.
Gardner: Thank you. You can see the manager reflected in the number of these questions, the ones we've already covered. Raving fans that often have quite a lot to do with the management of the company or the transparency of disclosure, also a factor that the Dan Rosensweigs of the world will either influence for good or for ill. Glad to hear they get a yes, in terms of experience. I hear you're on the Glassdoor ratings, that's a factor for some people's consideration certainly as well. Let me now turn to Alicia and the Toro Company. Alicia, at The Toro Company, do the top-three officers have more than 15 years of combined leadership at the company?
Alfieri: Yes and honestly the question is fulfilled by the CEO alone. Rick Olson who joined the company over 34 years ago. He spent time in nearly all of Toro's divisions, which I just love. The CFO has been at the company since 2011 and the VP of Global Operations has been at the company since 2013.
Gardner: Thank you for that. While this is a straight number answer, again, there is subjectivity. There is something that each of us brings to the system because we're asking the top-three officers. That's even a choice that you make as somebody who's looking at stock, which is the most important after, let's say the CEO and the CFO for some companies it might be the Chief technology Officer, or the Chief Information Officer, others might be Chief Marketing Officer. Alicia, you just rocked the -- who was it again?
Alfieri: The VP of Global Operations.
Gardner: There you go. For a multinational company like Toro, that makes a lot of sense to me, but it's a reminder that each of us brings our own experience and perspective as we rate the risk of a company. So thank you for that, I want to thank you both for yeses. That always makes me happier with this system. We move into two specialized questions, which I'll explain now with Chegg at 7, Toro at 6. All right. Now, Motley Fool Rule Breakers and Motley Fool Stock Advisor are two different services at the Motley Fool that have existed for a long time, and they're a little bit different from each other. For the 25-point system, I have a service specific orientation. Slightly different questions actually for Maria, and Alicia. I will speak to these briefly. First of all, for the Rule Breakers, there are two questions, and this is for Maria and Chegg. The questions are basically; does a company meet the majority of our six Rule Breaker attributes? The second question is; is the company's future business prospects easily able to withstand binary outcomes? Let's for example, imagine they get FDA approval, they don't get FDA approval. Some companies are vulnerable to big binary outcomes and that could be true of Rule Breaker companies. Those are the two for Rule Breakers and I might as well go right to you, Maria, and ask you, does this company meet No. 19, does this company meet a majority of the Rule Breaker attributes?
Gallagher: Yes. It has four of the six. It does not have a first-mover, top dog, or sustainable advantage, but it does have strong past price appreciation, good management and smart backing, strong brand and called overvalued.
Gardner: I agree with you and so that's a yes here. How is this company easily able to withstand any binary outcomes that might go against it?
Gallagher: Yes. I think this one is nuance because it does work within universities and it works within textbooks, but because there is such a broad range, if one textbook providers said, we're never selling you another textbook, I do think Chegg would be able to still do well, but it would not be unharmed. I think that it's a yes, with a little bit of nuance as well.
Gardner: Thank you. I appreciate both of those. We're going to give two yeses keeping Chegg's risk rating at 7 through these 20 questions. Now, I'm going to shift our focus over to more of a Stock Advisor orientation. As a service, Stock Advisor, a little bit less focused on disruptive innovation, a little bit broader. It makes sense to me that Chegg is in Rule Breakers and the Toro Company is in Stock Advisor. So here are the two questions that we ask in Stock Advisor. The first is we call it the Stock Advisor way. We've written some articles about how we think about things and Stock Advisor members should know the Stock Advisor way. The question, Alicia, No. 19 for you is, is this a solid business with proven management and a stalwart balance sheet, yes or no?
Alfieri: Well, I do believe it is a solid business with proven management. But when I did this analysis, it did have some concerns in terms of the company funding some acquisitions with borrowings under credit facilities, which are essentially lines of credit. For the 12 months ending in January, there is a net debt. But they've done a really good job at paying off debt and in fact they're dedicated to it.
Gardner: So I hear you there. You're allowed to break the rules because we're all rule breakers. Anybody who's listening to this podcast is allowed to break the rules within reason people. You are allowed to break rules, you gave a half point on this one.
Alfieri: I did.
Gardner: So that's why we're going to give Chegg, we're going to bump it up to six-and-a-half because you're right. You do like the proven nature of this business and management team, but a little bit of the financial flexibility is missing given the presence of debt on its balance sheet and a little bit of the reliance it has on that to grow. So I hear you on the half point and so we're going to put it at Chegg; 7, Toro; 6.5 as we proceed to the final five questions. Now, just as I kept an overview of those two, I'm going to do an overview for these final five. In fact, we're going to cheat a little bit because two of these, you both already know, two of these are always no. Let me speak to that briefly. They're the same two questions asked every time. Their questions are No. 21 and 25. Here's why I've programmed them always to be no because I didn't want to build a risk rating system that ended up saying zero. If you gave yes is to everything. The message to the world is now there's no risk there, and that is absolutely silly. There is risk in everything. There's risk to crossing the street later today after you listen to this podcast. There's always risk out there and I realize it's critical for us to have a positive number here.
The two questions, No. 21 and 25. 21 is, is this company fault-free and fraud-free in all its corporate statements and deeds? Do you know that to be certain and always will? Is this company, this is the title of the question, immaculate? The answer is, of course, no, we can never know. There might be somebody cooking the books right now. I hope not at either of these companies because they're our stock picks, but there could be. We just can never know what fraud might be out there or what fault. The answer is always no and that's No. 21, which bumps both of these companies Chegg up to 8 and Toro up to 7.5, and cheating forward to the final question. Can you be certain dear listener, that the company you are looking at, is invulnerable to external world or macroeconomic events such that you're sure you can get all your capital back and if we didn't just live through a year in which we all learned that there is no guarantee out there? This is important for investors to know as well.
The title of question No. 25 is bulletproof and the answer is no. No company is bulletproof and you never know what's going to happen next. That's a no, pumping Chegg to 9 and Toro to 8.5. Those are the two easy no's that we always give at The Motley Fool when we do our risk rating system, that leaves us with the three final questions. I want to ask you, they're questions 22, 23, and 24. 23 and 24 is where our conversation lies for the rest of this podcast; 22, I can give short shrift too. It makes an important point that I especially hope each of you, our dear listeners, will take to heart. Because the question, this is the only one of the 25 that isn't about the company or its management, or its competition. It's the question about you. This is a funny one, I hope you can embrace the right-brained thinking, the Foolish, capital F, thinking here this question is about you, and here's the question that you want to ask yourself as you look at a stock. Do I want to know more about this company? Am I willing to dig deeper, learn more, ask questions, let's say on the Motley Fool discussion boards, to actively try to understand this company.
Now, there is no pre-programmed answer to that question because some of the time you're going to say yes. Yes, I do want to know more about this company, I love the company's products or I work at this company. Yes certainly. But sometimes it might be a complicated or boring thing or somebody told you about and you'd be like, I have to admit in my heart of hearts, no, I'm not really willing to dig deeper or learn more here. There's too many other things in the world that interest me more and sure enough if you're saying yes, then that is a less risky stock for you. Isn't it? That's a powerful and important point. If you're saying no, that is a riskier stock for you because you don't really want to spend much time looking at it. That makes it riskier for you. That's why question 22 is entitled "you." I'll ask Maria and Alicia for the fun of it here. Maria, are you inspired to learn more about Chegg, you personally, yes or no?
Gallagher: Yes.
Gardner: You certainly lived it. You've bought from the company. You are old enough, no longer to be in college, but you're young enough to only be a few years out of college or so and you have direct experience with this company and you are also like me, fascinated by the Internet and buy all disruptive innovation happening out there. I don't mean to put words in your mouth, but I agree with you. I'm a yes, for this one too. Let me turn it over to Alicia. I don't know what you're going to say about this one. Alicia, are you personally interested in Toro, willing to dig deeper and learn more in Toro? Not everybody is.
Alfieri: I'm glad that my answer will surprise you. It's yes, I am very interested in this company. I love the idea of automation and robotics in this industry.
Gardner: I feel the same way. When you filled out this risk rating, which is what each of you as analysts do for every one of our stock research reports, I felt the same way you did because I find myself, I always love Great American brands and companies that stood the test of time founded in 1914, you said Alicia. But I especially love it when they are potentially transformational stages. They have the R&D and the tech-savvy and a willingness to acquire, to adapt and evolve as the world changes, and sure enough for snow blowing and mowing and all. Yes, we can make robots do it at night and yes, this company gets it and I'm excited about that. I found myself interested. But question No. 22, you dear listener, you might say yes or no, depending on who you are and we think that that makes the stock riskier or not for you. All right.
Our final two questions are the most interesting questions out of the 25-point risk rating system. Because speaking of you, they are the two best questions that you personally bring to this analysis. Now, this is a way to tailor the analysis because there's some cookie-cutter going on here, and I think in a good way, same 25 questions basically. Yes, no, yes, no, score everything, have a number at the end. There's a lot of cookie-cutters, there is a process-driven thing that I like about this system. But I also wanted to make sure it's dynamic enough to adjust for the questions that you think are unique, or interesting that should be answered to understand this company's risk better. Then if they weren't asked, it was just a generic set of cookie-cutter questions.
Questions No. 23 and 24 and I'll start with Maria, are basically, ask and answer the most insightful question you can come up with, that's No. 23. No. 24 is ask and answer the 2nd most insightful question that you can come up with and subtlety of the system, which we won't delve into too much here, is that since you're asking the question, you can angle it depending on how you ask it to a yes or a no, which allows you as a professional, which is what Maria and Alicia are, to guide the final number to a number they think is appropriate. Depending on how you ask these questions, you can move it up or down and that is by design. Let's now go right back to Chegg Maria, asking, answering the most insightful question you could come up with when you did this analysis about six months ago or so for Chegg; what was your most insightful question?
Gallagher: My question was snap tests. If the company is gone in five years, would consumers no longer be able to succeed in school?
Gardner: I love that.
Gallagher: I did have to word it in a way that the answer was no, because I was trying to get to the answer of no. Because as I said with all of my competitions being no, I think that that is a big risk with Chegg. When we talk about that, there are upstarts, there are behemoths in this space. There's a lot of free resources on the internet and there's accusations of people using these resources to cheat. It's such a fragmented industry, I wanted to really dial in on that and make sure that that was clear within my analysis that that is what I saw as the single biggest risk, is that this very fragmented industry. I worded it in a way, if it's gone, would people miss it? Probably. But would they be able to no longer succeed in school, would their outcome [laughs] be completely demolished? The answer to me is no and so that was my first question.
Gardner: I totally agree. I think it's a beautiful question. Speaking of a book whose author I once featured on this podcast, Warren Berger and his book, A More Beautiful Question or The Big Book of Beautiful Questions. Both are great books about asking beautiful questions and I think that's one.
Gallagher: Thank you.
Gardner: That you go into the snap tests and you angled it the right way and you gave it a no, which brings Chegg up to 10 on our risk rating system. Maria, concluding, what is your 2nd most insightful question about Chegg?
Gallagher: This question for me was in the opposite vein. What do I think was the single biggest risk? Then, what do I think it's one of the single biggest checkmarks and green flags for this company until that question.
Gardner: Did you say "Chegg mark?" Did I hear you say that?
Gallagher: I didn't but I should have.
Gardner: That's amazing. Keeps going. I see [laughs] Rick Engdahl, shaking his head, he doesn't like bad puns.
Gallagher: That was amazing and I'm upset, I didn't think of it. [laughs] But so I said, does the company have a management team that can lead it through more successful acquisition? Moving forward, that's going to be a big part of their strategy and I think that the way they pivoted so far in the way that they've acquired different ways to go outside of just high school and university and get more into that outside learning space, get more into citations has been really thoughtful and led by a management team that I respect. I wanted to also word that one in a way that I wanted to give that a yes because I do think that companies are just people and when you feel really strongly about the people, I really like to highlight that within the questions I asked, so that was a yes.
Gardner: I really appreciate that you looked at the heart of basically your thesis for and against with your two company-specific questions, No. 23 in our system and No. 24. The final tally for Chegg is, Maria?
Gallagher: 10.
Gardner: 10on our risk rating system, which I would say is just outside, quite safe, and just within the realm of pretty safe, which is an interesting thing to think. Because I think a lot of people would think Chegg is this crazy online fly by-night start-up. Could it really work out and some of our best Rule Breaker picks? People have thought that about the companies. Part of, I think, the secret of our approach to investing, because we're looking at the business, we're largely focused on business-focused investing. We look at the enterprise and say, I actually don't think it's as risky as a lot of people might and that's led us to some great stuff. We'll see if it works out or not for Chegg. But Maria, thank you for your analysis that you've shared with us fully up and down 25 questions about Chegg. We're going to put 10 on it and tie a bow on it. Maria Gallagher, you rock.
Gallagher: Thank you so much. It was really fun.
Gardner: All right. Now we'll turn to Alicia because we're going to close it out with your two best questions that you can ask as a risk rate of The Toro Company. Alicia, No. 23, what is the most insightful question that you can ask of this company?
Alfieri: Sure. My question was, is this company operating in a strong recession-proof or for today's times, COVID-proof industry? The answer to that was no. They were impacted by COVID, the worst of their COVID impact within their fiscal 2nd quarter when sales fell 3.4% and net earnings fell 14.8%. But in studying this question, they really won me over because of the things that they did, they instituted cost cutting measures. As I talked about before they took out a line of credit just-in-case because nobody knew what was going to happen with COVID. Then also residential sales increased. Then they began to see the professional segment revenues really begin to recover as well. While they're not recession proof or COVID proof, I think management is really creative with how they solve these problems, which is so important, I think for having a good management team.
Gardner: I agree. You're speaking in a sense, both sides of your mouth because you've given them a no. But you're also approving of them and I feel the same way I can see both of those for our purposes here, do they operate in a strong recession proof-ish sector? The answer is no. I agree with that. That gives them a +1, taking them up to 9.5. Now, we just tied up on Chegg with Maria, it was a 10. This puts Toro at 9.5. I'm curious. The final question, No. 24, Alicia, what is your second most insightful question about Toro?
Alfieri: Well, my second question was, has the management acquisition strategy been strong and value added? This is a really important question for Toro. The answer here is yes. While acquisitions, like we talked about before, impacted debt levels the company is paying down its debt, but also the acquisitions that they're going after are incredibly interesting. They added Charles Machine Works and what that really did is that opened up underground construction opportunities within 5G. The installation of all that fiber, it also sets Toro up really nicely if there's a national investment in infrastructure. Also they've had these really neat acquisitions in robotics and AI like we talked about it a little bit before. They bought TURFLYNX, which is a developer of a fully autonomous electric mowing equipment for golf courses and it's going to be a game changer. It's going to allow golf courses to prefer maintenance at any time, and it's going to really lower those costs as well. They also recently purchased left-hand robotics, a creator of a fully autonomous work bot, that could mow grass, clear snow, and work as a tractor so really interesting here and exciting.
Gardner: I sure want some of those things walking around my property at night, I think I do anyway. [laughs] Now that is exciting and I like your yes, and that brings The Toro Company to a final risk rating of 9.5. Basically let's round it. Let's point out. This is a fun fact this week that both of these companies are essentially right about the same risk rating, 10, 9.5. I think that's helpful, especially for new investors to realize that even though one is 100-years-old and the other is more like 10-years-old and even though one of them is profitable and the other isn't, and even though they operate in completely different industries, overall, we assess them at about the same level of risk. That might be an eye opener for some, this is a system that's really worked well for us though to assess risk and often to find some of the winning businesses that other people are missing. Let me say thank you to Alicia for her analysis of The Toro Company. Alicia, you rock.
Alfieri: [laughs] Thank you.
Gardner: Well, again, thanks to my friends Maria Gallagher and Alicia Alfieri for their work on Chegg and The Toro Company, Chegg, ticker symbol CHGG, The Toro Company, ticker symbol TTC. I hope that we have contributed not just to your understanding of these two companies. Both, I think, interesting stocks to research if you hadn't already looked at them before. But I hope we contributed to your general overall understanding and development as an investor especially if a lot of this material was new. As I said at the top, I did a full series on this five years ago. Maybe you heard it back then or maybe you're a Stock Advisor or a Rule Breakers member and you get these reports with every new recommendation that we've done or maybe you're just a new listener and you're hearing this for the first time. Let me say a few things here at close. The first is that this is a system that I developed about 10 years ago and even though in keeping with my announcement last week, I will not be picking new stocks for rule breakers and stock advisor, you should know that the team uses this system and I hope we'll continue to do so. Although I also want to say that I'm not requiring anybody inside or outside the company to use this approach. The Motley Fool may change, its products, services, and/or rating systems might change, I'm not locking anybody down to use this. That's point No. 1. Point No. 1 is The Motley Fool may change. Who knows?
Point No. 2 though is, it's again, it's for you. Here you go. Here are the 25 questions I use, I will mention by the way, that on The Motley Fool site, both Rule Breakers and Stock Advisor, they use the 25-point system, but some of the questions are different than the ones we just covered this week. That's because you can't automate some of the answers that we just gave. Some of the questions that Maria and Alicia asked can't be automated, but at The Fool, we wanted to automate the system. You're going to see a slightly different system online that you've heard this week. I hope that makes sense to you. Again, an effort to automate and have automated risk ratings on site, which are generally analogous to what you heard today. But you could never really automate what we just all shared together in roughly an hour's time, could you? That's why point No. 2 is this is for you, and also [...] from Chicago, this was for you too.
Last two points, point No. 3, what we're really doing with this system is I think we're looking at the quality of companies. Yes, on the face of it, we're assessing the risk. I defined risk at the start this week. You now know how to score risks around companies. I think that's a wonderful, innovative breakthrough. There aren't a lot of services or people who have real risk ratings on stocks. They might have risk ratings on debt or risk ratings on their NFL fantasy draft. But who has risk ratings for stocks? I would say not nearly enough people. I hope this has been a fun source view. But what our system is really doing is, it's looking at the quality of companies and sometimes the better the quality of the company, not just the lower the risk, but sometimes the better the stock too and we've seen that over the years. Now the fourth and final housekeeping point to close is next week. Next week is of course, the final Wednesday of May, which means it is the Rule Breaker Investing Mailbag.
It was a special month for a number of reasons this month. I want you to know that anything goes for this month's mailbag, our email is [email protected]. You can also tweet us @RBIPodcast on Twitter. I'm going to guess the mailbag is more stuffed than usual. There won't nearly be enough time to get through it all. I'll still try to deliver an excellent podcast. I hope in an hour or so's time next week, looking forward to being with you next week and what we have ahead in June. In the meantime, stay Foolish out there and assess risk well. Fool on!
