A Good Quarter for RH and an Upgrade for ServiceNow

RH (RH -3.43%) pops 15% after a huge first-quarter report comes with a raise to full-year guidance. ServiceNow (NOW -4.61%) gets an upgrade from Goldman Sachs. In this episode of MarketFoolery, Motley Fool analyst Asit Sharma analyzes those stories, plus, we dip into the Fool Mailbag to talk about how long new investors should give themselves to decide if stock-picking is right for them.

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This video was recorded on June 10, 2021.

Chris Hill: It's Thursday, June 10th. Welcome to MarketFoolery. I'm Chris Hill, with me today, Asit Sharma. Good to see you.

Asit Sharma: Good to see, Chris. So happy to be here once again.

Hill: We're going to talk about time horizons for new investors, we're going to talk about enterprise software, but we're going to start with furniture. RH, which is the home furnishings retailer formerly known as Restoration Hardware, is out with a monster first quarter report, profits and revenue higher than expected, they raised full-year guidance and shares of RH are up 15%, holy cow.

Sharma: Yeah. You know Restoration Hardware is one of those companies, Chris, it's like waking up from a dream. I keep wondering why I haven't looked more closely at the business. They have been on a relentless tear for several years judging by stock price alone. But some other factors behind that performance as well which we can get to. Let's talk a little bit about this first quarter though. Net revenues increased 78% to $861 million. Of course, we have to remember that this time last year, the company was seeing much lower customer volume because everything was shut down because of COVID. Nonetheless, management raised the fiscal '21 outlook before they said that they were expecting to grow that top line by about 15%-20%. This morning, management said, "Hey, we're going to grow that revenue in a range of 25%-30%. Also, adjusted operating margin looks very healthy. 

One of the things that I love about Restoration Hardware is you always get a very colorful letter from the Chairman and CEO, Gary Friedman. Chris, I have to read this straight from the letter because this is fun, but it will also give us some big picture things to chew on when we think about this company. While fiscal 2021 will surely be a tale of two halves, there are many data points that lead us to feel optimistic that our strong performance will continue through the second half of 2021. These include a strong housing market and renovation market, both with pent-up demand in a long tail, a record stock market, low interest rates, and the reopening of several large parts of our economy. Additionally, the unmasking of the general public could lead to a roaring twenties type of consumer exuberance. Town & Country captured that feeling perfectly on the recent cover of their magazine titled "Remember Fun? Get Ready for the Comeback." Chris, do you remember fun?

Hill: I vaguely remember fun, yes I do.

Sharma: I think I know what fun is, but I'm not sure, but it's slowly coming back to me. I love this because it's very colorful, but it's also true and what I have missed about this company over the long term is that they have built the business to withstand shocks like COVID to emerge stronger and they've done that by this, what seem like a counterintuitive strategy of moving into ever higher rent spaces while everyone else was trying to move away from physical retail, Restoration Hardware was creating these huge, beautiful galleries and what that really was was the first foray into making this more of a luxury company than simply a home furnishings company and they have done so well with that, improved margins over the years. The CEO, Gary Friedman, had a long history from the GAAP to Williams-Sonoma in transforming companies. This company can't take your eye off if you're looking for a play that has solid fundamentals in the retail space. If they cut that luxury component, which is only getting stronger, they're working on the next phase of that for the next five to 10 years. Chris, is this one that you own or you've looked at in the past?

Hill: I don't own it, and I know there's always a temptation for investors that see a stock that has run up and think I've missed the boat. I mean, if you go back to January 2020, which for me, that's pre-pandemic, this stock has more than tripled since then, and it's close to an all-time high. Again, I get the temptation to say I've totally missed the boat and yet from a market cap standpoint, it is less than half the size of Wayfair. I want to go back to a couple of things you touched on to make sure that listeners don't miss this. Their margins were already pretty good to begin with, and they are improving, they're just getting better and the full fiscal year guidance to go from, we think our revenue growth is going to be 15%-20%, and to bump that up after one quarter to actually we think it's going to be 25%-30%. That's a massive leap. I mean, this one is absolutely on my watch list.

Sharma: One that I think I'm going to pay more attention to going forward for sure.

Hill: ServiceNow is an enterprise software company that provides workflow platforms. Shares up 4% this morning after ServiceNow got an upgrade from Goldman Sachs. This is one you follow pretty closely. Does the upgrade make sense to you? I mean, do you look at the stock and say, yeah, I understand why the analysts at Goldman Sachs are putting this note out there.

Sharma: I totally get this one, Chris, you can look at ServiceNow, in terms of market capitalization, it's a pretty big company, about $91 billion in market value and say, a company that size is probably destined for slower-growth. ServiceNow operates in the digital transformation sphere. It takes manual processes, paper-based processes, stuff that's just hard and time-consuming and it turns those into digital workflows that are aimed at employees in big companies, aimed at customers, so many great advantages the company can provide through its Now platform. What I really like about ServiceNow and what I think maybe the market is starting to get in general is that they're very driven in a single mission, which is to take their annual sales from three billion dollars to $10 billion. I'd love this, it's very Stephen Covey, the writer who is famous for the 7 Habits of Highly Successful People.

Hill: -- Highly Effective People.

Sharma: 7 Habits of Highly Effective People. You have to be effective before you can be successful. One of his points was, begin with the end in mind. You don't see this enough in companies that aren't so small anymore but need to get to the next level. Put out an audacious goal, figure out how you're going to get there. They are really good at that. They're growing like a much smaller company. ServiceNow is the second largest Software-as-a-Service company. If we're talking about pure-play SaaS companies after Salesforce.com, but they're growing at annual rates that approach 30% year-over-year. The other thing which strikes me about ServiceNow, which I think is just not appreciated enough by investors, is how focused they are on this enterprise market. They've got customers of all sizes. But they go after local governments, Fortune 1000 companies, and their sales team is to be feared. What I mean by that is ServiceNow has one of the most prepared, most knowledgeable, and most effective, if we can use that word here, teams on the market. If you are a buyer of the services and you represent the IT department of, let's say, a Fortune 100 company, you better come prepared with your homework when it's time to sign the deal. There's actually a consulting company which advertises its service by being a specialist in how IT departments should negotiate with ServiceNow to make sure that they get some type of leverage out of the deal. That's how good the sales team is, and they have, I'll just cite this one amazing statistic. They have 1,146 customers that spend at least $1 million a year. That annualized recurring revenue is just a tremendous advantage. Lastly, they've got Bill McDermott, who's a very entrepreneurial CEO with a wonderful back history of putting himself through college, climbing up the ladder at Xerox and other companies, SAP included, and he has a vision to make this just a monster company. Stock is down from its highs earlier this year, but they deserve some more love. I don't hear the name ServiceNow as much as I should. I think in the investing community.

Hill: This is one of those businesses that has grown in part through acquisition. They've made half a dozen acquisitions over the past year or so. Now that the market cap is approaching $100 billion, do you expect either this to continue or do you expect that to accelerate as they become larger?

Sharma: I almost feel like they are in for an acceleration phase. This is something that you can actually look at if you pull up their investor presentation every quarter and follow something called remaining performance obligations. It's just a revenue backlog. The amount of revenue that they've got still to recognize in future periods, a lot of that is in the form of cash on the balance sheet that just can't call it revenue. It's revenue, that's money that's collected now to be recognized in advance when they perform the services. That number is sitting at around $8 billion and the current portion of that is over $4 billion. When you think about a company that is at a $5 billion level in annual sales, wants to get to $10 billion, but has about $8 billion in the [...]. You see how strong the equation that they have is, so I see some acceleration from them, advantages that they've gotten out, that they are going to only make fiercer as they go along and we shouldn't forget that they're really investing a ton of money in R&D and innovation to expand with the customers that they're already landed within in this big bucket of enterprise customers, thousand largest companies in the world. Not that they have all 1,000 of them, but they've got a surprising proportion of the Fortune 500 and that Fortune 1,000.

Hill: Just a quick note that our guest on Motley Fool Money this week is going to be Daniel Kahneman. I first heard Kahneman in Michael Lewis's great book, The Undoing Project. For those unfamiliar, he won the Nobel Prize in economics in 2002. In part for his work with Amos Tversky, the two of them the subject of Michael Lewis's great book and Kahneman himself has a new book that's out, so that's going to be our guest on Motley Fool Money this weekend. What's that?

Sharma: Amazing.

Hill: Yes. Just a fascinating and brilliant guy. Our email address is [email protected]. We got a note from Margaret Plattner, who writes, "Thank you so much for your podcasts. My partner and I have made a habit of listening every night over dinner, and it always provides us with interesting new information and ideas. You've answered some of his questions, so I thought it was high time I write in." Absolutely, Margaret. I don't know who your partner is, but if he's getting his questions answered, yeah, by all means. It's good for you because you have chosen.

Sharma: Of course, more.

Hill: She writes, "I know you've always encouraged that if you can't beat the market, picking individual stocks, you should just buy the whole market through S&P 500 index funds. My question is, over what time horizon? I'm a relatively new investor. One and a half years in and follow all of your Motley Fool recommendations, but I'm underperforming the market due to the hammering of tech stocks. I believe in The Motley Fool principles, but I'm feeling discouraged. How long should I wait before making a decision on whether stock-picking is right for me?" Great question, and before I hand it over to you, Asit, I will just say, and I think I've mentioned this on the show before. I'm right there with Margaret in terms of having bought earlier this year a basket of tech stocks, and they are all down. Actually, one of the 10 I bought, one is now in positive territory. Nine of them are down and a couple of them have been cut in half. I don't blame her for feeling discouraged because it's a downer. It's a total downer to look at that. The way I'm thinking about my own stocks is, my time frame when I bought them was 10 years, so I was thinking in terms of the year 2031. But if I were just in year two of investing in individual stocks, I would be thinking maybe this isn't for me.

Sharma: Very true. Chris, you've got a lot of experience, so you've seen cycles. You've invested for quite a while, and this is what I do for a living as well, so I can state that I've got some long experience and it's not quite as new for me as it is for Margaret. But you know what? I think sometimes that emotional level can be the same as Chris you were alluding to. I also bought some high-growth stocks earlier this year, and I did it last year, it worked out really well for me and I know for so many investors, you had the same experience. Yes,I was feeling good, and I bought some more, but that's actually not quite sure. I try to buy as frequently as I can throughout the year. But I did allocate a little bit more in the spring, and many of those positions are down. I'm just thinking through most of those. I think my experience is the same as yours and Chris's, Margaret. 

But first, I would say, Margaret, I hope you are following some messaging that you'll see among various Fool services, which is to buy at least 25 stocks and to consider holding those for a period of at least five years. If you follow that basic messaging, I think it becomes easier as for that time frame, our colleague, Brian Stoffel, I think, has convinced me that you need at least three years to get meaningful information about your own investing style that you can act on. He's mentioned this several times on Live and I thought about it. I agree with that. He also is a long term investor like Chris. He's the guy who will buy stock and think in terms of 10 years. For me, after three years of feedback or a feedback loop in my current stock strategy, how I'm buying stocks, what my parameters are going into it. I think it takes me another couple of years to make tweaks and adjustments. Full cycle can take five-years. Margaret, you and your partner listen to MarketFoolery while you're cooking dinner. I hope you're sitting down, but this is a five or 10-year gig to find out if you are cut out to be a stock picker or not. 

The good news is, I think if you do follow that messaging, make sure you've got a number of stocks. Try to equal weight them at first if you can hold them for that five years. I believe you'll learn a lot about yourself investing, which will be invaluable down the road, even if you end up deciding at the end of the day, "Okay. I'm just going to put my money into a big index fund, maybe one that mirrors the S&P 500 or the NASDAQ 100, and I'm content with that." I say it can be discouraging when you're starting and stocks are down, but stick with it for the long term in those parameters, you'll learn something about yourself and no shame at the end of the journey, if you do decide to index, because that beats the market overtime and gives you a couple of percentage points that you can add to returns you might have received with a dart port strategy just during a dart randomly at stocks and then also beats inflation. Either way, you win, but relax. Buckle your seat belt in for a long ride. Chris, how many years have you been investing instead of wild curiosity?

Hill: It goes back to the mid-'90s for me. Just in terms of investing in the market, like in terms of our retirement plan, early '90s. I'm one of those people who started investing at a time, I didn't realize that at the time, but for me, it was the start of a boom. My early impression was, "I think I'm good at this. I think I'm really good at this." The dot-com bubble burst sounds like, oh God, this is awful. Maybe I'm terrible at this and I need to get out altogether. Emotions are hard to manage even when you've been at it for decades like me. Totally understand Margaret's question. But yes, I will just underscore one of the points you made, Asit, which is, and this goes for everybody, don't invest in the market if you need the money in the next five years. Because anything bad can happen in a short amount of time, and frequently does, if you look at market history. But if this is money that you don't need for at least five years, than yeah, it should be in the market, and you'll learn about yourself as an investor and what your temperament is and also just the industries that you gravitated toward and your appetite because not everybody has the same appetite for this. You and I do this for a living. There are people who just want to get in the routine of putting money away every month, every couple of weeks, whatever it is, getting that habit. But they're not looking at pour-over earnings reports like you and me.

Sharma: Yeah, it takes a certain amount of weird self-fabulation to pour over reports in detail. But when more than one person is discovered, they actually like it. But good luck, Margaret, and let us know as you go along in your journey how you're doing. This golden advice from Chris, loved it.

Hill: Asit Sharma, thanks for being here.

Sharma: Thanks so much for having me, Chris.

Hill: As always, people on the program may have interest in the stocks they talk about, and The Motley Fool may have formal recommendations for or against, so don't buy or sell stocks based solely on what you hear. That's going to do it for this edition of MarketFoolery. This show is mixed by Dan Boyd. I'm Chris Hill. Thanks for listening. We'll see you on Monday.