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When Bad Things Happen to Good Stocks

By Brian Feroldi – Aug 23, 2021 at 5:21PM

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Here's why daily stock moves do not tell you enough about businesses and where they are heading.

We've got quarterly updates from companies we've talked about plenty on the show -- Squarespace (SQSP -4.01%), Wix (WIX -4.67%), and The Trade Desk (TTD -6.67%). In this episode of Industry Focus: Tech, host Dylan Lewis along with Motley Fool contributor Brian Feroldi explore the stellar results from each business and why they didn't seem to matter to the market.

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

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This video was recorded on August 13, 2021.

Dylan Lewis: It's Friday, August 13th. We're talking about when bad things happen to good stocks. We're talking about earnings from Squarespace, the Trade Desk, and Wix. I'm your host, Dylan Lewis, and I'm joined by fool.com's ill-advised illuminator of irrelevant information, Brian Feroldi. Brian, how is it going?

Brian Feroldi: Dylan, it's going great. Earnings season is coming to a close, but we do have several companies to talk about thankfully.

Lewis: We do, and you know, Brian, before we get into that, I'm going to push back on relevant information. I think that you are a high signal person, both in real life and on social media. I feel like you're not throwing a lot of junk at people.

Feroldi: Boy, I appreciate that, but it's still fun to have [...].

Lewis: It is. It's nice to be self deprecating a little bit. [laughs] Brian, we're in the heat of earnings season and we have no shortage of companies we can talk about. In today's episode we're going to be talking about one business that we recently did an S-1 on, Squarespace. You were out and so Anand Chokkavelu stepped in and we did that show together. Then two Fool favorites, The Trade Desk and Wix, companies that are in a ton of Fool premium services. Before we get into the results, I do want to talk a little bit about what we're looking for when we're looking at earnings. Really, the point of this, because I've seen so many odd movements with companies, particularly once they have done very well in this earnings season and in some of the recent earnings seasons due to COVID. Let's just frame this conversation a little bit before we get too far into the numbers in the companies.

Feroldi: When it comes to earnings season, the thing that I'm always trying to ask from myself is, is the most recent information that I have about this company confirm the reasons that I bought it or watched it in the first place or is there some new information that came along that is busting the thesis? That's what I'm really trying to assess. To your point, this earning season has been particularly strange, because we've seen so many easy or difficult year-over-year comparisons, and just by the very nature of what's happening in the world with COVID and reopening, we saw in 2020, a whole bunch of tech companies had their growth rate really pulled forward and accelerated. In response, a whole bunch of their stocks went straight up in 2020. We're seeing the other side of that equation where that growth that got pulled forward is making the comparisons tough and some management teams are coming out and saying, "Our growth rate might be slowing a little bit." In that case, we've seen some stocks report great looking backwards earnings, but their stock prices declined. That is something that can confuse a lot of people.

Lewis: Yeah, I am similar to you in how I would approach the quarterly updates that we get. We know there are really four things-ish a year that should actually move the share price of a company. It's the four quarterly earnings results that we get. Those are the indications of what's happening with the business. Unless we get a news item that really gives us a sense of what's going on in an in-depth way, a material way, those are the things that are going to be driving the results for the business long-term and the share price as well. For me, it's, does this confirm what I originally thought about this business, does it make me question it, or does it make me doubt it? The first one is great. The second one, I want to dig deeper. The third one, if I own it, puts me in a position where it's like, maybe I need to reevaluate this position and make sure that my thesis is what I think it should be and that it's intact.' I think with that, it can be a little overwhelming, especially as a new investor, to go in earnings season and just be like, 'how do I even make sense of this, especially, when you're seeing double-digit moves. I think that's a helpful way to go into this conversation, Brian. Why don't we talk a little bit about this first company, Squarespace? This is a digital native company and one that I think a lot of folks that have built websites or spent a serious amount of time online are probably pretty familiar with.

Feroldi: Or if you are a podcast listener of any type, you've probably heard an ad from this company. I've been hearing about this company for years prior to coming public simply because I listen to so many podcasts. Squarespace, ticker symbol, SQSP, just came public a month ago. They provide a platform that makes it easy for businesses or independent creators to come online. You can go there, you can set up a website, register a domain name, they have tools to help with e-commerce, help you manage your social media, etc. Squarespace has been growing in a pretty robust way, riding the general trend of businesses coming online. In their most recent earnings report, they reported some pretty favorable results. Revenue grew 31% to $196 million. That was $7 million ahead of what Wall Street was expecting. On a GAAP basis, on a generally accepted accounting principles basis, they reported a net loss of $234 million. Wow, is that a big number? That is a huge net loss and it sounds scary. However, a whole bunch of that, $250 million of that was related to stock-based compensation because the company came public. That was an event that caused a huge dilutive stock-based on compensation to be accounted for. They also took on a $25 million expense as a result of their direct listing. If you factor out those one-time, non-recurring, non-cash costs adjusted on earnings were actually $0.41 per share, and that was much higher than Wall Street was expecting. The company also produced $10 million in free cash flow, so the headlines earned for the company were confusing, but good.

Lewis: Yeah, I think the easiest period for a company to put up losses in excess of their revenue is like the first two quarters that they're publicly traded. That's where you get the leash to do something like that. A lot of companies have. It's a common thing, so don't be too spooked by it. But without the context of knowing those companies haven't been public for very long, it would raise some eyebrows.

Feroldi: This is why when we're looking at S-1 statements, we often highlight what stock-based compensation was historically, but we say, "We have no idea what this company's stock-based compensation policy is going to be once it comes public and we still don't have any idea what Squarespace is, long-term dilution rate or anything like that is going to be," so just take those numbers with a grain of salt. But if you dig into the numbers of the company a little bit more, their annual revenue run rate was up 28% to now $778 million. The number of unique subscribers was up 15% to 3.9 million. Revenue per subscriber was up 6% to $193, and their balance sheet improved. It now has $160 million in cash versus $533 million in debt. Despite reporting better than expected results on an adjusted basis and revenue, this stock has still dropped to 12%. If you get into the why, that's a little bit hard to figure out. I'm guessing it has to do with the company's full-year revenue guidance. They said that they're going to do somewhere between $772 and $780 million in revenue for the year. That's a 25% growth rate. Wall Street was expecting a number that was within that range, but perhaps secretly they are expecting more. But no matter what way, what the reason why the stock sale, the first quarter results for this company were pretty good.

Lewis: Yeah, and there does seem to be stubborn psychology too. If growth rates start with a three and then they get to starting with a two, there is this just overwhelming panic that a lot of analysts seem to go through in covering businesses. Grown at a 26% clip for three years in a row annualized, that's a double. There's nothing wrong with going into 20s as long as you can sustain it. This is one of the things that we have to work through with newly public companies, Brian, is understanding, we're seeing what looks like pretty impressive growth, what is the long-term trajectory of that number actually look like?

Feroldi: Given what you just said, it makes sense why we've seen so many weird reactions to earnings reports, especially this earnings report, because a lot of tech companies are having fantastic Q2 results, but then they're saying, "Business changed remarkably in May and June when the world started to reopen up and that's causing a slowdown." Those growth rates are going from 50%, 60%, 70% down to 20%, 30%. To your point, that can often cause stocks that take short-term hits.

Lewis: Yeah, and that growth story is precisely what's going on with The Trade Desk. This a company a lot of fools know. For folks that are maybe not as familiar, it is the world's largest demand side platform for ads, it allows Trade Desk's ad agencies, advertisers to bid on ad inventories and then manage those ads on a single platform. I'll give you the top-line numbers and then I'm going to rewind the clock a little bit, and take us back to 2020. Quarterly revenue grew 101% year-over-year to $280 million, which is a staggering number for top-line growth for a business. It's about a $40 billion business, The Trade Desk, which is huge. Usually, you don't see that type of top-line growth from a business that size. Net income came in at just under $50 million. The company is now at $1 billion in trailing 12-month revenue for the first time, which is impressive, a nice milestone for them. But these results warrant a trip back in time to Q2 2020. Brian, I don't know if you took much note of this as a consumer, but I remember in April and May of 2020, the earlier days of the pandemic, I would be watching streaming TV, the kind of TV that would normally have ads inserted like Hulu and be like, I watched one segment and then should've been presented an ad, and then got put right back into the next segment of the show. There was no ad inventory being bought. Obviously, that is to the detriment of a business like The Trade Desk. 

Regardless who the provider is, I think it was just anecdotally, it's something that's instructive and understanding where ad budgets are going. Ad budgets clammed up in Q2 of 2020 and it was actually, to my knowledge, the only time that the company has had a sequential revenue decline outside of the normal holiday cadence that they're on. They were coming up on what was pretty easy comps with this Q2, 2020 period and they absolutely crushed it. Triple-digit growth for a business this size, Brian, is super impressive. Unfortunately, we can't get too used to that growth rate.

Feroldi: That's exactly the thing we were just talking about, where the year-over-year comparisons, looking backward look fantastic. 101% revenue growth to $280 million, net income of $48 million, that's a really healthy net margin right there. The company has over $1 billion in trailing 12-month revenue for the first time. Those numbers are eye-poppingly good. But Wall Street is also often like, great, what you just did sounds awesome. What are you going to do next because that's what we really care about?

Lewis: For their purposes, they're acknowledging the guidance. [laughs] We had the benefit of pretty tremendous comps to be working off of and we put up some great numbers looking back. Going forward, we're going to be impacted by a lot of stuff that's outside of our control, namely; changing economic conditions, whatever may happen in terms of shelter in place, and really whatever happens with COVID-19 in terms of setbacks but also in terms of resumption of normal activity. All of those things weigh on the amount of time that people are watching TV and the number of ads that can be served up to people. For their part, they were guiding for revenue of at least $282 million for this next quarter and adjusted EBITDA of approximately $100 million. They say at least there at that low-end, that's 30% year-over-year growth, which, Brian, in my view, is really nothing to sneeze at. Especially because you go back over the last couple of fiscal years, they posted 39% growth, 26% growth, 37% growth. This is a company that has found dips and then acceleration within their revenue.

Feroldi: That is a very strong rate especially given the company's comps that this has. When I look at The Trade Desk's results and I've been an investor in this company for a couple of years now, the thing that I actually pay the most attention to is the company's customer retention and is it keeping those customers that it has? One thing I love about The Trade Desk is, they report right in their press release, our customer retention rate was, and it has been 95% or above for more than seven years. Now, if they fail to point that out in a future press release, that's when my ears will perk up and say, that could be a sign. But on that front, the company is clearly doing a good job of finding new customers, retaining those at tab, and convincing them to continue to spend more. That is a magic combination.

Lewis: It is. Actually, that might be the most important number in their earnings results honestly, because that is such a signal of strength. There are so few businesses that are capable of posting a number like that. It just means, they don't have to spend nearly as much money on [laughs] marketing and replacing old customers that have left the platform. I think, yes, it's great to check-in on that. Some other stuff that I think is important with this business. I'm a shareholder as well and so it's a company that I'm pretty familiar with. Connected TV is a huge part of the story for this business going forward. What we know about this is limited because we only got so much for breakout from their earnings results. But the connected TV segment significantly outpaced the company's revenue growth of over 101%. Company did not provide any exact numbers and CEO, Jeff Green, noted that CTV revenue rose more than tenfold in Europe and also said the CTV business would continue to drive growth over the next couple of years and beyond. I think that's the tailwind to really be excited about this business. I'd love some more detail on exactly what's going on there. But given the results have been pretty strong, I'm willing to give a little bit of leeway there, Brian.

Feroldi: I think that they deserved it given the results that they've put up and how forward thinking this company has been. Yes, like you, I am willing to take their word for it.

Lewis: Yeah. I continue to be a very happy shareholder of this business. They've posted positive net income for 20+ quarters despite the growth rates that we just talked about. Usually, there's the trade-off there. If you're growing in the 30s, sometimes 40s, you're not going to be prioritizing profitability. I think Trade Desk is probably not a business that's prioritizing profitability just in a position where they're able to enjoy it. You look at the balance sheet for this business, like zero long-term debt, great cash position. They're in an incredible financial position and they have a lot of flexibility. I think they can go out and do what they want to do, invest in their own businesses as they see fit. Love that. I don't see this company going away.

Feroldi: Financially, this company is incredibly strong and that's one of the things that impressed me the most. When I first learned about this business, they purposely have been profitable for years. Now, to your point, they are probably still investing for growth, so the earnings might be even depressed slightly from where they could be if this company said we are fully optimized for profitability. However, I am impressed with the profits that they're currently putting up. That means that this is a high-growth stock that you can actually look at the P/E ratio for. While I don't think it's a perfect variable to judge this company's valuation, it is one that is at least useful.

Lewis: It's at least available. There is a denominator, which is nice. I don't own this company with the expectation that it's going to be printing a ton of money on the bottom line and frankly, it's not really where I want them to be. They are in a Greenfield moment and I want them to capture as much of that as possible. Despite being what is already a relatively big business at about a $40 billion market cap, I think there's still plenty of growth ahead of them. If you can seize that opportunity, get as many customers online as possible, that should be the priority right now.

Feroldi: I agree with you there. When I look through the report, the slowdown doesn't bother me at all, the "Slowdown." I think it's completely reasonable. Like you when I read everything, I say, this is on track.

Lewis: The Trade Desk did not suffer a huge sell up, but they had a little bit of a disappointment there. The final company we're going to be talking about is Wix, another Fool favorite, which had a pretty sizable drop after it reported earnings, Brian.

Feroldi: Wix, ticker symbol WIX. They reported on August 11th. After reporting earnings, this company dropped 15%. Yet again, if you look at the trailing numbers, it's hard not to smile. 34% revenue growth to $316 million, that exceeded expectations. Net loss was $0.28 per share, that doesn't sound great, but it was $0.13 per share better than expected. If you dig into the results a little bit more, they've been investing heavily into their solutions business much more aggressively and that business which is lower margin, grew 75%. That shows me that they are clearly having success there. Another big news is that they announced a new partnership with Vistaprint that they think can bring new tools and products to their existing users. Again, if you look at the headline numbers, lots to like.

Lewis: On that Vistaprint note, I don't know that that specific partnership is like the game changer for this business. But knowing the business that they operate in, the space they operate in, those are exactly the kinds of things you'd like to see them doing. Like exploring options, looking for ways to better build out their platform for the people that use it to build their sites and just understanding what functionality, what types of tools, what branding opportunities, all of that kind of stuff, people who are using you for websites want to use because that's where you're going to find additional spend with your customers and create even stickier experiences.

Feroldi: They have a long history, if you've ever studied this company, of launching new products, new services that really make it easier to get started with their product and to run your business. They've also, in recent years, been swimming upstream and have a product that essentially competes with Shopify to bring new e-commerce tools to businesses. If you look at this company's operations, it's been doing essentially everything right. I think one reason that the stock sold off on the earnings is because of what management said was about to happen. For the upcoming quarter, they believe that their revenue is going to grow somewhere between 22% and 25%. As a reminder, they just grew 34%, so that's a bit of a slowdown. More importantly, for the full year, they were previously predicting that they were going to do about $1.28-$1.29 billion in revenue for the year. They lowered that number to $1.25-$1.27. That's a reduction of only a few percent. But when you reduce long-term guidance, Wall Street tends to freak out and not like it, and that's exactly what we saw.

Lewis: It's a story as old as time, Brian. So long as there have been analysts, there have been analysts that have been spooked by guidance adjustments.

Feroldi: That's right. But I think this is just a conservative move by management. If you dig into the comments, they said that COVID is causing some disruption to their business, it was a big tailwind last year. They don't know what's going to happen if the virus is going to resurge. I think this is more a conservative move than anything else. But this reminds me very much of the same report we just saw at The Trade Desk. If you were to just give me the numbers and look through this report, I would say, wow, is there a lot to like here? You can't ever predict what's going to happen to a stock the day after it reports. You can try but you're going to be wrong a whole lot. That thesis to my big take away with a company like Wix is yet again, this is on track.

Lewis: One of the things that I think maybe doesn't get talked enough about guidance is, it can be such a driver of how the market reacts to an earnings report. But if you don't know a management team particularly well, you lose the context of how they generally approach guidance. There are some businesses that are relatively conservative with the numbers they throw out there. Would much rather be in a position where they are surprised at the upside, under-promise and over-deliver. There are conversely management teams that throw some really big and gouty numbers out there and sometimes they live up to them and sometimes they don't. That's where I think understanding the culture business, understanding how the management team likes to operate, and also just tracking companies over time as they report earnings and understanding like, "This is what they threw out there a year ago, they're delivering on that." is really helpful as an investor.

Feroldi: Some Foolish investors completely ignore what happens to earnings and say, "Did they beat? Did they miss? I don't care, I care about the business." I actually am a fan of looking at how the company did when compared to Wall Street's guidance because I like it when a management team has established a history of beating the numbers over a consistent basis. That actually factors into my decision making. The reason is, controlling the expectations of the market is a skill that some management teams have and others do not. In general, I think that Wall Street rewards companies that consistently beat their earnings estimates more so than those that consistently miss them. It's a part of my process, but I also understand why other investors just ignore it completely.

Lewis: Yeah. Over a five or 10 year period, some of that stuff starts to wash away a little bit. The results speak for themselves. But as an investor, you probably wind up with a little bit less heartburn by understanding that, and working that into your criteria. Because if you're being surprised by 15% moves or 20% moves on the stock you own because of the way that management chooses to run guidance in their relationship with Wall Street. It's just going to add a little bit more angst for you as you check your portfolio every single quarter within those five or 10 years.

Feroldi: That's fair. But to me, the bigger thing is when you're looking at earnings reports, this could be really hard to do, but this is just general good advice for every investor out there. Do your best to ignore what is happening with the stock on any given day, week, month, or even quarter, and just focus on the business numbers. If you had no clue, pretend you had no clue what was happening to the share price. If you're reading through the earnings report, would you come away impressed or upset? Then look at the share price and see what's happening. But do your best to focus your attention on the business, not the stock. If the business executes, if the business performs well, the stock will eventually follow and the inverse is also true.

Lewis: Yeah, I'll add to that Brian. I think when you're just starting out as an investor and you're trying to figure out, "Okay, how do I interpret stuff?" I think it can be super helpful. Go to the company IR page, get the earnings results, get the press release, go through it and do all of that before you go to Twitter before you even check the stock price movements. The reason I say that is, I think it's good to approach that without the bias of what other people are saying about something and just see what you pay attention to. Then take that second step and look and say, "Oh, OK. I like these analysts. I'm going to see what they're saying about these earnings results." and learn what other people are looking for. It can be a helpful way to be able to form your own opinions, but then also source from the wisdom of the crowd and see what other people see as the results.

Feroldi: I love that advice, Dylan. Great job.

Lewis: Brian, three stocks. I think all of these, despite tepid market reactions or not so great [laughs] market reactions, pretty strong results on all.

Feroldi: Yeah, definitely. Again, I'm focused on what's going to happen next. The next quarterly results should be very interesting because that will be when the full effect of reopening of the world is in-charge. Are these management teams being overly conservative with their near-term guidance or is the business actually deteriorating at an even more rapid rate than we think? I don't know, but of course we're going to pay attention. But when I look at all three of these businesses, if you were an investor and believe in any of them, I don't know how you come and not believe the thesis is a done track.

Lewis: I think that's 100% right. Brian, I'm excited for those future Brians and future Dylans to talk about business results. It's always nice to be able to answer our future questions, but present me is very happy to get to talk to you every Friday. Thanks so much for joining me on today's show.

Feroldi: I look forward to chatting with future Dylan.

Lewis: That's going to do it for this episode of Industry Focus. If you have any questions or you want to reach out and say "Hey," shoot us an email at [email protected] or tweet us at @MFIndustryFocus. If present you or future you is looking for more of our stuff, subscribe on iTunes, Spotify, or wherever you get your podcasts. As always, people on the program may own companies discussed on the show, and The Motley Fool may have formal recommendations for or against stocks mentioned, so don't buy or sell anything based solely on what you hear. Thanks to Tim Sparks for all his work behind the glass today and thank you for listening. Until next time, Fool on.

Dylan Lewis owns shares of Shopify and The Trade Desk. The Motley Fool owns shares of and recommends Shopify, The Trade Desk, and Wix.com. The Motley Fool recommends the following options: long January 2023 $1,140 calls on Shopify and short January 2023 $1,160 calls on Shopify. The Motley Fool has a disclosure policy.

Stocks Mentioned

Wix.com Stock Quote
Wix.com
WIX
$81.57 (-4.67%) $-4.00
Shopify Stock Quote
Shopify
SHOP
$38.97 (-4.46%) $-1.82
Trade Desk Stock Quote
Trade Desk
TTD
$47.45 (-6.67%) $-3.39
Squarespace, Inc. Stock Quote
Squarespace, Inc.
SQSP
$20.09 (-4.01%) $0.84

*Average returns of all recommendations since inception. Cost basis and return based on previous market day close.

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