In this podcast, Motley Fool analyst Asit Sharma and host Ricky Mulvey discuss:
- Why Bank of America's $1.5 billion in net charge-offs can be forgiven by investors.
- A long comeback for wealth management at Merrill Lynch.
- Imax's cash flow story and the future of movie theaters.
Plus, Motley Fool host Alison Southwick and personal finance expert Robert Brokamp answer listener questions about tracking investments, leveraged shares, and life insurance.
To catch full episodes of all The Motley Fool's free podcasts, check out our podcast center. To get started investing, check out our quick-start guide to investing in stocks. A full transcript follows the video.
This video was recorded on April 16, 2024.
Ricky Mulvey: Big banks are wrapping up and earning season is just getting started. You're listening to Motley Fool Money. I'm Ricky Mulvey, joined today by Asit Sharma. Asit, good day sir.
Asit Sharma: Good day to you, Ricky. What up, Fool.
Ricky Mulvey: What up? What up, Fool? We've got another batch of the big bank earnings. We've got Bank of America, we got Morgan Stanley. Asit, the way I'm going to do this, I'm going to give, I've menu of appetizers. You can select off this menu. There's four options. Here are my takeaways. Number 1, traders are back. It was the best trading quarter in a decade for Bank of America. Number 2 is that Bank of America had 1.5 billion in net charge-offs. That's almost double from this quarter last year. That's coming from credit cards in commercial real estate. Number 3, the big banks are still facing declines and interest income. Number 4, an off-menu order. You can bring what you want to the kitchen. What do you want to select off that for the big banks?
Asit Sharma: Well, let's start with that big number from Bank of America, $1.5 billion in net charge-offs. I have a little saying. If you provision, you'll be forgiven. Meaning thereby, if on your income statement you allow an advance for some big losses, investors are OK with it, and that's what Bank of America has been doing. Every quarter they've been essentially saying, look, we think some folks are going to default on their loans on the commercial side, on the consumer side, so we're preparing for that in our books when it happens, but we're taking the impact now. It'll just be like a book adjustment when those people don't pay up. Of course, the government requires big banks to provision enough so that they won't sustain these big surprise losses and throw investors for a huge loop, but I think Bank of America has been doing a pretty good job of getting out in front of some commercial real estate exposure. Ricky, as you point out, man, the US Consumer is spending pretty heavily. Now, that's a factor of a tight labor market. There are more people employed and making money, but we're still tapping into those credit cards.
Ricky Mulvey: It's always the stuff on page 4 or page 5 that always gets the real attention from these investor presentations. One growth engine for both of these banks I want to chat about and I've got behind new, you'll see a cork board with some red string up. It's the wealth management of which they're seeing a huge increase in revenue, not just from a growing stock market, but also net new assets. I think there's a tremendous tailwind behind this. Merrill Lynch, which is in Bank of America has $3.3 trillion in client assets, benefited from a good market, also 6,500 new households. Their income is up about 10% year-over-year. Morgan Stanley, the gross profit is about flat, but they had almost $100 billion in net new assets for its wealth management division. Here's the stat that ties it together, Asit. The number of Americans 65 and older, which is when folks want to see a financial advisor more generally, that's going to go up by about 50% from 2022-2050. Pick this apart. Is there anything in this trend that investors should be mindful of that, you know what? Maybe I should invest in some of these wealth management companies that are going to benefit from this absolutely tremendous tailwind that already seems to be taking hold a little bit.
Asit Sharma: Ricky, this is a strong take, so I'm not going to pick it apart too much, but I do want to wind back the clock for just a moment. Let's go back 16 years to 2008 when a very stayed and venerable investment firm was teetering on the brink of bankruptcy. That was Merrill Lynch and Bank of America swooped in. I think it was like a $50 billion price tag and at the time I remember so many people in the investment community saying, this is a terrible purchase. Look what's happening to brokerage commissions because of this new-ish thing called the Internet. Look what's happening to the trading activities of companies like Merrill Lynch in the face of this big financial crisis we have. A couple of things. One, things always can seem a little bit more dire than they are in retrospect. That was a dire time, but Number 2, I don't think many people appreciated besides, I guess some statisticians at the Census Bureau, how much demographics would change in the intervening year? Now we come 16 years forward, you're showing us what things might look like in 2050. That was the real gem in this deal for Bank of America. They're benefiting not by a lot of fat brokerage commissions via Merrill Lynch, but the fact that so many people who've made money, the boomers, are transferring those assets to other folks. They're there to help people invest. I think this is a nice wave for investing thematically, but here's what I do want to point out as in any industry, when you have a market that's burgeoning, it's always going to attract competitors. You start showing a little bit of margin. You start showing some decent profits. Everyone comes to the table. They want that business and you have so many deep pocketed players in this business and a lot of boutiques as well that are going to fight for this business. I think we might see an erosion of the fee structure that's traditionally associated with wealth management assets under management between now and this 2050 year that you mentioned.
Ricky Mulvey: Let's pick your mind. Any interesting takeaways from these big banks we've had Goldman, we've had JPMorgan, let's add Schwab. We just had Bank of America ways that these reports maybe have compared or contrasted in your mind.
Asit Sharma: Bloomberg reported recently, Ricky, that companies have borrowed $573 billion so far this year. That to me, is the biggest surprise, but it's related to these big bank earnings. Many of us thought that with higher interest rates, corporations would be really hesitant to take on debt, but what we see is, if you're an investment grade borrower and you've got projects on the books. You're going to go ahead and invest in those projects, you are going to raise money in the capital markets because you can refinance a few years down the road. Those activities, the capital markets being very strong and the stock market has been strong. We are seeing a little bit of activity in IPOs. All this opens the door for the activities that big banks love, which is, they like to make money off of deposits, but when that equation is upside down and interest rates are high, they want to do this stuff. They want to help companies raise debt. They want to help them raise new money through the capital markets and this has been beneficial. The trading investment banking activities have really stood out to me among all these big banks as a propellant for earnings.
Ricky Mulvey: I want to move on to, little bit, this is a stock I have on my radar. One of the benefits of working on this show is before I really think about investing in something I can bring on a professional equity analysts to help me work through it. I haven't bought stock. I don't know if I will buy stock, but one on my radar right now, Asit is IMAX and here's the pitch. This comes from a lot of reading and listening to Matt Belloni's work who has a phenomenal show called The Town. He has a newsletter. Puck as well, one maybe unfair summarization of what he's been saying is that while people are going back to the movies, cinemas are not getting back to those pre-pandemic revenue numbers anytime soon, anytime in the next few years, but the things that are really taking over are blockbusters, these big events. He had an interview with the CEO of IMAX, Rich Gelfond. I think it really showed just how much share this company is taking. An IMAX are those massive screens that people go to see movies like Dune 2 of which I have a stat. This blew my mind. This came from their episode. Less than 1% of screens worldwide are IMAX. Yet for Dune 2, I think right now it's the biggest blockbuster the year, it accounted for 22% of the revenue for that movie, less than 1% of the screens, 22% of the revenue. I first have to ask, did you see Dune? Are you Dune head?
Asit Sharma: I am a Dune head. You can say that I read the first four or five of the books when I was a kid. I've seen haven't gotten well, I have to show off because the one time I work from home, this is the one time in a week I get to imagine that there are other people out there besides the screen in front of me. When you're undersocialized, you tend to show off. At any rate, I'm waiting to see Dune 2. I can't wait to see it. I just haven't been able to see it yet.
Ricky Mulvey: We got very deep for a moment. I hope you do. We'll talk about it off-air, but with that, with this growing eventize need, if you're going to go to a movies, do you think IMAX will continue to be the winner in that shakeout?
Asit Sharma: IMAX is interesting, Ricky. We'll start with the pros. Remind me to get to the cons that the pros takes some time to work through. But you're totally right. You're talking about the US Box Office receipts of dune. I think Gelfond, elsewhere, in a discussion with analysts, mentioned that 18% of worldwide receipts were through IMAX screens. I think it's underappreciated by most people how central IMAX is to Hollywood these days. In fact, it has an influence on when companies released their Blockbuster movies because Imax is a format that people love to see. The major Hollywood studios work with this company to make sure that they can shoot on IMAX and distribute according to amenable schedule for IMAX screens. That's one thing to understand about them. The second is this wave of directors who grew up as kids who really loved this format. Christopher Nolan, I think is the biggest proponent of IMAX. But there is an awakening among the directing community, especially of Hollywood Blockbusters, that this is a must have format. And artists, they create sort of control, the direction of everything else. I think Number 3 is just this steady accretion of IMAX productions. You can go to Wikipedia and look through the list of IMAX films year-by-year and you can see how it's a linear function, so it's a steady grower. I actually got interested in this company because of a really fine analysts at The Motley Fool, Meilin Quinn. She actually now has moved on still within the Motley Fool into artificial intelligence investing projects. But she got me on to IMAX. We looked at it together last year. I was just impressed by how pervasive the technology is, how important it is to Hollywood and how steady this company is. These are some pros. Now, let me give you the case of why the market has not appreciated the companies so far.
Ricky Mulvey: That's what I want to hear. I've heard a lot of the pros. Ton of screens worldwide, including China. This is the Easter Sunday experienced, it's exclusive. There's one IMAX and that's what you're going to and it's agnostic to what the big winners in Hollywood will be with the move to bigger Blockbusters.
Asit Sharma: Totally. When we look at the stock chart, we see that the market though must be worrying over something. You mentioned actually one risk that the market doesn't like. That China exposure, if you break down the commercial multiplexes where we find IMAX theaters, nearly half of them are in Greater China. This accounts for about 25% of the company's revenue. Increasingly, Chinese consumers, as they do in other walks of life, are becoming localized and brand-conscious, so the ability for Hollywood films to penetrate the Chinese box office has been decreasing for a while. Now, IMAX will tell you two things. Number 1, they'll tell you, hey, the local productions are booming. We're working with the Chinese producers, so there's not really a problem there. But they'll also tell you that we expect most of our growth is not going to come from China in the coming years. They built up over the years a really huge presence there and now they're walking that back and that's going to take some time. I think the second thing that investors are a little worried about is just the balance sheets of cinema houses into US. Now, your average IMAX location attracts more customers. Many of these are leased by the company, but of course you've got IMAX technology in so many different cineplex configurations. Investors worry if this industry, which did $12 billion in box office receipts a year or two before the pandemic, is only scheduled to do eight or nine billion this year. Can't really get into one higher gear. We're going to see more closures of cinema locations in 2025, probably 2026 timeframe. There's a little bit of a cloud over this dock, not for the virtue of what it is, but for the field in which it plays in. Lastly, I just want to say, like flip back to one more thing. I think the market is looking at this steady step up of revenue with the risks I've mentioned. But they're not paying attention to the cash flow. Imax is at a point where in just a couple of years it's free cash flow is scheduled to increase pretty generously. If you do buy shares Ricky, and you're patient, there's a scenario there in which the market starts paying attention to the cash this company is generating. And your investment might go pretty well.
Ricky Mulvey: Potential investment because what I'm thinking about, Gelfond said that they could double their presence in North America and still do OK I guess, hinting at the we're looking away from China expansion. I still have this thing in my brain where I wonder if and they will tell you they absolutely have a competitive advantage over other like premium large format offerings, which Regal has where he calls them fake ex, of screens that sound a little bit like Imax, but they don't have the aspect ratio. They don't have the sound or technology quite as down as IMAX has, but those still exist. I do wonder if that competitive advantage, if that's good enough, a little bit cheaper if that competitive advantage might erode over time, but definitely a stock I'm watching.
Asit Sharma: I love those two points. To that, I think one thing that IMAX has going forward is brand power. When you combine their brand power with these non-Hollywood's experiences like Beyonce's tour, like Taylor Swift's tour, they have that going against this fake competition as they call it. The second thing is they're really working on break into higher-quality streaming. They bought a small company a couple of years here for just 25 million bucks. They look for them to try to build some advantage there. That could be another way they can work against, what you rightly call out as maybe some competition. Then it's such a tight space where we really don't want to spend a lot of movie tickets unless they're getting IMAX experience or Alamo Drafthouse experienced. Those could be different.
Ricky Mulvey: We'll see what happens. We'll keep talking about it. Asit Sharma as always, thanks for joining me. Appreciate your time and insight.
Asit Sharma: A lot of fun. Thanks a lot, Ricky.
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Ricky Mulvey: Do you know if you're good at picking stocks? Up next, Alison Southwick and Robert Brokamp answer some of the questions about investing, insurance, and leveraged shares that you've sent to us at [email protected], that is podcasts with an s at fool.com.
Alison Southwick: Our first question comes from Hayley and it's a question we probably should all ask ourselves from time to time, but we don't want to. I'm trying to figure out if the investments I've made in individual company stocks are doing better than investments I could have made in broad market index funds. Because if I did worse investing in individual stocks compared to an index fund, then I'll just save time and energy and go forward with investing in index funds. The part I'm getting stuck on is that I've bought different stocks at many different times over the last five years. What's the best way to make the closest apples to apples comparison of an individual stocks gains versus a market index gains? Should I just get the overall unrealized gains and compare that to the price increase in the index brand from the starting point of when I bought the stock?
Robert Brokamp: Hayley, you are absolutely right that you should monitor your stock-picking prowess against the benchmark to see if you're beating irrelevant index because otherwise, why bother? Unfortunately, it might take some work to get a perfectly accurate answer. However, there's some things you could do that get close to the answer. I would start by visiting your broker's website and look for a tab or area labeled something like portfolio performance. There you should find some choices in terms of lining your portfolio up against some indexes. That said, there could be some limitations for this route.
First of all, your broker may provide just your overall portfolio's performance, which really may not indicate how good you are picking stocks if you have other investments in your portfolio such as mutual funds, bonds, cash. If your broker also allows you to break down returns by individual positions, that's better. Also, the results may not go back as far as you've been investing. You want to do some digging into how they've calculated the returns, because it is very important that they factor in additional purchases or sales of an investment. This includes what you do with your dividends. Do you spend them or do you reinvest them? Because every time you reinvest them, that's an additional purchase. If your broker isn't providing the answer you're looking for, you may have to do some work by figuring it out yourself with a spreadsheet or portfolio tools offered by folks like Morningstar and Yahoo Finance.
Now this is going to involve you entering your past transactions, which depending on the size of your portfolio, will be a lot of work. Although the online portfolio trackers usually allow you to import info from a spreadsheet or link up your brokerage account if you're comfortable doing that. If you go the spreadsheet route, do some research into how to use the XIRR function, which you can use to calculate your internal rate of return, which factors in multiple purchases and sales of the same investment. But that just calculate your return, not the return of a benchmark. So you have to create a separate portfolio of just an ETF or a group of ETFs that track the indexes you want to compare yourself to. Every time you make a purchase of a stock, you have to record it and your spreadsheet and then record an equivalent dollar value purchase of the index ETF on a separate tab and then compare the returns over time. It's an extra level of hassle, which is why I think an online portfolio tracker is probably the easiest route for most people.
Alison Southwick: Our next question comes from Ernie. My wife and I have term life insurance policies that will expire in a year. Should we get new term policies? Some financial background. Both boys are out of college and they do not have any student loan debt. The mortgage is paid off last month and we have no other debt except for credit cards that we pay off every month. I'm 62 and my wife is 59. We have almost enough money to retire now, but we'll keep working to have more during retirement and to build up a larger buffer for potential problems. What should we consider in deciding to renew our life insurance?
Robert Brokamp: You mostly only need life insurance if your family would be financially devastated if you or your wife passed away. Before you told us, I don't think that seems to be the case. The kids have been taken care of, mortgage has been paid off. You have almost enough to retire. Assuming your family would be financially fine if one or both of you passed away, then you probably don't need life insurance especially since a new policy at your age would likely be pretty expensive especially if you have developed any health issues. Instead, invest that money to further bulk up your savings. There are some cases where life insurance can make sense for estate planning purposes. If you don't have an estate plan, or you haven't updated your plan in a few years, work with an attorney to get an updated plan and then ask her or him if there are any reasons to have life insurance but for most people, it's really not necessary. Really I'll just say congrats on doing such a good job with your financial planning. You likely don't need to be sending money to a life insurance company once these policies lapse and you can instead spend that money on yourself.
Alison Southwick: Next question comes from just the letter J. Bro Nelson, I'm in my low 30s. My wife and I both have life insurance through our employers as well as term policies that we opened up and we got married in 2021. I also have a whole life policy that my dad opened up for me when I was young. He transferred the payment responsibility to me for this policy a couple of years ago. The monthly payments are a little over $12 and the total death benefit is about $16,000. I've been considering cashing out the whole life policy which would be over $2,000. The monthly payment for the whole life policy just seems a little pointless to me given the total death benefit. However, my wife and I recently received the exciting news that we have a baby on the way. Oh, congrats from upcoming little baby, Jay. This got me thinking. If I should keep the whole life policy and potentially transfer it to our future child if that's even possible. But I'm also not sure if there are alternative possibly better life insurance options out there for a new child. I could definitely use some bro advice here. Oh, but not some Allison advice? That's OK. We'll let that one slide. Thank you for all of the life and financial advice over the years. You both have given me sound advice from being a recent college grad to now being a somewhat responsible adult. Keep up the great work. Thank you, Jay.
Robert Brokamp: Yeah, and congrats on the new baby. I thanks for the kind words. Alison and I have been doing this podcast together for almost 10 years joined by Rick behind the scenes as our producer, and it's just nice to hear there are some folks out there that have been along for the ride. Thanks for that.
As I hinted earlier in my response to the previous question, life insurance is meant to replace the income of someone who is financially essential to the family. Most kids don't fit that description unless they're a successful baby model or something like that. I'm actually not a big fan of life insurance for kids. You're better off just setting that money to a 529 college savings plan rather than to a life insurance company. However, like many other life events, having a kid is a reason to evaluate whether you and your wife have enough insurance and you'll find calculators on the Internet that can help determine the amount you need. But a good rule of thumb is 10 times your salary plus another 100,000 to 200,000 for each kid you want to put through college. As for the policy your dad bought you, my guess is that it's best to just take the 2,000 and put it in an IRA or a college savings account. But you might want to talk to the insurance company about your options especially if you think you need more insurance on yourself. You might be able to use the cash value to buy a paid-up policy, which is life insurance that you don't have to pay additional money for. But even if that is the case, you want to compare with the current company's offering versus what you'd get from another insurance company because you could do something called a 1035 exchange and transfer that policy to another company especially if you cashing out the policy would result in fees or taxes. Just finally, best wishes on the upcoming addition to your family and get some sleep now while used to can.
Alison Southwick: Oh, yeah. Our last question comes from Abby. Could anyone shed some light on how leveraged shares such as AMZU, NVDU, SOXL on the bullish side and others on the bearish side operate? I'm curious if these funds borrow money to create leverage. While I've attempted to research the topic, the information I've come across only mentions that over the long term, they may not fully replicate the effects of 1.5x or 3x leverage. Any insight would be appreciated.
Robert Brokamp: Well, let's start with what's behind those tickers. AMZU is the Direxion Daily AMZN Bull 2X shares ETF. NVDU is the Direxion Daily Nvidia Bull 2X shares and then SOXL Is the Direxion Daily Semiconductor Bull 3X ETF. Now Abby said, 1.5X and the names of these ETFs are 2X because just two weeks ago, these ETFs increased their leverage from 1.5X to 2X. If you bought these ETFs a few weeks or a few months ago and you thought you were just getting 1.5X leverage, they now have been moved up to 2X leverage. These are leveraged ETFs and they are aimed to produce returns that are 2-3 times the daily performance of the underlying stock or index. These leveraged ETFs have been around for a while but we're mostly based on indexes like the Nasdaq or the S&P 500 or even the treasury market. But in 2022, the SEC allowed these to be based on individual stocks and it also issued a statement basically saying, we're allowing this but these investments will be so volatile that we think most people should avoid them. I have to say I agree. The way these work is, let's just use the Nvidia one as an example. Nvidia is up 10% in one day, the 2X ETF will be up approximately 20% that day. Not exactly 20% but pretty close. Just that day, the longer you hold these, the less you'll see that 1-2 relationship. Let's just look at Nvidia. Year to date is up 78%. Quite remarkable. You would think that an ETF that is two times the return would be up 156% but no, the bullish 2X ETF for Nvidia is up just air quotes, 124%. Still very good but not exactly 2X and that leverage goes both ways. So a 10% loss in one day would be at 20% loss in these leveraged ETFs but just for that day. Let's look at a stock that's not doing so well this year. Tesla, a stock I own, which is down 31%. Direxion does offer a daily Tesla Bull 2X ticker, TSLA. That's down 46.6% this year.
Still a huge drop but not quite a two for one drop. The gains are magnified but so are the losses and that 2X or 3X relationship won't hold up beyond today. Now let's finally get to our obvious question which is how these ETFs do this and whether it involves borrowing money. The answer is that yes, some of these ETFs use borrowings to get their leverage. But mostly, it's done through derivatives known as swaps. The swaps could get very complicated but they're basically an agreement between two parties. In this case, the ETF manager and investment bank and what they're swapping is cash flows. But likely happens if the fund pays the bank a fixed cash flow, and the bank pays the ETF a variable cash flow that depends on the performance of the underlying stock or index. This of course, costs money which is why these ETFs usually have expense ratios of 1% or higher which is pretty steep as far as ETFs go. Furthermore, companies that trade derivatives like these usually have to post collateral in the form of super safe investments which is why if you dig into the holdings of these ETFs, you'll see a lot of cash treasuries or treasury funds. Those are the basics and how these funds work. Direxion actually has very helpful articles and videos on its website. Just know that even though it's pronounced direxion, it's spelled D-I-R-E-X-I-O-N. You might want to say direxion but that's not how we pronounce it. Finally, just be very careful if you're considering these ETFs, especially the ones that add leverage to already volatile stocks because owning these ETFs could be a very wild ride.
