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Does Alphabet deserve a grocery store multiple? You're listening to Motley Fool Money. I'm Ricky Mulvey, joined today by the smirking David Meyer. David, thanks for being... What are you smirking about? What's so funny? Oh, it's all good today. All good. Okay, good. Just making sure I don't look funny or anything. That's why we do an audio-only podcast for today. No, you don't.
Politics keeps mixing with markets, and we have some earnings from a fast-growing apparel later in this segment.
Dylan and J-Mo hit the trade deal-ish, trade agreement question mark between the U.S. and China yesterday. But there's another move from the White House that could have significant implications for markets. President Trump signing an executive order that Americans must get a, quote, most favored nation price for prescription drugs. David, when I saw this, my first reaction was sweet.
And you know what? I bet the big drug makers stocks are going to dive on this. They did not flinch. The U S is where a lot of their profits come from. What's going on here. Yeah. The reason they didn't flinch is because the market doesn't believe that those profits are going away. I mean, it's, it's as simple as that.
If we look a little bit under the hood at what the executive order actually says, it does lay out some cases where, you know, hey, you know, other countries around the world pay lower prices than we do in the U.S. Well, they negotiate differently. The market for drugs is way more open in the United States than it is in other countries. Governments tend to negotiate on behalf of
of their people because they're the ones making the purchases. They have some negotiating power. We here in the United States tend to let markets determine prices. There are other players, there's PBMs and things like that. But this is basically the market saying that the U.S. markets will withstand higher prices. Basically, with the stocks not really moving on the news,
The market says, "Well, we look ahead and we don't see how you're going to do this." Basically, the other thing that the executive order said was, "Hey, Health and Human Services Secretary, go out and put together a plan in 30 days for what you think the prices will be." There's a negotiation that's going to happen in between. We'll see what happens. But as of right now,
I think that's what the market is saying. Well, the pharma lobbyists are saying something else, David. They're certainly sweating a little bit. According to Bloomberg, the brand drug lobby, PHRMA, my old employer, had an emergency call on Sunday and said that this could cost the pharma industry $1 trillion over a decade. You look at a drug like Ozempic, this was mentioned in the press conference with President Trump, where a month of it
is almost $1,000 in the United States, about $60 in Germany. Okay, that's not great if you need Ozempic. That's also a huge profit margin for Novo Nordisk. Novo Nordisk's CEO trying to defend the practice in Congress a little while ago saying, hey, don't look at me, look at the pharmacy benefit managers. Those are the ones that are really screwing up prices here. So, I mean, the lobbyists are certainly concerned here.
Is this a time where, if you own stock in a drug maker, especially someone making weight loss drugs, is this a time to revisit your thesis?
The short answer is yes. Should you panic? I don't think so. But you should go back, given how this all tends to work, and regulation does play a part in many industries, but in pharma specifically, the lobbyists are going to have to basically make the case to the HHS secretary to say, "Hey, this is why we think these drugs should be priced here."
Again, this is about pricing power, this is about bargaining power. The lobbyist, Pharma, is going to have to roll up their sleeves and do some work over the next 30 days and beyond that. If I read everything correctly, there's some other milestones at 180 days and a year out and multiple years out.
This is going to take a while to play out. They're going to have to do some work to basically say, look, there's a reason that we, one, should be able to charge these prices. And two, there are benefits to our industry as a result. Because you got to remember, a lot of that gets plowed back into research and development of all kinds of
to bring the next generation of drugs and next generation of care. So I don't think anybody would want higher prices just for the sake of higher prices. We should want our healthcare to be reasonably priced, right? But at the same time, we don't want to disrupt
the long-term innovation that happens here as a result. So I think the administration is saying, and I would actually agree on this point. I've been accused of being too liberal and too conservative on this show, so we'll see what complaints I get this time. The administration would basically say, we don't want to stifle innovation necessarily, but it shouldn't be on Americans alone to
to fund that innovation when you have other developed countries in the European Union, in Australia, for example, paying significantly less for the exact same drug coming out of the exact same factory. And that makes sense. And then the question is, who's going to do the negotiating, right? Is our government going to step in and do the negotiating? That would be a big change to how our markets work today. We'll see how it goes. I should also mention, I've never worked for a brand name pharmaceutical lobby. If
I'm afraid of catching heat today, David. I don't know why. Let's move on to earnings. Let's talk about earnings. Let's focus on the fastball here. On Holding, the maker of comfortable shoes where rocks and mulch often get stuck at the base of it. I enjoy wearing them still. They reported this morning, sales up a blistering 40% from one year ago. That is on a constant currency basis because we're going Swiss francs to U.S. dollars with this earnings report, getting us in some trouble.
It's about $860 million in sales for the quarter. That's in U.S. dollars. I'm looking at a retailer that is earning basically 40% more sales than one year ago. So David, what is on getting right in this environment?
They have the product that people want. I hope I don't sound glib when I say that, but that is true. Their products are very good and in demand all around the world. They had good growth in all of their geographical segments. It's because they have taken the time and made the investments and
to put technology into their shoes that make them both comfortable, functional, whether you're running, whether you're working out, whether it's casual, all these things. But playing tennis, can't forget about Roger Federer.
They have product that people want. And as we, you know, as we saw here this quarter, more people wanted it, even as we're, you know, starting to get into a little bit of the impact of the tariffs. Yeah. I mean, on clouds were one of my tariff panic purchases. Those included AirPods for birthday gifts. I had to get some basketball shoes. And then I was like, my on clouds have completely worn out at the bottom where the rubber is like,
gone, and I need to get these before the prices get jacked up by maybe 50% to 100%. I don't think that's going to happen now that we have the pause, but I do have some new on-clouds. I'm a big fan of the product. Is this something you own? Are you taking a Lynchian look at this company? I don't own shares, but I was a bit of a sneaker guy.
I have tried them, and I also like them. You probably aren't the only one making a purchase ahead of what may have transpired. And you did it because you liked the product.
And it was their direct-to-consumer channel that actually had the best growth. I don't think you are in the minority in terms of maybe pulling a purchase forward. But to management's credit, they actually said, "Hey, we still see plenty of demand for the rest of the year." It's not a top-line thing for them. What they are actually saying in terms of the tariff impact is,
"Hey, maybe margins will get pinched a little bit. We're doing our best to figure out what those might be. We're not really knocking them down heavily, but we just want to let you know that it could be volatile." But on a top-line basis, they say, "Hey, our product is in demand. We're making sure that all the places where we sell our shoes have plenty of product and good up-to-date products."
I credit management for, at least at the beginning, handling this uncertainty pretty well. Let's dig into the numbers a little bit more. Looking at operating margin here, I think there's a story because now on is about on par with Nike's historic average, about 10-ish, 11%. Nike dipped in a recent quarter, but we'll take that out to be nice to our friends at Nike.
This is significant for a younger brand that you would think needs to spend more as a percentage of their sales on marketing or maybe have less negotiating power with shoe stores like Foot Locker. Yet, there they are in an efficiency basis, pretty much on par with Nike. What story does that operating margin number tell investors?
This is actually a fantastic question. Let's use the Nike and On Holding comparison. Both companies do sponsor athletes, but Nike, man, think about the suite of athletes that market their products. That's actually a huge expense.
for Nike. They make the most of it by getting in terms of volume and pricing that they've been able to generate for their products over the years. Even though On does have, again, those sponsored athletes, it's less compared to what Nike spends. They have actually done a good job of
Again, creating a product that people want, creating a product where word-of-mouth marketing is probably more important than necessarily the sponsored marketing. Again, getting the products to consumers in the way that they want to buy them. Onn has the advantage of having a
a consumer that is more apt to buy in a direct consumer channel, an online e-commerce type channel, than Nike had when it was starting out. The other thing I credit is, in addition to putting good technology into their products,
They've actually done a good job of building their business from a supply chain management standpoint, from managing their marketing, all these things, and figuring out where they can price their product in order to keep moving it at the volumes that they need. At the same time, they've been able to reinvest back into the company to say, "Hey, here's our latest technologies that we want to put in shoes."
We want to expand into apparel. Hey, we need to open up a distribution center in Atlanta. I give management a lot of credit for not only creating a good product, an emerging brand, but they've created a very good business around this. This is something that's important for the long run. If you look at the history of Under Armour,
Under Armour had a phenomenal brand, but they weren't the best operator. Eventually, that caught up with them as they tried to get bigger and bigger and bigger. Going forward, we'll see how all this plays out for Onn. But they've done a good job of balancing all the things that they need to balance in terms of creating a good long-term business. You don't think Elmo's getting Steph Curry rates for those commercials? I mean, I don't know.
You know, I don't know. It depends, you know, it depends on how good, uh, Elmo's agent is. Right. That's a good question. I love the, so they have the commercial with Elmo and Roger Federer. They're using Elmo quite a bit in their commercials. I think on looked at Adidas and saw the trouble they ran into with Kanye West and said, what is the opposite celebrity we can find? And then you get Elmo selling shoes for him.
You asked about my smirk earlier. There is nothing but good entertainment value as well as educational value in what we're talking about today, because that is just awesome. Let's close out with the story on Alphabet. We've gotten a few questions about this company from listeners. Because of its underperformance relative to the market and storyline going into it,
There's a Wall Street research report from an analyst named Gil Lurie that he would like to set the company on fire, basically saying the only way forward for Alphabet is a complete breakup that would allow investors to own the businesses they actually want, making the point that the entire business is valued on the worst multiple that investors can find. That's the search multiple. It's about 17 times higher.
Before I get to your question on valuation, why do analysts need to assign the worst multiple to the whole business? There's a lot of smart people looking at Google, and I assume some of you can do math. That is essentially the average. One way you could go about valuing Google/Alphabet is value the search business, which is by far the biggest business. It generates the most cash flow.
has the most uncertainty around it today. What is AI search going to bring in the uncertain macro environment? Is search going to go down? Is it a commodity now? There's all sorts of things facing the search business, but they have many other segments. What this analyst is basically saying is, "Hey, these other segments deserve higher multiples." Well, maybe that's true.
As an analyst, you could do that yourself and say, "Hey, YouTube is worth this. The cloud business is worth that. The chip business is worth something else." If you think that as a whole, the business should be trading at maybe 24X a weighted average multiple instead of 16X, as an analyst, you can say that.
The challenge, in my opinion, in breaking this up, is where do these companies get their capital from? All of them need investment capital in order to operate. A lot of that comes from search.
While I understand that breaking everybody up could unlock a lot of value, if you look at the most recent breakup of a very large company, go to GE. General Electric has split into GE Aero, GE Venova, which is the energy business, and GE Healthcare. Right?
That had a conglomerate discount, and it took years to divide that business up. And now, the sum of those parts is greater than the previous whole. But it's not necessarily easy for those companies to operate on their own. Again, the internal capital allocation process is taking a lot of
of cashflow that comes from search and putting it in new businesses, making new investments, making new moonshots. I don't know. Do we call them the is moonshots? The thing is still associated with, with Google. We can count Waymo. They got self-driving stuff going on. There's all sorts of stuff. And while I understand breaking it up could unlock a lot of value. I also am sympathetic to the idea that, Hey, you know, most of the capital comes from search and, and,
If you put these businesses on their own, does that mean they have as much capital as they need in order to grow as fast as they want?
I don't know. I don't know the answer to that question. It's a risk to basically set all those free as individual companies in the market. The market might say, "Well, this is great, but Waymo, you need a lot of capital going forward. Maybe I'm not going to value you at the multiple that somebody else thought you were, now that I can see all of your financials." Let's close out with the question that introduced the show.
There's some narratives going against Google right now. The search business is declining. You're doing nothing compared to ChatGPT. Your business there could become obliterated. And for that...
Mr. Market is assigning Alphabet a lower than average earnings multiple, about 17 times. David, that is what Kroger trades at, a very mature grocery store business. And here you have Google, which still dominates the search market. It's got a growing cloud business. It owns YouTube, which is the biggest streaming service anywhere. It's free, but we can set that aside for now.
I've got this company on my watch list. Should I pick up some shares while Alphabet's in value town, or are we looking at a falling knife here?" Me personally, as someone who I've followed this company for a long time, I'm in agreement with you. I think shares are probably undervalued, but they're probably a little undervalued for a reason. That's because there's a lot of risk and uncertainty that's ahead of the company in the short term.
If you have a case where the lawsuits don't have a big impact, if there's not a call for a breakup by the FTC, if the other businesses that are growing, again, the ones we mentioned, YouTube, GCP, things like that,
things like that. If they have all of the earnings power that this analyst thinks they do, eventually the market will be able to see through all of it and figure out what's the right multiple. I just personally think this is a phenomenal business.
generate significant cash flow. They have multiple ways that they can reinvest that cash flow. And yeah, it's probably a little undervalued today, even as a conglomerate. We'll leave it there. David Meyer, thank you for your time and your insight. Thank you so much, Ricky. This was a lot of fun. Hey, Fools! We're going to take a quick break for a word from our sponsor for today's episode.
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All right, up next, Robert Brokamp joins me for a look at bonds and what investors should consider before adding them to their portfolios.
Investors own bonds for safety and income, but recent history has occasionally told a different story. The total return from the overall bond market has been flat to slightly negative over the past five years. That's if you bought into this safe investment as COVID kicked off.
And over the past few years, investors in bond funds have experienced unexpected and historically steep declines. In 2022, the Vanguard total bond market ETF lost about 13%. Bro, that is nothing for a growth stock investor, but this could spook anyone who's closer to retirement.
Yeah. And 2022 was probably the worst year for the stock market in U.S. history. It was quite notable. And the main cause of the declines has been the rise of interest rates. If you go back to 2020, in the middle of the pandemic, the 10-year Treasury yielded an astounding 0.5%. But over the last few years, it has risen to almost 5%, reaching that in 2023. It's fallen down a bit back, but it's still at around 4.5%.
And when rates go up, the value of existing bonds go down. Why? Well, if you had bought a 10-year treasury back in 2020 that yielded 0.5%, it's now less attractive, right? Because after all, who would want 0.5% yield if 4.5% is now available? So the price of the 0.5% treasury has to adjust downward.
However, there's good news. The price of that bond will return to its par value as it gets closer to maturity, as long as the issuer -- in this case, Uncle Sam -- is still in business. So, the price decline won't last forever.
Unfortunately, that same dynamic may not play out in a bond fund, which could hold hundreds or even thousands of bonds with different maturities and credit ratings that are constantly being bought and sold. What you can get varies with your 12-month trailing yield, your 30-day SEC yield, or your weighted average coupon rate. So one solution is to buy individual bonds instead of bond funds. However, it's not as simple as it sounds. So Bro's got a few tips, starting with...
Invest enough to be diversified. Yeah, there's one rule of thumb that says you shouldn't attempt to construct your own bond portfolio unless you have at least $50,000 to invest. And that's because the issuers, whether it's corporations, municipalities, foreign governments, they can all go bankrupt and default on the debt.
That doesn't mean you'll lose everything, actually. Investors typically recover 40% to 60% of the original value of the bonds after a company restructures, gets liquidated. But it usually takes a while for investors to get some money back. You want to spread your bond bucks around.
When it comes to investing in stocks, we here at The Fool generally say you should own at least 25 companies. That's probably a good starting point for bonds as well. Though, if you invest in really, really safe bonds, you can get away with a smaller number. For example, you can feel more secure with a smaller bond portfolio or a smaller number of issuers if you invest primarily in U.S. treasuries, which are still considered among the safest investments in the world.
Fledgling casino developers may not like this tip, but No. 2, stick to investment-grade bonds. To minimize the risk of buying bonds from a company that may go belly up, you want to stick with investment-grade issuers. Those are rated
BBB or higher by Standard & Poor's or BAA or higher by Moody's. According to Fidelity here, the 10-year default rates on bonds of different ratings from 1970 to 2022 as rated by Moody's. AAA bonds have a default rate of only 0.34%, so pretty darn safe. Investment grade, 2.23%.
Speculative grade, high-yield junk, whatever you want to call it, 29.81%. That's a high default rate, which is why they pay such high yields. But even if you stick with investment grade, there's still the risk of default. In fact, if you own individual bonds long enough, you probably will see a couple of defaults. It's still important to diversify your bond portfolio, but you can mitigate that whole default risk by choosing highly rated bonds.
Next up, find out whether the bond can be called. Every bond has a set maturity rate, but many can be called before then. What happens is that a company decides to pay off its bondholders before maturity. You bought, let's say, a 10-year bond, but then it got called five years in. Why did they do that? It's usually because interest rates have dropped or the bond's credit rating has improved. It allows the issuer to redeem the old bonds, issue new ones at lower rates. Unfortunately, that leaves investors
left with having to reinvest the money at lower rates. You want to make sure you know beforehand whether the bond you're going to buy is callable, and if so, what the yield will be. You'll often see at the quotes, you'll see either the yield to call, YTC, or the yield to worst, YTW. That's what you'd receive if it does get called. By the way, another benefit of Treasuries is that they're not callable.
This next one gets a little tricky if you like owning investments in standard brokerage accounts, Bro, but pursue the primary market. Yeah. When bonds are first sold to investors on what is known as the primary market, they're usually sold in $1,000 increments and will be worth $1,000 when they mature. This is known as their par value.
But once a bond is issued, it trains on an exchange. This is known as the secondary market. And at that point, a bond rarely trades for $1,000. The price is going to either be higher or lower, depending on changes in interest rates and what's going on with the company, maybe what's going on with the economy. And if you buy a bond that is below or above its par value, this is going to add a layer of tax complexity, because when the bond matures for $1,000, you're either going to receive less or more than you paid for it.
This is a really complicated topic, but in most situations these days, investors are buying bonds at a discount, meaning they're paying, let's say, $950 for a bond that will eventually mature at $1,000. That $50 difference is going to be taxed as ordinary income in most situations, not as a capital gain. You can avoid all this tax complexity if you buy bonds right when they're issued in the primary market and then hold to maturity.
That said, buying bonds in the primary market isn't easy. You're going to increase your chances by having an account with a brokerage that underwrites a lot of bond offerings. Some of the bigger discount brokers also have access to some primary offerings, but you might want to check with them beforehand to see how big that inventory is going to be. And if you want to play this game, you got to know what you're buying. Understand how bond prices and yields are quoted.
Now, if you've never seen the quote for a bond, it's going to look a little interesting to you. Despite being typically worth $1,000 at issue and at maturity, bond prices are quoted in a different sort of way. You basically move the decimal point to the left. A quote for $99.616 for a bond indicates that the bond is being offered for $996.16.
You'll likely see both the coupon and the yield quoted. The coupon was the interest rate on the day the bond was issued. But once the bond begins trading and moving above or below its par value, the yield is a more accurate representation of what you'll actually receive as a percentage of what you paid for the bond. And then finally, most bonds pay interest twice a year.
When you buy a bond in the secondary market, you'll owe accrued interest to the previous owner for the time she or he owned the bond in between payments. But then you'll get the full six months' worth of interest during the next payment, even though you only owned the bond for maybe less than six months.
Bro, our engineer Rick Engdahl was asking for more excitement before we started recording in our segments. I think he's getting it with understanding how bond prices and yields are quoted. Let's keep going with the tip of buying directly from Uncle Sam. Yeah. You can buy savings bonds, treasuries, I-bonds, treasury inflation-protected securities, otherwise known as TIPS, directly from the government, commission-free at treasurydirect.gov.
So, it's a really convenient way to buy treasuries. Unfortunately, it can only be done in taxable accounts, right? Because the government isn't set up to serve as a custodian for IRAs. But the consolation here might be that interest from treasuries is actually free of state and local income taxes. So, that makes them somewhat more compelling.
Also, in the case of treasuries and tips, you don't actually buy the security immediately, knowing the exact yield you'll receive. Rather, you're basically signing up to participate in an upcoming auction. Once the auction is complete, you'll be informed of the rate you'll receive. And finally, you can get the best of both worlds with defined maturity ETFs. Yep. If you've been listening so far, you can see that buying individual bonds requires more education and effort than just buying a bond fund.
Fortunately, there's a type of bond ETF that offers most of the benefits of buying individual bonds. These are known as defined maturity or target maturity bond ETFs. These are funds that only own bonds that mature in the same year. That year will be identified in the name of the ETF. Toward the end of that year, after all the bonds have matured, you just have a bunch of cash. The cash will be distributed to the shareholders and the ETF ceases to be. The two main issuers of these types of ETFs are Invesco, and they call them bullet shares.
or iShares, and they call them iBonds, but that's not to be confused with the inflation-adjusted bonds issued by Uncle Sam. You can use these ETFs to invest in all kinds of bonds, corporates, munis, tips, high-yield bonds. Both the Invesco and iShares websites have tools that can help you build a bond ladder with these ETFs, so you have a certain amount coming due each year, probably particularly attractive to retirees.
Like all bond funds, these ETFs are going to go up and down in value depending on what's going on with interest rates in the economy, but they should return close to their initial share price, that is the price of the ETF on its very first day, once the fund matures. But there are no guarantees. This is more likely if the ETF invests in safer bonds, less likely if you're choosing an ETF that invests in high-yield or junk bonds.
But the bottom line is that with these ETFs, you can get the ease and diversification of a bond fund, yet a measure of the predictability about what the ETF will be in the future, similar to what you'd get from an individual bond. In other words, most of the best of both worlds.
As always, people on the program may have interests in the stocks they talk about, and The Motley Fool may have formal recommendations for or against. Don't buy or sell stocks based solely on what you hear. All personal finance content follows Motley Fool editorial standards and are not approved by advertisers. Advertisements are sponsored content and provided for informational purposes only. To see our full advertising disclosure, please check out our show notes. Motley Fool only picks products that it would personally recommend to friends like you. I'm Ricky Mulvey. Thanks for listening. We'll be back tomorrow.