What Bonds, Dollar Stores Say About Economy
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What's the bond market trying to tell you? You're listening to Motley Fool Money. I'm Ricky Mulvey, joined today by Asit Sharma. Asit, thanks for being here. Ricky, I appreciate you asking me. Did I ask you? I just said I appreciate you being here. You sent me an invite to record with you. I appreciate that. That's fair enough. You're welcome. I'm glad you're here to record with me. Let's start with CrowdStrike. CrowdStrike reported after the bell yesterday,

The street is reacting to their guidance, but let's look at the actual results here with this cybersecurity business. Total revenue growing to $1.1 billion. That is a 20% increase from the prior year. 97% gross retention. That's pretty good for a subscription business. And it's also rolling out more AI agents with CEO George Kurtz saying, quote, we're on the cusp of the fifth industrial revolution with artificial general intelligence on the horizon.

End quote. Let's break down here, Asit, what stood out to you in the results? Ricky, I liked that annualized recurring revenue or ARR, as it's commonly called, is growing and even a little bit in excess of the other metrics you mentioned. So this is up to $4.4 billion, sort of just

a solid foundation for both CrowdStrike and its Falcon platform, which is the engine of its subscription revenue. So I like that number. I did like that the company continues to show this double-digit growth, 20% or above, despite the issues it had last year. And I thought the net retention numbers, so dollar-based retention for new business, plus the one that you mentioned,

Not losing that many customers. In the quarters where I was expecting, maybe we could see some drift, some customers saying, all right, I had enough of trauma last year. Let me look for some other solutions. I thought all this together came up to be a pretty positive package for shareholders. The main revenue driver for this business is subscription revenue. And it made a billion dollars this quarter in subscription revenue. Asit, they are doing that with a 77% gross margin. That is high.

And still, this company is losing money on the bottom line. What do you make of that? This company at all-time highs, fully recovered from the outages. Does this deserve the same sort of patience that an earlier Amazon did where investors shook their fist at its lack of ability to make a profit and then was a fabulous, fabulous long-term investment? Or is the clock ticking on profitability here?

That's a great question, Ricky. This is a little bit of a "where my money at" question if you're a shareholder. You point out all this great revenue growth and a high gross margin. There's not a lot in the way of cost of sales to impede profits hitting the bottom line. There must be some fixed expenses out there that are squeezing, and those happen to be in the form of payroll expense. The first place I usually go look is the statement of cash flows to see maybe

There's some stock-based compensation expense in there that's pulling the profit and loss statement down, and that's what's happening here. This company in the last three months generated about $384 million in operating cash flow. It had $253 million

Let's round that up to $254 million of stock-based compensation. Now, to do credit to this company and to dig a little deeper, I will say that a good portion of the stock-based compensation here is going towards R&D salaries. It is comping people who are engaged in broadening out this Falcon platform. That's the mojo of this business.

They keep adding modules as they gain new capabilities and customers keep buying them. And also, in building this direct sales force that George Kurtz is very keen on, having that go-to-market motion in place. There's not a huge amount that seems to be going, let's say, to the C-suite, where the management team is just enriching itself.

If that operating cash flow is strong and free cash flow is strong, you can stomach that long term. How does it compare to Amazon, though, back in the old days? Well, Amazon was building out its logistics operation. It was running its e-commerce business at a net loss, and it was trying to get to scale. So it had a reason to lose money. It knew that on a unit economics basis, it was already profitable, and it was going to be

GAAP profitable one day, and that happened. You can see the same thing here with these SaaS companies though, Ricky, because they can keep upping the stock compensation that they give to employees. They can really drag out the day that shareholders start to see that positive net income. But here you could be patient. Clearly, the numbers show if they wanted to, they could throw profit down to the bottom line. That's going to be my new move. If I wanted to make a profit, I could. You talked a lot about share

share-based comp there. What do you think shareholders should make of the $1 billion that's set aside for share repurchases? When you're doing more than $250 a quarter, you can do the algebra there. You seem to just be kind of offsetting dilution there. Yeah. I mean, great insight. I'm not sure that shareholders need to be too excited about this. This is something common that companies do when they are running shares.

a really nice profit and have strong cash flow, but shareholders are also looking at getting diluted quarter after quarter. In some ways, this is talking about offsetting dilution, but it really depends on the run rate of the share repurchases. If they drag it out over

let's say a couple of years, it's really not going to keep up. But what this is a signal is that management is sort of aware that this could be a concern for shareholders. So it is going to offset a little bit of that dilution with the share repurchases. So I wouldn't get overexcited about it, but it's a gesture. And then we've talked a lot about the numbers, the financial statements here, but clearly there's a reason customers are sticking around even after that outage from about a year ago. Yeah.

What should listeners who aren't as familiar with the cybersecurity space, what do they know about specifically the Falcon Flex platform that was getting a lot of shine on the call? Right. So, Flex is sort of a way to purchase the products that this company offers.

Originally, CrowdStrike was like many other software security companies in that you had to go through these really tough procurement cycles. It was a battle between the customer and the vendor to ink out these long-term agreements. A lot of grief. And then if you wanted to change something a year later, let's say that CrowdStrike itself came up with this brand new module that would help you better offset threats out there in this very scary world we live in.

Well, you would have to renegotiate that whole contract. You'd have to go through another procurement cycle. And so what Flex brought to the table was a way that companies could sort of pay up front for consumption without having to get locked into specific modules and sort of trade them out as they went along. And what George Kurtz was saying on the call is that customers really like this and it's helping them spend more. I think that's because if you have the confidence that you can switch your spend

between things you're testing out, new modules that come, needs that arise that you weren't aware of six months ago, you're going to be more willing to commit the funds up front and have bigger spends. You feel more comfortable with the vendor. And I'll note that some other companies have started copying this model, which is sort of a mix of choice and a consumption-based model. And it may be the future of offerings like this. I feel like we're going to see more companies sort of adopting this innovative approach to selling modular type services.

And I think it's worth looking back on CrowdStrike from, it was July, I think, of last year where they had the big outage.

And if you bought shares at that point, you're looking at a tidy 50% gain. That's less than a year. So I guess any thoughts on the recovery of CrowdStrike here? And as we reflect back on this huge problem for the company, why do you think this ended up being a dark cloud that longer term investors were able to see through?

I think the company did a pretty good job, Ricky, of owning up its mistakes upfront. Maybe not in the first weeks, but eventually they made good with customers. There were some gestures that seemed like window dressing, again, in the early days. But over time, the way CrowdStrike responded to its customers and listened to them and tried to make amends and make sure that they undergirded their processes,

Those are impressive, but I want to say that they're not out of the woods yet. I mean, it's only been a few quarters, as you point out. So just fast forward a year or two years. With cybersecurity, it can be a fool me once. All right.

Fool me twice, dude. I don't care how easy it is to spend money with you or how many new products you put in front of me that are fantastic. I'm at least going to send out my bids for another vendor or another couple of vendors in the next cycle if you're going to continually expose me to this kind of uncertainty or shutdown or risk in my business operations. So they really can't afford to make a similar mistake. I don't think they will. I think they have their act together.

But with these types of things, when people need that 100% uptime and it is mission critical and you're a cybersecurity company to boot, you really can't mess up twice in this vein and get away with it. After the break, we're going to take a look at Dollar Tree and what that business says about the economy. And we're going to take a closer look at the bond market. Today's show is brought to you by the Range Rover Sport.

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All right, Asit, Dollar Tree reported this morning. It turns out it's a tough time to sell goods that are manufactured in China and across the world. Adjusted profit during the second quarter, the CFO announced, could be down.

as much as 45% to 50% compared to a year ago. Actually, some impressive numbers in terms of comp sales growth and more people coming into their stores. But this is what's getting the headline here for Dollar Tree. Is this just a tariff problem or is there more to the story here? I think it's just a tariff problem, Ricky.

Like you, I saw a lot to like in the report. Net sales up 11%, and that same store sales growth of over 5%. That's pretty strong in this environment when most consumers are pulling back a little on their spends. So, I thought the traffic flows looked good. The company is finally going to sell its family dollar division. So, on the whole, we've got a positive story here. And I will point out that, sort of like Dollar General, we're seeing

more affluent customers drop down to the dollar stores. A little bit of a cloud, what that says about the overall economy, I'm not so sure, but I don't think it's good. But that's a good tailwind for this company. So I think they're in fine shape, except for the tariffs. And here's the issue that maybe investors think about today.

first place, Dollar Tree was very good about quantifying its costs vis-a-vis the tariffs. I like that. Not every company is able to forecast forward. The impacts don't seem to be actually that large. If you listen to what management was saying, they were saying that this is like a fraction of our overall payroll increase in a given year. It's not a huge amount of dollars that we're talking about. Take this bit of uncertainty and a drag on the profit

margin, with potential commodity inflation, when the tariffs really start to take effect and forms fewer of those shipping containers that you and I have been talking about coming into the U.S., I think investors are maybe seeing beyond management's numbers and extrapolating a bit here that they could come back in the third quarter, the fourth quarter and say, "Okay, we laid out a good scenario for you, but man,

All the prices are rising beyond our expectations. And even where we shifted goods to other venues that had lower tariff regimes, those costs are rising too because of supply chain problems and shipping and logistics. So I think investors are just a little bit concerned of tariffs plus higher commodity costs, higher goods coming in. In this case, not true commodities, but the products that Dollar Tree resells to its customers. So there's some maybe warranted costs

Caution here? Overall, though, companies are doing well this quarter.

Yeah, you said that they're willing to, they're able to forecast. I would say willing to forecast because there is a lot that could change between now and in the coming quarter. I think something that was surprising to me in this call too is that they were seeing a meaningful traffic increase. You mentioned from higher income consumers. Yeah, people making, or household incomes making more than 100 grand a year are going into Dollar Tree more. And Asit, that was surprising to me because...

Walmart has been the winner of that in the past, but now dollar stores are starting to get more of that as well. Management would say this is because of Dollar Tree's broad appeal. Yeah, there's some economic concerns there as well. But given all of the dark clouds that you've mentioned before, do you still think a company like Dollar Tree can win long term in this environment?

Probably, Ricky. They've been, along with one of their rivals, Dollar General, working on the movement of inventory

and gradually just pulling those costs down. And they've also, like Dollar General, been pretty good at adding stores at this tremendous cadence. So, sort of like quick service restaurants, when you buy into a chain like Chipotle, part of the math why earnings rise is they keep adding locations. And Dollar Tree has that going for it. It'll be a bit leaner as it disposes of family dollar. So, I think it can win in this environment. Do I think this is going to be the greatest investment during this period?

No, but it probably is a decent defensive idea. I wouldn't look down at my nose at it for that reason. It's not a stock that I own, but it's sort of an interesting finger in the wind for the economy as I look at a business like Dollar Tree. Totally. Speaking of the economy, let's talk about the bond market.

Because on Friday's show, you said this is something you were keeping a close eye on when we were doing our big macro discussion. And especially what's going on in Japan, which has a higher, I believe, higher debt to GDP ratio than the United States. We don't really talk about stocks on this show, but why should stock investors, even people earlier in their investing journey, why should they care about what the heck's going on in the bond market?

A long time ago, the bond market used to be a very lucrative place to invest. And lucrative, what I mean by that is, for the risk you took, you got a pretty decent return between the interest you collected on your bond investments and a little bit of appreciation on those bonds.

When I was your age, Ricky, which was a little while ago, there were many investors who had a 60-40 split, 60% of their portfolios in bonds and 40% in stocks. Now, in today's world, most retail investors are all stocks and hardly think about the bond market. And that's fine. But there's this other world where sovereign governments need to finance their operations, like the U.S., those that have

debt in excess of GDP. You just mentioned Japan, which we talked about as the poster child for having a lot of money that it owes against its ability to throw off value each year in the form of gross domestic product. The United States isn't quite yet a poster child, but man, we're trying to become one. We're trying to knock Tokyo off the wall in that regard. Why this matters is capital flows

need to come into the U.S. for us to have our assets inflate on multiple fronts. For our borrowings to inflate so that we can pay our bills because we operate at a deficit, for the capital flows to stay in the U.S. and help stock prices increase as companies throw off earnings and folks want to invest, we still have to attract that capital into the country from other places.

So, just to focus on the bond side of the equation for a moment, I'm sure so many of our listeners have heard this preliminary argument before. As the U.S. becomes less of a stable place to invest, investors really are tempted to avoid our bonds because they're perceived not as risk-free anymore, our longest-dated bonds, but maybe a little bit risky.

And so, we have to offer a higher interest rate to induce them to come to the U.S. and let us borrow money. And that has follow-on effects for everything. It also makes our stock markets less attractive. Now, I think moving forward, there's this other interesting phenomenon that's emerging. The Wall Street Journal was talking about that just this morning. When our currency depreciates because of trade policies, that means that foreigners who buy our bonds

they are losing in two ways. One, they have higher risk, and two, they are losing on the currency differential. So, the value of a U.S. denominated debt obligation decreases because the dollar decreases. So, you have to hedge against that risk, and that costs money, making our bonds even less attractive. So, if we have this scenario for an extended period of time,

then what you see is not only will everything be more expensive and the U.S. run wider deficits and our costs for long-term borrowing go up like home mortgages or buying a car, but we'll see capital outflows out of the stock market, which will then affect stock investors because money will go chase safer havens, countries that are better positioned vis-a-vis their economies, and

relatively lower valuations out there versus the United States, where big tech has made our multiples look really extended, really expensive. So, capital will chase cheaper markets. We're seeing a little bit of all of this in real-time, but it's very slow-motion right now, Ricky. And my concern is that one day this thing just becomes a little bit of a snowball, where it will be hard to quickly reverse the conditions we are in now.

Well, I think you're seeing that with the spending bill that's going through Congress right now. And it is impossible to have this discussion without mentioning the existence of politics. But this budget being proposed is estimated to add, I think more than... I've seen estimates between...

like two and a half to like $3 trillion to the deficit. That's on top of the deficit we already had. And I think there was some expectation that, you know, we're going to start to see spending get clamped down in the United States and really start addressing that the national debt. And at least in the current version of this spending bill, that does not appear to be the case.

And what bond investors do is they demand higher yields for higher risk. And this is why the 30-year U.S. Treasury is now flirting with 5% yields. It's been flirting with that, I think, through the start of the year. That's not something that's really been going on since 2007. So when you look at that, Asit, as an analyst, is that a big deal? Concern troll? What say you?

I think it's a big deal, Ricky. The thing that I can't forecast is when kicking the can down the road reaches a wall, so the can is against the wall. And if you kick it any further, you're just going to hurt your toe or break your foot. And I think that day is coming. I think it's on the horizon now. Whether this is five years from today, 10 years from today, nobody knows. The U.S. has a very dynamic economy, and it can

improve itself a lot more quickly for such a big economy than you might think. But I don't know how many times we can pull that trick out of the hat before you have to pay the piper, which is to say there's only so much appetite for sovereign debt in the world.

You hear a lot of concern about the U.S., but still, this is where the biggest, baddest companies in the world are. There's a lot of macro geopolitical concerns no matter where you look in the world. So, I mean, we can talk about the concerns within our home country, but is U.S. debt still that tina? There is no alternative type investment if you're looking at debt and bonds.

It still sort of holds that role, and the reason is this: there is a market for sovereign government debt that's pretty huge. It's still a fraction of ours, but it looks attractive, and that is sort of Eurozone-denominated, Euro-denominated debt. Now, the issue with that is, when you're buying those bonds, you're looking

at various countries, and those markets are only so big together. If you add up Germany, Italy, Spain, all these very productive economies over in Europe, yeah, that number adds up to not anywhere near our market, but it's still substantial and can attract that capital wave. But bond investors then are looking at each economy. Do I really want to invest in Italy's bonds, which at the end of the day, they're also trying to vie for that poster child place? There are only so many German bonds

that global investors are going to be able to buy. There's some constraint of size in here, and I think the U.S. is coasting on that for now. But politicians, are you listening? I bet you're asleep by now, because you always tune out when you know this is coming. Get your act together from both sides of the aisle. This has been going on not years now, but decades. We've got to do something about this to enjoy the types of returns we have in the stock market for all those little domino effects that you and I just talked about in the last 10 minutes or so.

And politicians, congresspeople specifically, if you have stock ideas that you'd like to share with the show, our email is podcasts at fool.com. That's podcasts with an S at fool.com. We'll leave it there. Asa Charm, I appreciate you being here. Thank you for your time and your insight. Thanks, Ricky.

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, so 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. I'm Ricky Mulvey. Thanks for listening. We'll be back tomorrow.