In this podcast, Motley Fool senior analyst John Rotonti discusses:
Why the rise in investor pessimism gets him excited to go shopping for investments.
What he's watching.
A mind-blowing stat about how important it is to stay invested in the market.
Motley Fool senior analyst Tim Beyers talks with Tim White from The Motley Fool's The Ascent about which software-as-a-service (SaaS) companies have sticky software (as opposed to skippable).
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 September 19, 2022.
Chris Hill: Announcements from the Fed are like early season NFL games, you see a lot of overreacting out there? Motley Fool Money starts now. I'm Chris Hill joining me today, Motley Fool Senior Analyst John Rotonti, thanks for being here.
John Rotonti: Thanks Chris, glad to be back on the show.
Chris Hill: I wanted to get your thoughts on a number of things, including just how you're feeling right now because I said on the show on Friday, I think I said this to Ron Gross, I feel like if pessimism were a stock, I would be buying it because the pessimism that's in the market right now is really high and I understand why that is. But before we get into the Fed meeting later this week, just generally as an investor, how are you feeling right now?
John Rotonti: It's so funny that you said that quote to Ron because I think it was Friday, I tweeted out that the time to buy is when pessimism is prevalent and so I feel that pessimism right now as well, but that's when I get excited. I'm not saying stocks can't fall further, but you know, there's that old Howard Marks quote, if it's cheap, I buy it and then if the story doesn't change and it falls, I just buy more and so I'm at this point where I think there are some very good buying opportunities and I think it's a good time to nibble, take some small positions and then if they fall more, and the story hasn't changed, just buy more of those assets. Regarding what I'm looking at, believe it or not, one-year and two-year US treasury yields right now give you a four percent yield, that's pretty incredible, Chris, after years of a zero interest rate policy or ZIRP policy, you can get a one-year for four percent, those are some of the highest yields that I'm aware of out there.
Now, four percent yield is not going to cover inflation when inflation is eight percent, so the yield is still negative on an inflation-adjusted or real basis, but honestly, Chris, I don't think a lot of investors think on a real basis, I think they see yields and they think on a nominal basis, they say, what's a high dividend yield? What's a high treasury yield? I think these treasuries offering four percent short-term dated one year and two years are going to offer some competition for stocks right now. In the very least, it's going to drive up the cost of capital that we used to value businesses and a higher cost of capital, all else equal does mean some pressure on valuation, so stocks could fall further, but I do think even at these prices, there are some very attractive buys out there.
Chris Hill: Are there categories of stocks that you are looking at or avoiding? Because a lot of the refrain I hear lately is just stay away from anything related to tech, not that non-tech stocks aren't falling as well, but I'm just saying I'm hearing more of that lately.
John Rotonti: Yeah, so once again, being contrarian when I hear that and I've heard the same thing, that's when I start looking at tech and so I'm very interested in tech right now, more interested than I've been in a while. Believe it or not, last week, I was interested in the railroads when there was the possible strike on the horizon and some transportation, railroad stocks were getting knocked around. Obviously, they were going to work out some agreement, some bargain arrangement at some point and I think that the railroads are wide moat, they're still growing, they're indispensable to the US economy, so railroads, tech, and then anyone that follows me on Twitter or on the morning show knows that I like the alternative asset managers right now, like KKR for example.
Chris Hill: Just as the NFL with the start of the season, there are wild overreactions to the first couple of games, some teams are 2-0 and it's like, oh my goodness, I think there's going to be an amazing year for them when there's still so much of the season left to redeploy. I feel like it's a pretty safe bet that whatever the Federal Reserve announces later this week after they're meeting, I feel like there's going to be an overreaction of some sot run off, I'm sorry, rates half a point, whatever it is, I'm just stealing myself for overreaction.
John Rotonti: Yeah, the markets are on a edge right now and I do think that the Federal Reserve has been doing a good job lately, they've been going on these communication campaigns where they speak at different conferences and different events and they basically say, look, we're committed to the two percent target for inflation and we're going to do whatever it takes to get us a two percent and so there could be some pain in the short to intermediate term. They're doing a really good job of trying to prepare the market for it, but like you said, I just think markets are on edge and so we're ready for a surprise, you're right.
Chris Hill: We're ready for a surprise and yet it's probably not the way to bet, because so much of the mentality right now is almost like, I don't know, if you go to a big family event or something with your friends and you're not really excited about it and there are a couple of other people aren't and your mentality is, let's just get through this. We have to go to this thing, let's just get through this and it seems like that's where we are for a lot of investors because earning season is going to start next month, you don't really hear a lot of people thinking it's going to be great, so it's almost like, let's just get through the end of 2022 and maybe we'll start seeing some good stuff happening in early 2023.
John Rotonti: I think so Chris, I think analysts on average were slow to lower their earnings estimates and then FedEx came out big surprise last week, pull their guidance for the year, stock was down over 20 percent in a day. FedEx is seen as a bellwether, I don't know if it's as strong of a bellwether as it used to be now that it doesn't have Amazon‘s business anymore, but it is a global logistics company, they move a lot of goods for a lot of different businesses and I think that was a wake-up call for the market, that's some earnings estimates do have to come down and so I think in the third quarter we could see analysts bring their estimates down, which could put some pressure on stocks in the short term.
The thing that I keep going back to is Chris, you've been doing this for a long time, I've been doing this for a long time, we always say this time is different and it always is, but this time, for me in the 20 years I've been investing is truly unique, we've had 40 years of a bull market in bonds of falling interest rates. We've had 30 years of benign inflation and we had basically a decade coming out of the global financial crisis when money was pretty much free most of that time and all of those things are reversing, in addition to that, the Fed is going to sell off 95 billion worth of its balance sheet or let it run off, I'm sorry, let it run off of its balance sheet every month, it's a nine trillion dollar balance sheet or thereabouts. We've never had this level of quantitative tightening trying to unwind a nine trillion dollar balance sheet, so there's lots of unknowns right now and there are lots of examples and reasons why this is new waters for a lot of investors.
Chris Hill: Should the mindset, having made the comment that I made about, let's just get through this, I should also say, I don't feel like that's necessarily a bad thing for investors to have that mentality because on alternative to that is I'm out, I'm just pulling my money out of the market altogether and I'm going to try and time a bottom some time in the future.
John Rotonti: One of my favourite pieces of advice to myself, whenever I get anxious or pessimistic, is to zoom out. If you zoom out on the market, there's been a lot of scary times, whether it's pandemics, whether it wars, whether its global wars, market crashes, runs on banks, whatever it is, and overtime, whenever the market falls from a high, it always historically, always has recovered to a new high. If you zoom out enough, it's up into the right is what's the stock market looks like and if you zoom out enough and you invest long enough, you get 9-10 percent on average, overtime annualized over time, that's what the market has provided. You don't want to get out of the market if you miss JPMorgan Asset Management put out some research recently, if you miss the 10 best days, Chris, over a 20 year period, the 10 best trading days over two decades, you returns got cut in half.
Yeah, not a typo, not a misquote, your returns got cut in 10 days over 20 years because most of the returns come on magical days and believe it or not, most of those magical days come after really bad days, Chris. It's like a really big down day and then a really huge update and so you don't want to get out of the market on those really scary days, you want to stay invested. Last thing I'll say is overtime and I mean, going back 200 years, 100 years, 75 years, 50 years, 25 years, stocks have been the best hedge against inflation. Stocks have provided higher returns after inflation than corporate bonds, treasury bonds, junk bonds, gold, and home prices. Stocks are the best hedge against inflation over the long period of time.
Chris Hill: The perfect place to end, John Rotonti. Thanks so much for being here.
John Rotonti: Thank you, Chris.
Chris Hill: Software-as-a-service is supposed to mean high-margin recurring revenue for investors, but more companies are taking a close look at their budgets, Tim Beyers caught up with Tim White to talk about why some software is sticky and some is skippable.
Tim Beyers: Hey Fools, Tim Beyers here with Tim White. You may know us from This Week in Tech. Tim, we're going to talk some SaaS today and we're going to talk about when SaaS isn't sticky. Because usually, it is like the overall argument for software as a service is that once you commit to it, it tends to stick around. It has a little bit of a Roach Motel type of reputation where once you're in, you're not necessarily out, but sometimes that's not really true. In fact, I think maybe the reputation is less true than the reality.
Tim White: Right. I think as companies are evaluating their costs, going into tougher economic conditions, they're really looking at ways to save money. Those monthly recurring expenses they're spending on SaaS products are easy targets.
Tim Beyers: Yeah. They do get targeted a lot. Let's talk about some instances where SaaS is not so sticky. I'll hit you with the first one here. Very often, it's not necessarily the software itself. That is the issue. It's not like the software suddenly went bad, but it may be and we were talking about this off air when a free tier option comes up and you are looking to cut costs, sometimes those free tier options are amazing. You decide I'm going to switch.
Tim White: Right. Many SaaS tools offer a free tier, meaning that you can use their product without cost up to a certain amount.
Tim Beyers: Right.
Tim White: You might be able to use it for a few different users, can have accounts or a few different hits per hour, hits per day. Now that you can get for free, and a lot of these tools will have free tiers in order to get people in and try them. It's like a free trial, but those free tiers typically persist. That as long as you never go over that number, you can continue to use the tool free forever. If a company that you have a product with and starting to ratchet up their prices and you're really not pleased with it and another competitor has a free tier that really does everything you need, you're essentially cutting your costs from pretty expensive to zero and it makes it worth the pain of switching.
Tim Beyers: Right. There may be if you have an ally inside the company and says, “You know what? We're paying all of this money.” You are talking about Adobe XD. “We're paying all this money, but I used Figma at my last company and we can get that for free. You want to try it?” That happens a lot.
Tim White: Right. I think Adobe in particular, because of their monthly subscription product pricing model, really makes a lot of people question every single month, do I really need all of these Photoshop users? Do I need all of these users? That questioning comes with just, OK, I can get rid of a few users to lower my cost, but then it starts to come. Is there some other product I can get for a whole lot less? I think that's part of why Adobe has decided to buy Figma.
Tim Beyers: Yeah. A $20 billion purchase. Number two, sometimes competitors who really want to make an inroads. I think it's more true with smaller competitors, Tim, or ones that are actually really large and trying to make a play to command the market, they will come in and they will dramatically lower prices. Sometimes a great product gets displaced because a salesperson comes in with the authority to say, cut costs by 50 percent or more. We've seen that here at the Fool. It does happen probably more than we'd like to admit.
Tim White: Right. Those bigger companies also come with armies of consultants that are ready to help you with all of your switching needs and move all of your data around. There is no SaaS product that's going to be competitive in the marketplace that isn't hiring consultants and engineers like crazy and building clear and easy pathways to convert from their competitor's products to their own.
Tim Beyers: Right. That is one of the biggest hidden advantages. It's one of the reasons I tend to like the consultants the contractors of the digital era. They hold a lot of power. Contractors that have particular skill sets. There are companies that will invest quite a lot of money to train up consultants in their product because they know those consultants can recommend their product into different situations. It does happen quite a bit.
Tim White: Right. In the case of a company like Atlassian, they use third-party consultants and system integrators to do things like even convert between their own products. If you currently have Trello and you want to switch to JIRA, third-party integrators are there and waiting to take that business to make that conversion happen for you.
Tim Beyers: Absolutely. Let's talk about the third, and this is probably the one that is, I think it's common, but it's also the one that if you are a SaaS company and if you're an investor in SaaS companies, it may be the most frustrating, but it is the reality. This is where a company is sort of bounded by its market, which is that you have a piece of software, but you've just outgrown it. You've just outgrown it and now you need to start shopping for a different and better tool. Tim, I think you've probably been through, I don't even know how many migrations to like we had to graduate to a different tool you've been through, but I'm going to guess it's a lot.
Tim White: Sure, let's just give a small business example. Let's say you started with a tool like Squarespace or Wix for your website and you're selling a few PDFs or a few products that you're creating and you're really enjoying that. Then you suddenly decide, OK, it's time to take the plunge and I want to sell 1,000 products or 10,000 products. At that point, you might be looking at switching to a different, more capable sales provider that has the ability to have a lot more products and make that all much more simple.
Tim Beyers: Yeah. Something that has a lot of history may be handling a lot of different skews. There's a huge difference between like say, a Squarespace and a Zuora, which has a lot of experience with a highly customizable product and it's designed to handle a lot of different skews.
Tim White: Somewhere in the middle might be products like Shopify which can have lots and lots of skews, much more customizable, maybe handles international a little bit better. But it's a little more complex to use than a Squarespace.
Tim Beyers: If you're an investor, there is nothing inherently wrong with that. I just want to be clear about this, but this truism Tim, about sometimes a product only lives in a certain segment of the market and so a customer will say, “I love this product, but I need to move on to something else.” This is why I say something like HubSpot. A sales force can co-exist because a Salesforce is for a much different type of customer that needs, say, customer engagement versus a small business customer, like a HubSpot. It's not a problem that HubSpot doesn't necessarily service a Salesforce customer and vice versa.
Tim White: Right. Especially small businesses they don't have big IT departments may prize the simplicity of a tool like HubSpot over the complexity of a tool like Salesforce, even if it doesn't have all those capabilities, they don't have the people who are technically experienced enough to take advantage of all those capabilities anyway.
Tim Beyers: Right. Three ways that SaaS can sometimes not be sticky. Sometimes the free option is just so great that it's an easy way to save money. That can be downgrading to the free option of the tool you already have or it can be another free tool that's a competitive free tool. Sometimes a competitor comes in and just dramatically lowers prices. They offer a deal that it's the godfather deal, the one you can't refuse. Then sometimes you just outgrow the tool. In each of those cases, Tim, I would say, that's not necessarily a knock-on SaaS. I want to be clear about this, these forces existed long before. There was such a thing as a SaaS model.
Tim White: Right. I think that business has essentially just caught up with things that were happening already in the old days of enterprise software and are now switching themselves to SaaS.
Tim Beyers: Right. Because it is an interesting model that gives you a tax-advantaged way to adopt software and can really reduce your maintenance costs, or at least the way we used to do maintenance back in the days when Tim was going to server rooms in the middle of the night. I'm sure you don't miss that.
Tim White: I certainly don't.
Tim Beyers: That's it for this segment on when SaaS isn't sticky. I'm Tim Beyers for Tim White. Thanks for tuning in to Motley Fool Money. We'll see you again soon.
Chris Hill: As always, people on the program may have interest in the stocks they talk about and the Motley Fool may have formal recommendations for or against, so don't buy or sell stocks based solely on what you hear. I'm Chris Hill. Thanks for listening. We'll see you tomorrow.
JPMorgan Chase is an advertising partner of The Ascent, a Motley Fool company. John Mackey, CEO of Whole Foods Market, an Amazon subsidiary, is a member of The Motley Fool's board of directors. Chris Hill has positions in Adobe Inc., Amazon, Atlassian, JPMorgan Chase, and Shopify. John Rotonti has positions in Adobe Inc., HubSpot, KKR, Salesforce, Inc., and Shopify. Tim Beyers has positions in Amazon, HubSpot, Salesforce, Inc., and Shopify. Tim White has positions in Amazon, Atlassian, HubSpot, Salesforce, Inc., and Shopify. The Motley Fool has positions in and recommends Adobe Inc., Amazon, Atlassian, FedEx, HubSpot, KKR, Salesforce, Inc., Shopify, and Wix.com. The Motley Fool recommends Zuora and recommends the following options: long January 2023 $1,140 calls on Shopify, long January 2024 $420 calls on Adobe Inc., short January 2023 $1,160 calls on Shopify, and short January 2024 $430 calls on Adobe Inc. The Motley Fool has a disclosure policy.