Banner results from 2020 darlings haven't turned into strong 2021 returns. In this episode of Industry Focus, we talk about the tech landscape in 2021 and how a recovery economy affects high-growth businesses, and we look at earnings results from MercadoLibre (MELI +0.41%), Zoom (ZM +0.30%), and Cloudflare (NET +1.40%).
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This video was recorded on March 5, 2021.
Dylan Lewis: It's Friday, March 5, and we're talking about the dip in tech stocks. I'm your host Dylan Lewis. I'm joined by fool.com's daft day-to-day delinquent of drawdown deep dives, Brian Feroldi. Brian, how are you doing?
Brian Feroldi: I'm doing great, Dylan. How are you?
Lewis: I'm doing OK. How is your portfolio doing? I think that's probably the better question to kick off the show with.
Feroldi: Well, it really depends on what time frame you're talking about. Over the last 10 days, not so good. Over the last 10 years, pretty good. I prefer to focus on the latter, not the former.
Lewis: I think that's a great way to put it, Brian. Yes, I think it's shocking to log in, and I don't know about our listeners and our members, but I am someone who checks my brokerage account every day. I don't activate every day. I'd say in any given year I'm maybe doing something in my brokerage account in terms of transactions 10 to 15 days. But I check every day and to see a 5% or 10% swing in a couple of days is drastic and [laughs] it does give you pause like, huh, I thought those first couple of numbers started differently [laughs] last time I was in here.
Feroldi: That's how it goes with investing and that's how it goes with stocks and start picking like us. If you're going to invest in some of the greatest companies, the most dynamic, the biggest innovators, big drawdowns are going to come and they're going to come swiftly.
Lewis: They are. We lose sight of it sometimes, particularly during rosy periods, when we talk about the S&P returning 7%-10% annualized, that's an average number. You're working to that annualized figure based on overall movements over long periods of time. It doesn't have that consistent march that some of those calculators and retirement calculators will have you believe.
Feroldi: That's exactly right. If you look at the historic returns for the S&P 500, they are truly all over the map. You see +20%, +30%, -20%, -30%, you average it all out over long periods of time, you get a pretty satisfactory return. But when you're looking day to day, week to week, month to month, anything can happen.
Lewis: Yeah, anything can happen and you will see even larger swings with some particularly high-growth stocks. We're going to be talking about that in the middle of the show. I think maybe just to start things off, why don't we set the stage for folks that have maybe been tuning in and out of the news a little bit? Just with what's been going on in the market and then specifically in the tech space over the last two or three weeks.
Feroldi: Yes. So, the stock markets started out 2021 pretty good. They were up double-digits in mid-February. Over the last few weeks, there has been a relatively modest sell-off. But if you look at the Dow and the S&P 500, they've barely budged. They are only down a few percent from their all-time highs. But the Nasdaq is down more than 10% from its February high. So the Nasdaq is officially in "correction territory". But even that doesn't really tell the whole story. Because while the Nasdaq is predominantly tech, certain sectors of the technology market are down even more. A couple of ETFs that I track to look at Cloud stocks and SaaS stocks are doing, which we love talking about on Industry Focus are the SKYY and the CLOU, which are just two ETF that hold a whole bunch of SaaS stocks. Those are down 17% and 18% from their February highs, and a couple of other ETFs, notably the ARK ETFs -- ARK has a group of active ETFs that have really caught fire over the last couple of years. They've become hugely popular with investors. Two of their bigger funds, the ARK Innovation ETF and the ARK Internet ETF, both of which are very focused on high growth tech stocks, are down 28% and 26%. Again, these are just the averages. We've seen lots of stocks that are down much more than that. So, it's been rocky over the last couple of weeks.
Lewis: I know that a lot of our listeners are Fool members or people that generally follow the Fool investing philosophy. That means that they're probably a little overweight tech. I imagine that their portfolio probably looks a little bit like mine, where there's a little bit of an overweight to growth oriented businesses, a little bit more tech in the portfolio. So, when that's the case, and we see that with some of these specific ETFs, you're going to have some outsized movements. Definitely the case in 2020 for me. Also, the case in 2021 for me.
Feroldi: Yeah. Exactly. As you said at the top of the show. When you're investing in high growth areas of the tech market, you have to think of them that they generally are going to move at a step change market in general. When the market goes up a little bit, these stocks are going to go up a lot. When the market goes down a little bit, these stocks are going to go down a lot. That is the downside to the upside of owning high growth businesses.
Lewis: I think one of the confusing things, Brian, for people that have been following the market is, you look at 2020 and you say, boy, just a rough year all around. A really tough year for a lot of Americans and a lot of people all over the world. Tough year in terms of how you would look at most economic indicators. Pretty solid year for the stock market, even with the massive sell-off that we saw. I think the S&P on a total return basis is about 17%, 18%, and personally, one of the best years I have ever had investing. There was a massive disconnect between what we have seen with the market and the economy. What's odd is, you look at 2021 and I think some of the major news that's moving these companies and it's the flip. We're seeing some positive signs and that's great, but it's actually not particularly good news for a lot of these high growth businesses.
Feroldi: A lot of the high growth stocks that you said really prospered in 2020, in many ways, were prospering because of COVID. So much of how we live our day to day lives was disrupted in 2020 and that forced us to live differently. People were working from home, they were shopping from home like never before, so it made complete sense that companies like Amazon, Microsoft, Google, Facebook, companies that thrive in a work from home, shop from home world, that their stocks just absolutely took off. The worst news was at the time, the more drive there was for people to use their products and services. Now that we're on the flip side of things and the world is getting better faster than we would have thought, it does make some sense that investors are actually rotating out of those stocks and into some of the stocks that have been left behind.
Lewis: There have been a lot of positive movements, a lot of positive news on that front recently. You go back to January and we were looking at triple digit new case counts every single day in the United States and we're down to about 50,000-60,000 in recent days. That's a good thing. We're seeing the Johnson & Johnson one-shot vaccine was approved. That's a good thing. We're seeing positive signs on the supply for Americans with the vaccine. That's another good thing. These are all things that I think we're generally rooting for. Unfortunately, it creates a spot where the valuations for some of these higher growth businesses are going to suffer.
Feroldi: Which just again proves to me that it's so hard to try and predict what the market is going to do based on the headlines. Would you ever have predicted that terrible headlines in 2020 would lead to great returns in the stock market. Now, we're seeing great headlines in terms of the vaccine being rolled out faster than anticipated and new supply coming on market and that's leading to the decline in the market. This is why I never try to guess what's going to happen next with the market, just focus on buying awesome businesses.
Lewis: Yeah, we joked in 2020 several times. I could tell you the headline a week in advance and you could try to trade off of it and almost every time you'd be wrong. [laughs] It didn't matter where the jobs numbers were, or the new case numbers were, it just seemed to always be the polar opposite of what you expected to happen.
Feroldi: That's exactly right, and that's nothing new, to be honest. If you've been investing for a long time, I can't tell you how many times I've seen a company report just great earnings, like, everything in the earnings report looks fantastic and the stock fell. I've also seen companies report terrible earnings, just everything was bad across the board, and the stock rose. Even if you have the news ahead of time, you can't necessarily predict what's going to happen next.
Lewis: We talked a little bit about the dynamics with 2020 stay at home stocks and how they really benefited that pushed up valuation. I do think it's worth taking one step back and looking a little bit at long term forces at play here because I think there's a little bit of this too where, Brian, we have basically had low interest rates in terms of modern history, unprecedented amounts of time. The Fed funds rate, which is basically our baseline rate for all other debt in the economy, has been so low for so long. You look at the chart over the last 60 years, it has never been this low for this long. That creates a lot of movement of money within the economic system. It pushes a lot of people to more of a risk-on environment where they are willing to put money into stocks, willing to put money into real estate because they're looking for a return, they're looking for yields, and they're not able to get it as much in the debt markets. Within that category of equity investments, people looking for outsized returns are going to be putting money into growth stocks. That's where the money is going to flow. On top of what we have generally seen over the last year or so, I think there's probably a decade long trend of money flowing in one direction and at some point people deciding maybe I'm going to take some profits and take a little bit of that risk off the table as well.
Feroldi: Which makes sense. To your point about just what's happening at the macro level economically, yeah, interest rates have been terrible now for over 10 years. If you need to generate an income from your portfolio, you can't really do that from bonds. You can't do that from savings. There's a whole bunch of money that is chasing returns out there. It does make sense in an environment like that, the asset prices get pushed up. When you combine that with the fact that the stock market has been roaring now for basically 11 years in a row, and couple that with the fact that a whole bunch of people were forced to stay at home and many of them took up investing for the first time as a hobby, it does make sense that stocks have had a tremendous run and that now we're seeing the reversal of that.
Lewis: Brian, we want to talk about a couple of specific names that are very relevant to our Fool audience, ones that our members and our followers probably hold pretty widely. Because if you look, we're not talking about necessarily 10% drops. In some cases, we're looking at businesses that had been high-flying that are now 30% off highs. I think that's something there if you're a recent buyer, probably creates some high blood pressure for you and it might be the first time that you're really going through this. I think maybe it makes sense for us to talk a little bit about the results from some of these companies and just philosophically, how both of us are approaching this investing landscape.
Feroldi: Sure. One of the things I try to hammer home all the time is that there's a difference between a business and its stock. A business sometimes can produce fantastic results and its stock can go down. A business can sometimes produce terrible results, and its stock can go up. We have a couple of examples here that really highlight that. Cloudflare, the ticker symbol there is a NET, is a company that I've really started to get to know over the last couple of months. This is a company that has done tremendously well both prior to Covid-19, as well as basically throughout the pandemic. We haven't really talked about this on the show much, but Cloudflare at a high level provides web infrastructure and security services to the Internet. Their products and services will reach 99% of the world's Internet users, within 100 milliseconds.
Cloudflare is a way to speed up and get Internet content to people faster. If you look at this company's 2020 results and their Q4 results, wow, are they having a great time. In the fourth quarter alone, they added 10,000 new customers. That was up 10% sequentially to their customer ground, and they now have 110,000 total customers. 92 customers in the fourth quarter alone will spend $100,000 or more with Cloudflare. That brings their total up to 828. Their DBNR, dollar based net retention rate, retention, the good one, was 119%. When you add it all up, revenue grew 50%, gross margin was 78%, and their adjusted net loss fell by about half to $8 million. Every single thing that I just said says, wow, they are crushing it, adding 10,000 customers in a quarter. Yet, this company, since reporting earnings, is down 31%.
Lewis: It's incredible. Brian, just as a side, whenever I hear you say, retention the good one, I always think of the evil twins, dollar based net expansion and dollar based net retention, how maybe expansion is the evil twin. But those are incredible numbers. What I think is hard is like, we knew 2020 was going to be good. We're seeing the lagging results coming in and then we're looking backwards. Unfortunately, we know that the market is always looking forward. What we see in terms of the market price is basically an aggregate of future value assessments of what could happen. But I see all of that and I see a business that seems to be doing just fine. I don't really see too many reasons for concerns.
Feroldi: The reason there has to do mostly with valuation. All three of the stocks we're about to talk about just had a heck of a run in 2020. While their businesses improved mildly, you could make the argument that the stock prices got ahead of the business fundamentals, and not only were they pricing in great growth, they were pricing in even better growth than the growth that we've seen. This could just be a case of valuation reset. But this is why I try really hard to always focus on the business. If you just focus on the business and ask how Cloudflare is doing, it's very clear that they're executing brilliantly.
Lewis: I think focus on the business is the thing you have to remind yourself for stock No. 2 here, that's MercadoLibre. Even in a world where COVID didn't happen, focus on the business was going to be a huge part of the way you talk about this company, because we've talked about this company at length on the show before. But they work in, I think, 13, maybe 14 different countries. Different currencies, they repatriate back to dollars. There's a lot of crazy stuff that happens with foreign exchange and having to denominate all their results in dollars. Already this is one where you got to look at the business metrics. You can't look at the revenue quite as much, and the numbers have been stellar. In their case, year-over-year growth for them recently has been somewhere in the 50%-60% range. [laughs] Final quarter of 2020, Brian, 97% year-over-year growth, which is bonkers. I know I said don't focus too much on the dollar figures, but I have to highlight that one.
The user numbers and what they're seeing in terms of usage on their platform is incredible, 70% user growth, now at 74 million. Items sold for their e-commerce platform up 100% year-over-year. Total payment volume almost $16 billion for this last quarter, 84% growth in U.S. dollars. To highlight that disconnect there, 135% foreign exchange neutral basis, which is just insane. Those are great, great numbers, and yet this is a company that is down almost 30% since late January.
Feroldi: Very similar to Cloudflare. It's like you would dig through their earnings report and you're like, "That looks good, that looks good, that looks good." The business is executing flawlessly, but the stock has not responded since January. Now again, if you back up and look at how they did throughout 2020, the company had a tremendous run. This is again, more of a valuation reset and a sector rotation among investors as opposed to something going wrong with the core business.
Lewis: MercadoLibre shares since January 1st, 2020, up 150%. I think anyone who bought back then, even with this dip, probably felt OK. What is hard is if you're one of the newer buyers. I think in Cloudflare's case, those returns are about 270% since January 1st, which is market stumping. One of the other elements I guess which we probably touch on, Brian, 2020 set really hard expectations for new investors. The idea that you could buy something and six months later have it be worth two or three times what it once was, that doesn't usually happen. It was happening for a lot of names, particularly a lot of very popular names in the market.
Feroldi: Exactly. 2020 was the weirdest year of investing I've ever been through. If you only started paying attention to the market anytime from March 2020 until now, the only thing that you've known is instant success; buy any company and it instantly goes up and you are instantly rewarded for buying and holding. Whether it was a week, a month, or three month period, that's what you experienced. For a lot of people that have started investing over the last year, what they're seeing now is really the first time that that hasn't worked and that they've actually experienced what can happen when you invest in the market. It's really challenging for anybody that's got started over the last year.
Lewis: Maybe the story of 2021 with Zoom. [laughs] If you didn't know Zoom because your company used it, you learned it quickly because a friend or a family member wanted to use it. The video communication app just saw incredible adoption in 2020. I think they jumped about four, five years in growth adoption with where things were last year.
Feroldi: Totally. Zoom had the year of years, and how many earnings reports did we go through and said, "Is this the greatest earnings report of all time?" "Is the beat that came out here the greatest that we've ever seen?" The fourth quarter was just more of the same. The number of Zoom customers that have 10 or more employees that are signed up grew 470% to 467,000. The number of customers that will spend more than $100,000 with Zoom over the next year grew 156%. The dollar base net retention rate, retention, the good one, that was above 130% for the 11th quarter in a row. What does that mean for the financial statements? Revenue growth of 369%, adjusted net income growth of 839%, and management issued some pretty bullish guidance for fiscal year 2022.
For the full fiscal year, they expect to generate a revenue of $3.77 billion. That would represent growth of 42% off of the stellar numbers that we just started reading off, and they expect to grow their profits, although at a much, much slower rate. Keep in mind, every time that Zoom has issued guidance, it's blown it away. The company has established a culture of issuing low guidance and then blasted off. The numbers out of Zoom have just been phenomenal. There's no other word, phenomenal. Yet, the stock is down 41% from its October 2020 high and 26% since January. Yet another case of the business executing brilliantly and the stock going down.
Lewis: If you are a recent shareholder, maybe a little bit more concerned, if you've owned it since the beginning of 2020, you're looking at close to 400% returns, which I don't have the words for. [laughs] We're not really used to seeing anything quite like that. I think what is hard for people is if you got your initial slug for any of these companies, your first buy for any of these companies recently, you are looking at this downturn a lot differently than someone who has been a long term shareholder. In my case, I'm a MercadoLibre shareholder, I've been for years. I'm sitting on multi-bagger returns to the stock. It's not as concerning to see a 30% dip. It's a little bit harder to hear this if you bought your first share in the last couple of weeks.
Feroldi: That's exactly right. That just reinforces to me that you have to take a multi-year outlook with any of these stocks, because what the stock does and what the business does over the short term are completely different from each other. As we've seen with all three these companies, great results, terrible stock returns. But if you zoom out and look over longer periods of time, great business results always lead to great stock results. You just have to give the market time to recognize that because there are so many forces that play in the short term. That's why we always talk about how the business is doing, do we like this business over the next three, five, and 10 years. I've owned MercadoLibre since 2010 or 2011. MercadoLibre, I have seen go through so many ups and downs. This is a kind of stock that doubles and then falls 60% and then goes up 150% and then falls 50%, and then goes up and then trades sideways, and it just goes all over the map. But if you zoom out and look at the long term picture, it's been one of my biggest winners ever. Whenever I buy it and whenever I own, I just have to say, I own this business for a long period of time and I just accept that I have no clue what's going to happen over the next day, week, month, or year.
Lewis: Brian, you are a must follow on Twitter for a variety of reasons. You are a nice calming voice when things are going a little crazy, but you're also excellent with graphics. I think one of my favorite things that I've seen come out of your Twitter account was a look at, I think they were all stocks that have 10-bagged or stocks that basically put up multi-bagger or 1,000% returns and the declines that they have all experienced at various points. I don't remember all the stocks off-hand, but I think it was Amazon, Netflix, and several others. It's a good reminder. [laughs] Highly disruptive businesses wind up going through some really sharp corrections from time to time.
Feroldi: What's really interesting about that is not only do highly disruptive businesses do that, really stable boring businesses often do that. Warren Buffett has pointed out that Berkshire Hathaway, top tech to bottom tech, has fallen 50% four times since he's become chairman and taken over. Four separate times, Berkshire Hathaway, a big stable conglomerate as reliable as it gets, has also seen its share price get cut in half. What do you expect of high growth companies like Netflix, of Amazon, of Tesla? Their stocks are going to be even more volatile than that. If you are going to buy individual stocks or if you're going to put money into the market, the price that you pay for long term returns is occasional, short term volatility. You just have to be willing to pay that if you want to generate great returns.
Lewis: We know if you're thinking of this way as you're going into your buys, it's a little bit easier. You can be planned and you can say, "I'm going to be buying into this over time. Going to maybe build out the position in three, four, five purchases, spread it out, dollar-cost average. Keep a cash position on the side in the event that there are some interesting buying opportunities." I think a lot of people are looking at things right now and saying, "Interesting buying opportunity." It's nice to get something on sale. If you happen to be in that position, I think this is a much easier thing to encounter. The thing I will say to folks that are relatively new to the market or maybe are new investors in some of these high growth businesses that have really taken a whack, the core thing I come back to is think about whether the thesis is intact. That's the easiest shorthand thing I can come back to when I see a lot of red in my portfolio. In the case of MercadoLibre, is e-commerce going to continue to build out really across the world in a new market where they own it? Yes. Digital payments, is that can continue to build out over the next couple of years? Yes. Are they going to be the market leader? Most likely. Even though there's a 30% dip there, everything that made me originally buy that company is still there for that business.
Feroldi: That's exactly it. When I'm going over the earnings report, the question I'm always asking myself is; is the thesis on track? Is the management team executing? Are they adding more customers? Are their margins stable or improving? Is revenue growing? Are they launching new products and new services? When you dig through all three of those earnings reports that we just talked about, the answer is yes, yes, yes, yes. Across the board, all three of those companies are just executing brilliantly. If they can continue doing that for a long, long period of time, I'm 100% convinced that all three of those stocks will be higher in three years and in five years and in 10 years than they are today. That's why you have to focus exclusively on the business and do your best to ignore the stock.
Lewis: I think what is immensely helpful is we talk about investing journals all the time and the idea of tracking thoughts. There are a lot of different ways that you can do that. You can have a physical journal, you can have a notepad. Some people use Twitter as their diary for that kind of stuff because there's public accountability, that's awesome. I think with anything you own, I think in two sentences, have the summary of why you own it. As long as that continues to be true, it's a really simple way to gut check yourself when you see scary headlines or where you see a lot of red in your portfolio. As long as those things continue to be true, you're on the right track especially if you're thinking three, five, 10 years.
Feroldi: I love that. Yes, I've been using an investing journal for several years. Exactly what you just said, whenever I'm about to buy a stock, I go through and I write down what's the price today, what are the few reasons why I'm buying that stock versus all the other stocks that exist, and then I periodically go back and look at my past decisions. When I view some of my past decisions and I know the outcome, like, boy, that was a dump stock to buy. It's useful to go back and see why I was thinking what I was thinking then, because it's easy to tell yourself if something doesn't work out that you made a mistake, but when you're actually reading your rationale, it can prevent you from making that same mistake again.
Lewis: One layer I'll add to that Brian is if you really want to hold yourself accountable, write down why you sell stuff when you sell it. I know that we don't really talk about selling things too often, but [laughs] one thing I have noticed is pretty much everything I have sold, it's been the wrong decision. [laughs] What I haven't done is track the new money that I put it in and really what the opportunity cost was of doing that. But there are businesses like Chipotle and Costco where I kneecap to what would have been pretty strong results and pretty good returns, just because I was interested in other ideas and I had limited money. In addition to understanding why you buy, if you're looking to improve over time and just holistically improve your investing process, understand why you sell and remember why you sell as well.
Feroldi: Totally. All my biggest most blunderous mistakes have been selling and I've bought a whole bunch of bad stocks. I bought a lot of bad stocks over time, but I sold DexCom for $8. That company is over $400 today. So every other good selling decision that I make was overwhelmingly -- the amount of money that I missed out on by selling Dexcom for $8 has not been made up by all my good selling decisions. So yes, like you, all of my worst decisions usually have the word "sell" in them. [laughs]
Lewis: Those are some good humble brags there, Brian. [laughs] I mentioned the selling stuff because I'm sure there are some people that are thinking about that right now and are looking at the declines and are thinking, it might make sense for me to move out of these. These aren't performing the way I expect them to. Look at the long term charts for some of these businesses. I think MercadoLibre in particular does a great job of illustrating the dips that come with the long term appreciation. But if you think the thesis is intact, if you think the mega trends that are pushing those companies forward are going to stay there, and I think for all these businesses we talked about today, that's certainly the case. I don't think that we're moving away from e-commerce, I think we're only becoming more dependent on Internet infrastructure. Companies have seen the value of Zoom. The web meeting is here to stay and we're increasingly getting decentralized with our workforce. You're probably in OK shape.
Feroldi: Exactly. MercadoLibre is one of my largest holdings, if not my largest holdings, it depends on the day, what's happening with MercadoLibre essentially. I've owned the stock for many, many years. Yes, I'm down from what it was worth a few weeks ago, but like you just said, I have no plans to sell this company. Everything that I see when I dig through their earnings report says the thesis is on track and I want to own this company for a long time.
Lewis: Same for me. If you're sitting there holding MercadoLibre, even if you're in the red, you're a fellow shareholder along with Brian and I. That's the power of the community. I think that's also one of the things as we wrap up here Brian, I'll mention last is just it's helpful to have supportive voices and I find Twitter surprisingly good for that. For all of the things that Twitter brings into the world, I think the Fool investing community and then some of the other folks on Twitter that are really long term oriented are great reinforcement for that. We try to do that here at The Fool and I think selfishly we get to do that with our colleagues a little bit more, because we're talking all the time about stocks. I know that some of our members may not have their voices so available to them, but that's what we're here for.
Feroldi: There's nothing like a good community around you. If you are interacting and engaging with a strong community of like-minded people that also buy and hold great companies for long periods of time, they can help to talk you off the ledge if you are having a bad day in the market. Whenever I see big time red and I'm feeling down, I fire up Fool Live and I see what other people are saying. I go on Twitter and send out messages to people I know and respect. I go on the Motley Fool's discussion boards and read posts from some of my favorite people. Every single time it helps me feel better and refocuses me on the long term. Totally, don't invest alone, invest with other good people.
Lewis: We're just lucky enough, Brian, to get paid to talk about it together and get to enjoy that community as part of our jobs. I'm always happy to have you on and always happy to talk about stuff with you.
Feroldi: Always love being here, Dylan. Thanks for having me.
Lewis: Listeners, that's going to do it for this episode of Industry Focus. If you have any questions or you want to reach out and say "Hey," shoot us an email at [email protected] or you can tweet us @MFIndustryFocus. If you're looking for more of our stuff, subscribe on iTunes or wherever you get your podcasts. As always, people on the program may own companies discussed on the show and The Motley Fool may have formal recommendations for or against stocks mentioned, so don't buy or sell stocks based solely on what you hear. Thanks to Tim Sparks for all his work behind the glass today and thank you for listening. Until next time, Fool on!
