In this podcast, Motley Fool analyst Bill Barker and host Deidre Woollard discuss:
- Why Home Depot is buying a distribution network.
- The cyclical nature of home remodeling.
- If RH's lofty goals are attainable.
And as a tribute to Daniel Kahneman, we revisit his 2013 conversation with author Morgan Housel.
To catch full episodes of all The Motley Fool's free podcasts, check out our podcast center. To get started investing, check out our quick-start guide to investing in stocks. A full transcript follows the video.
This video was recorded on March 28, 2024.
Deidre Woollard: Home Depot's largest acquisition ever is all about the pros. Motley Fool Money starts now. Welcome to Motley Fool Money. I'm Deidre Woollard here with Motley Fool analyst Bill Barker. Bill, how is your Thursday going?
Bill Barker: It's going great, thanks.
Deidre Woollard: Well, one of the things that's happening today, an acquisition on a Thursday, usually we see them come in on us on a Sunday night. It involves one of my favorite companies, Home Depot. I got up and went to the computer. I'm excited about it, I'm interested in it. Let's talk about what it is. It's a company called SRS Distribution and if you haven't heard of it, you're in good company. Their spending reportedly $18.25 billion, biggest acquisition the company has ever made. SRS Distribution, what is it? Why is this appealing?
Bill Barker: Well, it's, as it declares in the press release, a leading specialty residential specialty trade distribution company working across professional roofing, landscaping, and pool contractor supplies. A healthy amount of the professional outdoor and roofing work goes through SRS. It's a segment of the market that is getting more interest lately, including from Bradley Jacobs, whose next venture QXO is going to be doing work and rolling up some of this very fragmented part of the market and expands Home Depot's already healthy professional services sales.
Deidre Woollard: Brad Jacobs, the only man who loves the letter X as much as Elon Musk. All of his companies seem to have an X in them. I want to talk a little bit about what this means for where Home Depot is going. They talked about expands the total addressable market by 50 billion. We all raise our eyebrows a little bit at total addressable markets, but there is something that's been happening with Home Depot recently. It hasn't been a great few quarters really for Home Depot and others because the home improvement market has stagnated.
I'm looking at SRS. It's got the 760 branches around the country. Home Depot has around 2,300 stores, so this seems like a really big swing to me. Home Depot, they hardly ever add stores. On the update call, they talked a little bit about maybe they add more stores because of this. But my question is, is Home Depot shifting as it goes more toward pros? Does Home Depot and Lowe's become less like each other as it goes deeper into this direction?
Bill Barker: To a degree, it's already been very heavily into the professional segment. You mentioned $50 billion increase in the total addressable market. That's now up to, I think a trillion, as Home Depot declares the whole addressable market for its services. It moves it by 5% and they've got some expanding sales opportunities. They are big, except in comparison to what Home Depot already does. Although the biggest acquisition, as you pointed out, it's not something that's transformative. It's additive at the margin and at the right margin at the place where Home Depot already has experience and can just have more buying power and serve more people and it probably won't move the needle a lot.
But since Home Depot is not in the adding stores business and hasn't been for, well, over a decade that money, all those profits have to go somewhere, they can go into buying back stock, they can go into dividends, they can go into acquisitions. If you're not going to grow your store count and they've grown the square footage of the existing stores, but this is one of the relatively few expansion opportunities that they would have if they're just going to be very happy at the store count they have.
Deidre Woollard: Yeah, and I think one of the things that's interesting here is you get a 4,000 truck delivery service here. Really you get a lot of it's less about driving people to the branches and far more about delivering to pros wherever they may be. Home Depot has made a lot of moves toward pros that I've found interesting. They've made portals for pros, for construction jobs, and things like that.
But the thing that I'm really starting to think about is the cyclical nature of the world. Everyone was spending on and is still spending on travel and we had spent on nesting during the pandemic than that was ending. Now, maybe we're hitting the start-up another cycle. It's too soon to say. One of the things I track, it's called the LIRA. Its Leading Indicator of Remodeling Activity comes out from Joint Center for Housing Studies at Harvard. They're saying this might be the last year of the Lowes. Do you think Home Depot is getting ready for an upswing in projects?
Bill Barker: Well, they're very long-term oriented so this is a purchase that is looking for decades. Going back to Brad Jacobs, this is an area that he's focused on. He sees opportunities in the same area. I don't know if it's been a modest cyclical downturn is certainly since the peaks of 2021. It's been a big fall off since there. But going back to pre-pandemic, the line tracks to where we are today, fairly normal growth. It's a cycle that they are more weighted toward the residential and do it yourself, a part of the cycle and so this smooths things out a little bit. But there's a big overlap between the professional services and the home-buyer aspect of the business. It mitigates a little bit of the cyclicality of the business, but it's pretty closely aligned.
Deidre Woollard: I'm going to take us in another direction, still in the home area, but we're going to level it up, folks. We're talking about Restoration Hardware, no, it's RH. Long way from that tiny little hardware store in Eureka, California. One of my favorite earnings calls, but just because of the hyperbolic nature of Gary Friedman, who I enjoy the way he talks. I'm not sure I believe in his vision. They missed on earnings and revenue, but the market got really excited because they're forecasting revenue growth of 8-10% year over year. This is a business that sales very expensive couches. They're building these fantastic experiential real estate places. I don't know. The market loved the guidance. I'm not sure, I believe it.
Bill Barker: No. I understand why you would say that because he does wander toward the hyperbole quite frequently. I think that one of the references was the most dynamic and transformative outdoor furniture supply there's ever been this season. Maybe, maybe not, I don't know that the entire outdoor furniture market is quaking at Restoration Hardware or RH's spring line, but if they are, then RH will do very well. He's a positive guy on a call and so I would take everything with a grain of salt. He's succeeded with a lot of optimism but if you think Home Depot is there, click all-tech, take a look at RH.
Deidre Woollard: Well, and also they're just spending so much money on everything, on building these estates that people visit that he thinks will sell furniture, and they're working on planes, they're working on yachts. The thing that piqued my interest, of course, it's about housing, is that he said that they're going to get into RH condos and homes. I don't know. I'm vaguely intrigued because the aesthetic is so interesting and he talks about, we're scaling luxury, we're bringing tastes to the American market. Is there a world for RH homes?
Bill Barker: We'll find out, I guess, I don't know. It's worth a swing, I guess at a small scale and they've taken some big swings with membership models, and that's worked out well for them. I just think the company is cyclical on steroids, like when things go well, they are going to go very well for RH, and when they slow down, they're going to be taken down more than the next guy, particularly as they operate in the high-end.
The high-end American consumer is doing pretty well right now. Stock market is supplying people with more funds, more confidence in the near-term future. I imagined it's going to be a good season and they did increase their guidance. But if you look longer-term taking say this year's expected sales and comparing that to pre-pandemic, there has been about 4% growth. There was the huge surge, a huge pull forward, and now a couple of steps back, go longer-term over the last 15-20 years. It has grown top line about 8% a year. Keep those numbers as better guidelines for how to value the company than the most recent quarter and the most recent guidance.
Deidre Woollard: I think that's interesting. I think the other point here is this isn't a business where you're not buying a couch every year. I think there's also a long span in-between and I think that's something to watch as well.
Bill Barker: It depends on how many dogs you have. I know that our couches go faster than most because of the multiple dogs, but hopefully, most people there aren't suffering rip, frequent couch turnover the way some of us are. Certainly not yearly.
Deidre Woollard: Not if you're spending RH prices, you're not. You're keeping the dogs off the couch at that price.
Bill Barker: We've got an outdoor item from RH. The dogs spend a little bit of time on it, but they're not damaging that one too bad. I think it's cyclical people who, as you said, they don't buy a slightly better couch every year or add to the existing couch that they have. But there are times when various macroeconomic events lead people to spend more on their houses that they're already in or move and that leads to a lot of new furniture sales when people are moving, that's been stuck a little bit as the interest rate situation has not led to a lot of home turnover lately. When that loosens up, that's going to be good news for RH. They seem very positive, even though they miss their numbers for the quarter, and this is another example of the fact that the believed future is more important many times to a stock's price than the observed past.
Deidre Woollard: Very true. Thanks for your time today, Bill.
Bill Barker: Thank you.
Deidre Woollard: We talk about a lot of stocks on the show, but it's just a peek at the Motley Fool's investing universe. This year we're rolling out a new offering. It's called Epic Bundle. The service includes seven stock recommendations every month, model portfolios, and stock rankings, all based on your investor type. We're offering Epic Bundle to Motley Fool Money listeners at a reduced rate as a thanks for listening to the show. For more information, head to fool.com/epic. We'll also include a link in the show notes for you.
Yesterday, Daniel Kahneman, a founder of behavioral economics, passed away. As an academic, Kahneman was highly decorated.
He was the author of the best-selling book, Thinking Fast and Slow. A professor at Princeton and Nobel Laureate and a recipient of the Presidential Medal of Freedom. Kahneman was a psychologist first, his research exposed mental biases like loss aversion and challenged the economic idea that humans are fully rational actors. Today, as a tribute to the man and the thinker, we're playing an excerpt from a 2013 conversation between Kahneman and Fool contributor, Morgan Housel. We hope you enjoy it.
[MUSIC]
Morgan Housel: Daniel Kahneman, you won the Nobel Prize in economics, but you're not an economist, you're a psychologist. From what I understand, that's the first time that's ever happened in that award for economics, and to me, that's a confirmation that so much of what is important in economics and in investing has less to do with numbers and spreadsheets and Greek formulas as it does what's going on in our head and fooling ourselves.
Just to get a background of your career, from what I understand, the first time that your work intersected with economics was in the early 1970s. When a colleague brought to you and economics paper and the first line in the paper was, "The agent of economic theory is rational, selfish, and its tastes do not change." Which for a psychologist, that's ridiculous. So what happened next?
Daniel Kahneman: Well, nothing happened immediately, but I find that very surprising actually because the economics building was next door. I was at Hebrew University, Jerusalem, and we had one building and economists were next door, and I learned from that one sentence, something I had known before that they lived in a different intellectual world than we did. I know for a psychologist, it's obvious that people are not fully rational, and that they're not selfish, and that they have taste change. It was just a collection of statements that seemed almost absurd, and I had no idea at that stage that a lot of my career would be dedicated to that conversation. That happened almost by accident later.
Morgan Housel: Let's talk a little about your book, Thinking Fast and Slow. The theme throughout the book is that there are two types of thinking, fast and slow, system 1 and system 2. Tell me about the difference between the two.
Daniel Kahneman: Well, fast thinking is as I think most of the way that we think, it's what your memory delivers to you. You start talking and you talk, you don't have to deliberate about one word and then the other. You walk, you don't deliberate, and decide to put one foot in front of the other. Most of what we do comes automatically. Most of what we do is highly skilled and emotional, and some of it is emotional, much of it is highly skilled, and all that is automatic. There's just an awful lot of automatic stuff that goes on.
Then there is a system 2. If I say 2+2, a number came to your mind, that's system 1. If I say the relationship between China and Japan, now it's not one word that came to your mind, but a whole set of words, a whole set of ideas. I mentioned that you were thinking islands, you were thinking war, you were thinking Navy's. You might have been thinking about the history of China and Japan, a lot happened that you will know it happened at once. Those are not explicit thoughts, but you are ready for a whole topic as soon as I mention something, that's system 1. I mention the word mother, your mother. You're having an emotion, that's system 1.
There's an awful lot that system 1 does. System 1 has judgments and opinions and attitudes and impressions that are generated. They're generated like when I said think of China and Japan, that a whole lot happen at once, you were not conscious of it all at once, but your mind was getting ready with it. That's the idea that there is that thing going on in our minds silently. Then you have system 2, and system 2 is the effort for one, and it depends on the allocation of attention. It's what we are paying attention to mostly, and it's involved in computations, it's involved in difficult decisions.
It's involved in controlling ourselves and not telling somebody to go to hell, that demand system 2. It's all part of that effort forces. What's the relationship between the two of them, and that's the interesting part. I compare that and maybe that image. It's not in the book, but I now wish it had been. I compare it to a newspaper room. You have the reporters and they're writing stories, and they're interpreting the world. Then you have an editor. In my story, the editor is lazy and is badly overworked. What the editor does mostly is endorse the stories and send them to the printer. Now, occasionally, the editor will stop a story, think more slowly, assign it to another reporter, or altogether stop it
Like not telling somebody to go to help. Now, if you look at what the product is, the newspaper is really written by the reporters. Now, it's not that the editor has no role. It's not that the editor is very important figure, but the newspaper was basically produced by the reporters. So that's the theme, one theme of the book is. Basically, it's not that the editor produced the newspaper. The editor is to a large extent in the business of endorsing emotions and responses and impressions that come from somewhere else.
The editor also is in the business of defending what's in the paper to the public. So here whether it's a story and endorsed it without really thinking about it, but now there is flak about it. Now, he's asked, why did you publish that story? He's not going to say, well, I just sent it into the printer, he's going to find a reason for why that story. And that's the way our mind works. We believe the thing that we believe, and we have opinions that we have, not so much because we have reasons for them.
If we had reasons for religious beliefs and people are trained their religious beliefs, if we had reasons for our politics, we would change our views in arguments. I don't want to say that nobody ever trained with their minds, but people really trained their minds. And that's because our beliefs comes from somewhere else. We believe the arguments that are compatible with our beliefs. It's not that we believe in things because we have the argument for them. So a lot of things, system 1 comes first, system 2 endorses and rationalizes. That's a big theme in the book is this view for the mind works.
Morgan Housel: Is system 1 my gut and system 2 is my head? Is that a fair way to put it?
Daniel Kahneman: System 1 is extraordinarily clever. System 1 knows about the world and then your knowledge about the world, all your skills are in system 1. You drive without paying attention, that's system 1 because you have learned to drive. You maneuver social situations without getting into too much trouble most of the time, that's system 1, and it demands a lot of alertness to cues. To say system 1 is the gut, that's addressed that there is no thinking there.
The best thinking we do with system 1, creativity, stuff that comes from your memories and that's in system 1. It doesn't work the way we think it works. But it's not the amount that system 2 is more elevated than system 1. Actually, I don't want to say that the reverse, but system 1 is much better at what it does. Then system 2 is good at what it does. That is, the automatic memory system really does an awful lot of stuff very quickly.
Morgan Housel: You've written about hindsight bias with the financial crisis in 2008. What can you tell me about that?
Daniel Kahneman: Well, there's something I actually find shocking. They're now quite a few people who say, I knew it was going to be a crisis. I think that's perverse. It's a perverse use of the word know. That's because we use the word know for something, you know, when I believed in something and my belief was true, those are the two conditions under which we're allowed to say the word know. I believe that with very high confidence. But in fact, they didn't know that there was to be a crisis.
They thought there was going to be a crisis. Then there was a crisis. Then all of a sudden they knew it was going to be a crisis. But there were people who would just a smart and as motivated and so on, who didn't think that was going to be a crisis. What is very important about this is whether you conclude that the crisis was really knowable. Given the number and the quality of the people who fail to see it. The fact that there are many people now who are sure that they knew it doesn't convince me. I think it wasn't knowable. It was much less knowable than we tend to think because of the ease with which we can explain it. Everybody who didn't predict it looks blind. In retrospect, that's hindsight.
Morgan Housel: If we suffer from hindsight bias and we think that the past makes sense and it was predictable, does that make us more optimistic about the future? If we think we understand the past and we have to think we understand the future.
Daniel Kahneman: Yeah. It makes us way overconfident about a knowledge of the future. Overconfidence is everywhere. That's if you are going to pick among the biases of judgment, then thinking that we know when we don't, that's a big one. Thinking that we control things that we don't is another big one. So optimistic overconfidence accounts for a lot of the mistakes that are made. In the financial context, there was a really frightening study that was published a couple of years ago. It shouldn't really surprise you and maybe it won't.
But here is the way it goes. There is a study being conducted at Duke, I think for many years now, where they pick the CFOs of, I think the biggest 500 companies. They send them a questionnaire every year. It has a lot of questions, including forecasts. One other thing that they're asked to forecast is they're asked to set up an 80% confidence interval for the S&P 500 over the next 12-month. They have thousands of those judgments because many people come year after year. In the first place, they have no idea what the S&P is going to do. The correlation is negative between their judgment and what actually happens.
It's barely significant, it's nothing. They have no idea. The thing that's worse is how overconfident they are. So when you set an 80% confidence interval, if you are at least aware of how ignorant you are, and you do that many, many times. Then 80% of the time, the truth will fall inside your confidence interval, and 20% of the time it will be surprised. In fact, pretty sure that I have that correct. They have not 20% surprises, they have 67% surprises. They have no idea, and their confidence intervals are way too narrow. Now, let me tell you what the true confidence interval ought to be for the S&P 500 because I asked the authors of that study to compute it.
For somebody who has no idea looking, at the last decade or so, that was not counting the last two years. I think I had that computation done in 2011. Somebody who doesn't know anything about the S&P 500, and that's everybody. Should the correct confidence interval, there is a true answer to that. The correct confidence interval that the S&P the 80% probability is going to grow between minus ten and plus 30. What's striking about this, that this sounds, you are saying nothing. And it is saying nothing because you'd know nothing. That's where the confidence interval ought to be. If you know nothing and you know that you know nothing. But those CFOs don't know it.
Morgan Housel: To put it in a practical sense, what are some things that I can do and everyone else can do to help live a better, more fulfilling life based on some of the stuff that you've.
Daniel Kahneman: I would say there are a number of things actually that you can do. One of them is, we do tend to neglect our experiencing self. I think we do too much to build up a resume and I don't mean that in a narrow way. The resume, what I mean by that is each of us as a story, has a narrative. The narrative of our life. It's our prized possession and we do a lot to keep it looking good. And we may be doing too much for it. There is also a matter of living, living your life. And they're all decisions that you might make differently. For example, in the life-work balance, there are decisions you might make differently if you're thinking of the experiencing self. Not only of accomplishments and goals and things like that.
Deidre Woollard: As always, people on the program may have interest in the stocks they talk about. The Motley Fool may have formal recommendations for or against, so don't buy yourselves stocks based solely on what you hear. I'm Deidre Woollard. Thanks for listening. We'll see you tomorrow.
