A few weeks ago, Industry Focus: Financials host Gaby Lapera shared that her New Year's resolution was to buy five new stocks, one from each sector on the Industry Focus podcast.
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This week, she's interviewing each show's host about which stocks from their sectors they think are good candidates for long-term investors. In today's Tech episode, Gaby talks with tech experts Dylan Lewis and Sarah Priestley about Shopify (NYSE: SHOP)and Facebook(NASDAQ: FB).
Find out what both companies do and how they make money, what makes them such compelling buys for long-term investors, some of their most important risks to be aware of, what investors should know about their growth horizon before buying in, and much more.
A full transcript follows the video.
10 stocks we like better than Facebook
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This podcast was recorded on Feb. 10, 2017.
Dylan Lewis: Welcome to Industry Focus, the podcast that dives into a different sector of the stock market every day. It'sFriday, February 10th, and we're talking tech, anddesperately vying for Gaby Lapera'sapproval. I'm your host, Dylan Lewis,and I'm joined in the studio by Fool.comtech editor, Sarah Priestley, and the host of the Financials show, Gaby Lapera. So, Gaby,pretty awesome to have you on the show. I haven't done --I don't know if Sarah has --anything with you before. Do you want to give people a little background on why you're here?
Gaby Lapera: Yes. My name is Gaby Lapera,and I don't own any stocks. This is where you say, "Hi, Gaby!"[laughs]
Lewis: Hi, Gaby. This is yourconfessional?
Lapera:I don't own any stocks,and that's kind of pathetic for someone who has worked at The Motley Foolfor a whole year and a half,almost two years, a year and three quarters. So,I made it my New Year's resolution to buy five stocks,one for each sector Industry Focus. Originally, I was going to talk to you guys off the air, and be like, "Educate me about your sector." But thenwe decided, why not do it live? So here we are. But I want to remind our listeners thatthis is not personal advice for me. Dylan is not going to say, "Hey Gaby,I know you like to slack off at work,so I'm pitching youFacebook."
Lewis: Thatwould totally makesense, though. And, yes, I am picking you, Facebook.[laughs]
Lapera: So,this is more just, stocks that they like,potentially that they already own,and they think that everyone should have a little think about. This isn't personal advice for you,because Dylan probably doesn't know you. Maybe he does, probably not.
Lewis: Probably not.
Lapera: Sarah might know you. She knows more people.
Sarah Priestley: Potentially.
Lewis: Sarahhas her eyes everywhere.
Lapera: Yeah, so,keep in mind, no personal advice. We also have some disclosure stuff thatif you have listened to every other show this week,you can probably fast-forward the next 15 to 30 seconds whileI tell you about it, because it's the same stuff you've heard onevery show this week so far. TheMotley Fool has a disclosure policy,and we must publicly disclose if a contributor has aninterest in any of the stocks mentioned,which is any of us on the show. Additionally, Fool employeeswork under trading restrictions. We must hold stocks for at least 10 days,because we are not about that day-trading life. We also cannot write about a stock in the period of two market days before to two market daysafter purchasing or selling the stock,which means that no one on this show has purchased or sold any stocks that we'regoing to talk about today. Not a shock for me because I haven't bought any stocks yet. But very good on you guys for exercising self-control.[laughs]
Lewis: One of the things,before we get into the stock discussion, thatI thought was really great about this week --I don't know if you listen to the episode I did with Michael Douglass about New Year's resolutions,but we talked about the idea of having an accountability buddy on your resolutions. You, whether you realize it or not --
Lapera: I have 10.
Lewis: Ten, yeah. So,that was an expertly crafted resolution by you,because you basically outsourcedall of the motivation to other people.
Lapera:Oh, no,I am an expert at that. That's management tier.
Lewis: So, if you're struggling to set up your resolutionseven now or you're wondering how to get them done, take notes from Gaby Lapera, whomanaged to rope in 10 peopleto help her out with her stock buying decisions for 2017.
Lapera: I'm just very well liked around the office.
Lewis: I guess so. This is going to be a fun show. I think the idea of doing a theme week andhaving analysts pitch stuff is really awesome. To get us started,I think Sarah is going to go first in talking aboutShopify.
Priestley: Yeah.I am very bullish, like a lot of Fools here, onShopify. I would like to give you a little bit of background about the company andtell you what they do.I apologize if you already know.
Lapera: No,I don't actually. Tell me what they do.
Priestley: Shopify IPO'd in 2015 for $1.27 billion. Their current market cap is $4.9 billion, so,still pretty small. Thecompany was founded in2006 by Tobias Ltke . I think that's how you say his name. I'm very sorry if that's not how you say his name.
Lewis: That sounds right.
Priestley: So,he is now chairman and CEO,but originally the company was founded as a snowboarding company. Butthey found they couldn't find anyonline store software that would work for smallcompanies at the time. You're talking around 2004, remember if we can. It was all for big companies that wanted toestablish an onlinepresence. There was nothing that was custom tosmall companies. So, they discovered this glaring hole in the e-commerce market, and they believed that future businesses will becreated onlineand almost online only. And obviously,that was pretty futuristic of them. That's exactly what we have now,if you look atEtsyand a lot of other companies. So, in 2006, they launched Shopify. Ltkedescribed Shopify as the only platformyou need to build your empire. I would say, given their offerings,that's pretty true. The company has325,000 merchantscurrently using their platform. There's mostly small and medium businesses, but there's some bigger names that you'llrecognize. There's someAmazonweb stores,Tesla,Johnny Cupcakes... Does anybody know them?
Lewis: The Boston chain? Yes! I know Johnny Cupcakes,having spent five years in Boston.
Lapera: Thatsounds like a mob member.
Lewis: Well, they're T-shirts, but also, it's kind of a cupcake place, too? It'ssomething like that.
Priestley: I know the way that they present their T-shirtsis that they wrap themand they give them to you in a cupcake box,which I think is pretty cool. If they do cupcakes,I will definitely sample them, too.[laughs]
Lewis: Yeah,that's a very popular joint on either Boylston or Newbury Street, but one of the main shopping strips in Boston.I don't know if they have any other locations.
Priestley: I'm there next weekend.I'll check it out.
Lapera: I'm not kidding. Johnny Cupcakes sounds like someone who will whack you.
Lewis: We'lltake you out through the back, go see Johnny Cupcakes.[laughs]
Priestley:Wikipedia Shop also uses them, and theLos Angeles Lakers. But the important thingwith this is that when you goon to these sites,you would not know that you are using the Shopifyplatform, and that's completelydeliberate. Shopify says, "Our job is to make our merchants look their very best inevery interaction they have with their customers," andI would say that's completely true. When you go on their sites,you have no idea. It's not branded with Shopify. They're giving merchantseverything that they need behind the scenes.
So,what do they actually do? It's a cloud-based platformand it allows customers to add to the functionality that they need to sell onmultiple platforms, so, web, mobile,social media, Facebook,Twitter,Pinterest, and even physical retail locations. They offeranalytics in real time, and they really offer aplethora of things, but I'll just touch on a few. Sales analytics by channel and customer,Inventory management,discount and gift cards,order processing, customer management --so, this is really data tilling to better understand your customerpreferences and build relationships -- and,importantly, payment processing. In the U.S.,Canada, the U.K., and Australia, that'sfully integrated with their platform. ThinkPayPal,Square, those kinds ofcompanies. And where it's not available, or the company has apreferred payment processing partner likeVisa, whichI'm sure you're very familiar with, theplatform connects with those payment gateways seamlessly.
You cando it all by yourself if you're a merchant. You can set up online. Desktop and mobile,they have 150 customizable storefrontdesigns, and they are optimized for SEO and social media. They also servephysical locations with point of sale. You get all the sameintegration with allof the analytics that you would if it was online. So, yeah,they make it super easy for you to operate as a small to medium business and grow to be a huge business, too.
Lapera: That was,I think, one of the most coherent stock pitches that I havereceived.
Lewis: I really regret letting Sarah go first.
Priestley: You'rebeing too nice.
Lapera: Doyou want to tell me about your company? I don't know if I need to hear about it, but...[laughs]
Lewis: [laughs] Before we get into my pitch on Facebook,why don't we talk a little bit about some of the things that Sarah likes about Shopify?
Priestley:The crux ofmy argument on Shopify is basically thatit's a really comprehensive platform. So,you can grow from being a tiny start-up to a multi-billion -- no, multi-million.I'm pretty sure they don't have any billion dollar companies on there yet. But, theycompletely offer everything, and thatcradle to grave functionality is incredibly rare, and I would say that is,probably, their biggest competitive advantage. The company is yet unprofitable,and that's something that you really need to bear in mind. If you invest in them, you'reinvesting in their growth story. They intend to grow in two ways --that's to grow the number of merchants that they serve, and togrow the amount of revenue that those merchants transact.
The last one is long-terminstrumental to their successbecause it's symbiotic. If they can offer their merchants this full suite of products tomake them successful, their ecosystembecomes super sticky,the customers are unlikely to leave. And as they grow, Shopify grows,which is the perfect recipe. So,Ltke isaware of this, and he frequently references investments to help merchants sell better. You often hear this, "meetmerchants where they are" or "meet customers where they are." This is thedefinition of this. He says they have launchedApple Pay, [...] Messenger,and a brand-new Shopify app that lets merchants set up and run theirentire business from their mobile phone. Andthis is what they've done recently. So,all these investments are tobolster the offering,continually, that they have for their customers, and tostay ahead of the game.
Andas far as the opportunity to grow their base, theiraddressable market is absolutely phenomenal. According to a 2014 survey --that sounds outdated, but it's the most comprehensive recent study --there were 47 million small-to-medium businesses globally, and 10 millionoperate in Shopify's core markets. So, bear in mind,they have a little over 325,000 merchants right now. That is a tiny fraction of their potential market, in a really growing space. The e-commerce space grew 11% in the first half of 2016. Experts estimate that in justthe holiday season, e-commerce is going to grow by 11% to almost $100 billion.
Lapera: That's crazy.I saw a study the other day saying that for every $4 spent inAmerica, $1 is spent on Amazon in America.
Priestley:Amazon is the top dog in this arena, and Shopify is, I guess, acompetitor for them, even though they share some similarities.
Lewis: Andactually, foras much as we think about e-commercebeing pretty ubiquitousand something that we interact with all the time --I mean, I order stuff off of Amazon all the time -- itspenetration is actually fairly low,especially worldwide. I think it'ssomewhere in the single digits or very low double digits. This is still, in a lot of ways, a trend that has a huge runway.
Priestley: It really does. And I feel like we're in the kind of cycle where small-to-mediumbusinesses are being empowered,people are focusing on craft. If you look, Etsy, Pinterest, and those kinds of smallorganizations that are really fostering individual entrepreneurs, it's all workingtogether. And I really feel likeShopify has the platform,as you can see,Teslahas their storefront with them, they can go all the way through thespectrum of different business sizes. So, personally,I think that what they offer is really compelling. And they increased theirnumber of merchants 60% year over year last quarter,so obviously there's a lot of people that agree. Theirmerchandise volume 100% increaseyear over year. They're making somefantastic momentum.
Lapera: Are there problems, Sarah? Tell me the truth.
Priestley: There are problems.
Lewis: Youwant to talk problems now? Ordo you want to talk problems at the end?
Priestley: I can talk problems at the end. I want to give you your moment in the light.[laughs]
Lewis: All right.Gaby, second half of the show.
Lewis: It ismy turn to wow you. I don't know if you've ever heard of this company...
Lapera: [laughs] OK.
Lewis: ... it'sFacebook. Formerly The Facebook.[laughs] But I'm guessing that you and many of our listeners arefairly familiar. For anyone who isn't,Facebook is basically the umbrella company fora bunch of different social platforms.Facebook, their namesake one,being the main one,but also Instagram,Facebook Messenger,another one of their main properties, andWhatsApp. So, really,this is a company that's looking to connect to people, buildonline engagement, create these communities andplatforms where people can exchange content,exchange ideas, connect with each other. Theyfinance all of that through advertisements. That's how they make the bulk of their money. So,if you want to look at how the numbers break down for them,advertising makes up 98% of the company's revenueas of the most recent closed quarterearlier this month. Within that, mobile makes up 84% of that revenue, and that's up 80% year over year. To give you an idea of the growth rate --because this is a business that's kind of in a little bit of a different phase thanShopify -- they are, at this point, just under a $400 billion market cap company. Shopify, for comparison, is a $5 billion market cap company. Facebook posted Q4 year-over-year growth, revenuewise, of 51%, and on EPS (earnings per share), was 124% growth.
Lapera: That's incredible. So,Warren Buffett --oh my God, I can't believe I'm doing this.
Lewis: Do it!
Lapera: I complained about, onevery single show, someone said something about Warren Buffett, and now it's me.
Lewis: I heard you do that, so I intentionally wanted to leave him out of this discussion. Not thathe would ever invest in Facebook.
Lapera: (groans) See,I love Warren Buffett. He's a nice guy. He actually lives inNebraska. I lived near him at one point.
Lewis: You guys werepractically neighbors.
Lapera: I drove past his house one time. But, no,Warren Buffett, one of the things that he talks about is,when a company gets really big,it's really hard for them to post astronomical growth. Andthat's pretty astronomical growthfor a company that's really big already.
Lewis: Yes. Those are gaudy growth rates,and I think in the future, those will come downa little bit. We can talk about some of the reasons for thata little bit later on. But a lot of the reasons that I really like them as a company isin spite of the fact that they are already a $400 billion market cap company,roughly, they have a ton of growth coming their way, and there'sa lot to really like with their business. So,I mentioned the revenue and EPS growth. But,if you look at their namesake platform, last quarter Facebook recorded 1.86 billion monthly active users,1.23 billion daily active users. That's good for17% and 18% increase year over year. So, think about the denominators that those are increasing on,it's kind of crazy. Also, to put the number in context, there's about7 billion people in the world, abouthalf of them have access to the internet, andabout half of those people are on Facebook monthly.
Lapera:Wealso tape the showson video, if you ever want to see what we look like, Dylan'seyes are twinkling right now.[laughs]
Lewis: Yes.I get excited.[laughs] But,the point with that is, what really drives a business for them isusers coming onto the platform, so growing that user base,and having them spend more time on the platform,because those two metrics allow them to have more adsappear in people's feeds. So, when you see abusiness that already has a user base in the billions still adding moreat a double-digit clip,I think that's pretty impressive. If you want to look at some of the growth opportunities for them with users,I think there's still some pretty big potential in the Asia-Pacific andrest of world regions. Mostrecently, those were up 25% and 19% year over year. So,a lot to like there. I will caution that,in terms of the average revenue per user for those regions, or the value of those users, the strongest markets adwise are U.S.,Europe, and Canada,because the consumer buying power is the strongest there,so the ad rates are commensurate with that. So, thosemight not necessarily bethe same value in average revenue per user, but there's still a very long runway in alot of those markets.
Beyond Facebook's core platform, though,one of the other reasons I really like the business is the scope of their properties andsome of the opportunities that that opens up for them.I mentioned that they haveFacebook, WhatsApp, Messenger, andInstagram. Facebook, WhatsApp, and Messenger all have over a billionmonthly active users. Instagram has over 500 millionmonthly active users. And a lot of those platformsbenefit from what we call in tech thenetwork effect. I don't know if this is something you're familiar with, Gaby,but the idea is, aseach property grows, the value propositionfor that property to users isstronger, and it's more compelling to non-users. So,if I'm on Facebook and Sarah is on Facebook and we're twobest friends, you're probably going to want to join Facebook.
Lapera:That's true,that's how I ended up on Facebook,that's exactly what happened.
Lewis: Ifthat's how we're all communicating, if that's how we're all posting pictures. Exactly,you just get sucked into it. That's something that you enjoy when you have those critical masses of userslike they have on all these different platforms. Something to be kind of excited about is, when welook at the company's financials here, really,Facebook and Instagram are the two properties that they monetize. So,I think we are more or less at full monetization with Facebook. There will be growth, naturally, with user base growth. Butin terms of ad load, we're kind ofat the saturation point there. Instagram, they'restill rolling stuff out. There's still some ramp there. But with WhatsApp and Messenger, they'restill in really early days. And those are properties that have, combined, 1.5 billionmonthly active users. So, if they can crack that nut andunderstand how to monetize those users effectively,I think the growth runway is fairly long for those otherproperties. So, I think that's something to like.
Thelast thing that I really love with this business is they're managed in a very Foolish way.Mark Zuckerberg and Facebook's management really likes to think with a three- to 10-yearoutlook and approach. They're very good in theirquarterly calls about keeping investors in the loop about what the priorities are for that roadmap. Mostrecently, they talked a little bit about three years,looking to improve and expand the community they have continue to grow users, andcontinue to double down onpushes like live video,things that will engage people in their feeds,get people to come to the platformand interact with them more. Five years out,the main priorities, and,over the next five years is how you can think about that, Messenger and WhatsAppmonetization,doing some more work with video and search,things like that. And more broadly, in 10 years,I don't know if you've heard about internet.org,it's anon-profit that's largely funded by Facebook. That wholenon-profit is aimed at growingaccess to the internet worldwide. LikeI mentioned before, there's about three billionpeople that have access to the internet of seven billionin the world. Obviously, there's a lot of benevolence towanting to make the entire world access the internetand have all the information and agency that enables. Asthose people come online, there'salso the element of, well,they're probably going to be fairly familiar with Facebook. So, the 10-year plan for them is tocontinue to grow access to the internet and bring those people into their ecosystem as they do. Some of theother stuff that they're targeting,which is a little bit farther afield from theircurrent businesses but could be really interesting down the road, isinvestments in artificial intelligence. Right now, a lot of that is being used to tailor their news feeds and reallyprovide people with the content that's most relevant to them. Then, they've made somesplashes into virtual reality. I don't know if you heard about the acquisition ofOculus a couple years ago?
Lewis: Well,it's a little different than what they typically do,getting into hardware and virtual reality. I think the market there isn'tnearly as clear, andit's not really certain what the opportunity will be, or whatadoption might be for consumers. But that's another field that they're playing in. Withall of this long-term thinking, at the end of the day,it's going to be Mark Zuckerberg's show to run. Thecompany and management has been very clear insetting themselves up so that he willmaintain his controlling stake in Facebook. A little while back, theyannounced that they wanted to do at 3:1 stock split. What that will basically do is giveexisting shareholders two class C shares for every A and B they own. The class Cs will be non-voting, andZuckerberg will be able to give away, via hischaritable efforts, the C shares, and maintain his super-voting B shares and control of the company. So,you have a management that thinks long-term, and you have thecorporate set up where they are going to be able to continue to think long-term without reallyhaving to worry about any major shareholder coming in and pushing them around. So,I really like that as well.
I've beentalking quite a bit,so I think maybe, it might be time for us toopen this up a little bit, talkconcerns or any questions that you may haveabout some of these businesses.
Lapera:I have questions. I have so many questions. And if you guys think of any questions for each other while I'm talking,feel free to jump into the fray.I think it gets boring when one person talks for a really long time.
Lewis: Yes,I can take a hint.[laughs]
Lapera: [laughs] But, no. Sarah, Shopify versus Etsy, can you explain the difference to me?
Priestley:Etsy is amarketplace platform. Think about eBay, but more specifically niche tocraftsand things like that. So, essentially, you rent a store or you have a store, and theytake a percentage of the transaction. This is completely differentin the sense that Shopify iswhat you would have if you wanted to have your own brand.
Lapera: So, you'rehosting your own content.
Priestley: You'rehosting all of your own content, it keeps youcomplete control, you can track your sales, you getall of that back-end facility, and it's the payment processing, too, whichis actually kind of tricky for companies to establish by themselves. There's a lot of fintechcompanies coming into the space now, as we know, as you knowprobably better than us. But, yeah,that's probably one of the key things the company offers.
Lewis: And,actually, on that point,I think there might be a lot of people who test out early concepts for craft-oriented businesses or niche businesses within Etsy, and then realize that there's traction there, and then switch over to a Shopifybecause the offering is stronger and they want to be able to build themselves out in theirinternet presence.
Priestley: Theother thing that Shopify does is they have a buy button.I don't know if you use Pinterest or Etsy, but there's a buy button, even on Twitter. AndShopify embeds those, and that's another thing that they offer.
Lapera: Another question: DoesShopify take a percentage of the sales, or are they just making money onlicensing fees?
Priestley: No,they take a percentage of the sales. Thattransaction volume, they'retaking a cut of the transaction volume.
Lewis: So,that's a business that scales as the customers succeed,which is nice. You have the growth of acquiring new vendors,but you also have, as those vendors scaleand become increasingly larger businesses, them enjoying the business success as well.
Priestley:That's the merchant solutions revenue. That's fees from sales, and that was up 115% last quarter.
Lapera: Last question:Remind me of someone, a customer, that uses Shopify.
Lewis: Gaby is punching Tesla into her computer.
Lapera: I am looking them up. There's a shop button,which I just clicked on. You can buy a very sexy leather jacket andcharging accessories.
Lewis: It'spretty slick.
Lapera:I would have no idea that Tesla didn't make this themselves.
Priestley: Absolutely,and that's the whole point. The whole point is, they're empowering merchants. And they're reallymaking it hard to leave,because it would be difficult for customers to move away andreplicate that exactly as it was before.
Lapera: Thatinteresting. I wouldn't have expected Tesla to rely on a third party. It'snot like they don't have the tech expertise to make it themselves.
Priestley: Yeah, but it can save companies a huge amount. One of the reasons thatShopify is unprofitable is stock-basedcompensation. The reason that a lot of techcompanies use stock-based compensationis because they don't have much money at the time, and they use it to attract talent. Anda lot of that talent is developers and tech people. So, ifanybody out there is about to make their college choices,think carefully about the tech space. So, yes,that's one of the things that use, andif a company can outsource, essentially. Andit really is pretty idiot-proof. I mean, bless him, my husband set up --[laughs] no, I'm kidding. He's very intelligent. Butit's a very easy platform to use. And if they don't have to hire somebody to do that, that's a cost saving on that point.
Lewis: Shopify'stag line could be "let us do the share-based compensation for you."[laughs]
Priestley: [laughs] It really could be.
Lapera: That'sreally funny. I haddinner with a friend last night, and she was saying that she has been offered a job wherea lot of it is share-based compensation, and it's for a company that hasn't had an IPO yet. And it's like, "Well? What do you do there?"
Lewis: Do you like their prospects?
Lapera: I don't know. I think it's actually a companythat you have probably talked about.Uber.
Lewis: Interesting. We will couch that for another episode.
Lapera: Anyway. I mean,we could do a personal finance crossover episode, Should You Accept A Job With Share-Based Compensation?
Lewis: It could be something for Motley Fool Answers.
Lapera: Thatwould be a great idea. Questions for you now. Unless you have any questions for Sarah?
Lewis: No,I'm not going to cross-examine her.[laughs]
Lapera: You said98% of the company's revenue comes from ads. Is that a problem with peopleincreasingly using ad blockers?
Lewis: Itdepends. When you look atdesktop traffic, yes. That said, avery small portion of internet browsers use ad blockers. But I personally use Adblock Plus, soa lot of ads that would be popping in,whether they be throughGoogleor through Facebook, don't appear. But,when we're talking mobile and the shift to mobile, andI talked about how 80% of their ad revenue was coming in viamobile at this point, because people arecoming to Facebook on mobile via the Facebook app, that is a walled garden that mobile ad blockers cannot get into. So,that is not something that is impacting most of that traffic. Andbecause general consumer trends are pushing that way,it's not something that I'm super worried about.
Lapera: Interesting.I had not thought aboutmobile ad blocking it all. I'm not sure how that would work in the ecosystem of your phone.I do have a question about, you talked about them expanding, how they only have a seventh of the world's population using their platform. But there are countries where there is no Facebook. China,for example, they have their own social media platforms. Do you think that would be a problem in any other setting for theirexpansion? Do you think they would just buy those companies?
Lewis: No,I think that's a legitimate risk. One of the things that,in addition to these regional upstarts that we have, the idea ofdemographic shiftsmaybe pushing people out of Facebook,or having them not come in to Facebook, issomething that I'm a little worried about. I think about how, Facebook has been in the U.S. for 10 years at this point. In the tech world, that's aneternity. That's a long time. You think about how youmight have looked atMyspaceor something back in the day and been like, "Ah, I'm not a part of that," and instead gone to Facebook. I think there's the risknot only internationally of their beingmore entrenched platformsthat are specific to certain countries, maybe, and have really great traction there, but I'ma little bit more worried aboutpeople that are coming onto the internet now, younger folks, maybe early teens,looking at the offerings that are out there in the social networking world and instead deciding to go with maybe Snapchat, rather than going to Facebook, because they see Facebook as this old, dowdy --
Lapera: It's an old person thing.
Lewis: -- internet relic. Like, "Oh,my parents are on Facebook, I don't want to be on Facebook."
Lapera: Mygrandma is on Facebook.[laughs]
Lewis: Both my parents are on Facebook.I'm not friends with my dad. Interesting.[laughs] But one of the things I'm really excited about with that is, Snap will be going public. So,we will be getting some color on their business andcustomer acquisitions,hopefully. You can watch those two track each other. Tomitigate some of that, Facebook has beenpretty good recently about bringing in Snapchat-style functionality.
Lapera:Like Facebook Live, right?
Lewis: Kind of.
Lapera: Is that a thing?
Lewis: Facebook Live is a thing.
Lapera: I'veseenthat advertise on bus shelters.
Lewis: Yes. They arepushing that like crazy. But the Snapchat-style functionality ofstories and little posts andthings like that that are disappearing, that is...
Priestley: [laughs] Who does that remind us of? I don't know...
Lewis: [laughs] Yeah, right? That is beingbrought to the Instagram and Facebook Messenger platforms. So, I think they're seeing what resonates with people and bringing it there as a point to attract them to these platforms. That was a roundabout way of answering your question.
Lapera: No, that was a really good answer. Thatmade me think about things that I hadn't thought about before, so I really appreciate that. Mylast question is actually about internet regulation. This is for whoever wants to answer it,I guess, but you made me think of itwhen you were talking about the 10-year plan toget more people on the internet. In the past and likely again, there have been bills that talked aboutinternet throttling and stuff. That could be a problem for online businesses. What do you see? Do you seepotential future regulations as a problem? Do you think we're moving away from that as a society? This is a touchy-feely question, I know,but I'm interested in hearing your opinions on this.
Lewis: WhenI think about regulation and Facebook's 10 year plan, I tend to focus on the netneutrality side of the internet.org offering.
Lapera: Do youwant to explain net neutrality really quick? It'scomplicated.
Lewis: Absolutely. Netneutrality is basically a free and open internet,and the idea that people are not getting restricted versions of the internet, orcensored versions of the internet. Some of thepush back that Facebook has met with in Indiawhen they were trying to roll out internet.org there andbuild out connectivity is, the suite that is part of internet.org is basically, you have access to theseat the time, it was like 30 or 40 platforms, and they were a mix ofmessaging, social networking, job hunting, news,that kind of stuff. But it was a curated package of all thesedifferent internet properties. And theregulatory push back they got was, "Well, that's not the internet. That is a hand-pickedversion of the internet. If people come online and see that, they might confuseFacebook for the internet, and that's it. And they might not realize that there'sall of this indexed world out there that they can explore,and it might lend itself to some monopolistic forces." I think, with the big tech pushes from Facebook, and Alphabetisgetting into this as well, thebenefits from having more of the world connectedprobably outweigh thecompetitive risks of having it being pushed by major tech titans that have an interest in staying entrenched in that space. I think those willprobably win out. They might have to do it in a watered-down way that gives people more access generally. ButI'm more worried about the net neutrality side of stuff than internet throttling, if that makes sense.
Lapera: No,that's totally fine. It's aninteresting thing. And every time it has come up recently, it has been defeated. Butthere's a new administration, we'll see what happens.
Lewis:And thedomestic side of that is a whole nother host of issues. We could spend a whole episode on that.[laughs]
Lapera: There you go. Do you haveanything you'd like to say about that?
Priestley: No,I completely agree. It'sinteresting becauseback home in the U.K., there'sa lot of companies threatening to leave becausethe actual internet infrastructure isn't as good as they would like. So,you have those issues, too, whichI realize is separate from that big macro issue. But, I would say the U.S. is in aparticularly good place with the wireless and onlineinfrastructure.
Lapera: Yeah,it was wild, I studied abroad in Australia for a few months, and this was many years ago, many many moons. It was wildbecause here, there was wifi on campus everywhere, and you paid one set amount and you hadaccess to the internet. And sure, you could pay more for faster speeds. But there, youliterally paid for how much data you used. The more data you wanted to use, the more you had to pay. Here, it's the faster, the more you pay, but they don't put a cap on your data, in theory, for your computer internet. It's interesting.
Lewis: Andnot to plug Facebook again in this conversation --
Priestley: You know,I feel like you're getting a lot more airtime.[laughs]
Lewis: Speak up, then.[laughs] But with the focus on mobile, and that being wherea lot of their revenue is coming from,most people first come online,in a lot of developing areas, viamobile devices and not desktop.
Lapera: Which do have data caps.
Lewis: Which do havedata caps. But there's also data caps andvery often wifi connectivity. So, you have two ways to approach. That'sanother thing to think about. Anything you'reworried about with Shopify, Sarah?
Priestley: Yes. As I said,I'll be really quick about it, but the big thing to bear in mind, andobviously, we always encourage everybody to do their own background and stuff,but the company is not profitable. They lost $9.5 millionin the third quarterdespite making really healthy gross margins. They had 79% on theirsubscription business,26.5% on the merchant solutions,but a negative net margin of 10%. We're $27 million last year to date. Andthe reason for that is SG&A, which is sales, general, and administrative costs and stock based compensation. I will say, SG&A is trending down as apercentage of revenue. It was 84% in 2012, it was 58% in2015. I will caveat that by saying that2016 is probably going to trend up slightly. Again, stock basedcompensation, we've already talked about it. It's regular, it's a usual thing to see for these high-growth tech companies. Butwe are starting to see some companies pull backespecially in the cyber security sector and things like that. So, it'ssomething to be mindful of. Liquidity, they're carrying debt. I wouldn't worry about their debt ratio. In terms of valuation,obviously, they don't have any earnings, sotraditional metrics like P/E, we can't use, but price-to-sales is 13, and it's 3.9 average for software andservices. If you take Square, which we referenced, I don't knowhow familiar you are, but it's kind of a similar payment processing, theirs is 10. So, it's not crazy, but you're going to pay a premium for the growth story here.
But,the bottom line is, it's exactly what you're paying for, it'spotential growth. And honestly, Dylan, you've madesuch a compelling argument for Facebook. Theyreally do have a lot more growth left in them,and it's a safer, more stable long-term bet. I honestly believe that this has a long way to go because I think theplatform is just so compelling, and there'sso many more entrepreneurs coming onto the market,there's a lot of innovative solutions that are being developed. Even it couldconvince large companies to switch to its platform, too. So, yeah, that's my pitch. Bear in mind the fact that they're not profitable, so valuing them is tricky, and you really have to convince yourself about the stewardship and the growth story.
Lapera: OK.I know that I'm going to go home and check on their debt, because I'm wild about debt. It'sjust a side effect of having been on the Financials show so long, but I'm just like, what is it? What's the interest rate? In what form is it? I want to know.[laughs] But,I'm not going topelt those questions at you.I do have a question, though, which is, do you own Shopify?
Priestley: No. But I will soon.
Lewis: It's on Sarah's watch list.
Priestley: It'son my watch list. It's kind of pricey right now.I think it's $50 a share. It's been on a bit of a tear. Mypersonal expectationfor this next quarter is that the SG&A is going to track up slightly, and I'm wondering if that's going to have an effect on the share price. They report next week atthe end of the week. I am going to buy shares, because I believe they have a lot of potential. I would love a low entry point, but we shall see what happens.
Lapera: Samequestion for you. Do you own Facebook?
Lewis: I do. Michael Douglass and I did an episodeabout two or three weeks agotalking about Facebook in depth,and after the necessary compliance period ended,I bought shares because I had convinced myself of buying shares. AndI had to be very careful in planning this show and that show to make sure that I was in a window where I was in the clear. In theinterest of painting a full picture here,there are some other concerns that I havein addition to some of the other demographic stuff with Facebook,and I think it's worth mentioning. AsI talked about before, that 50% growth rate issuper appealing for their top line. Management has guided that that isgoing to come down considerably in 2017. One of the main reasons for that is, ad load has more or less reached full saturationon the Facebook feed itself. So,that's one of the main drivers of that. So,I don't know exactly what that's going to look like, butdon't expect the company to continue to be growing 50% year over year. It might drop down into the mid 30s, I'm not 100% sure. They'renot a very guidance-oriented business,so it's a little tough to peg. But given some of the other opportunities, even if what goes on with Facebook itself is kind ofrelatively steady state, I like the story there.
Some of the other risks to consider with monetizing Messenger and monetizing WhatsApp, they're both messaging apps. And the way that userinteract with the messaging app isfundamentally different than the way someone goes to Facebook or Instagram. Those are both feed-based content styles wherepeople are naturally going to be scrolling down their phone, and in-line adsare a very natural part of the user experience. So, they've donea great job monetizing platforms in the past. A lot of people doubted that they were going to be able to make mobile work, and that's why they traded down in the 15s at one point. But themessaging apps are a slightly different animal,and it's going to provide a unique challenge to managementin order for them to really monetize it. So,I think that's another risk to be mindful of.
Lapera: Fair enough.I think that we're running pretty long.
Lewis: Long episode.
Lapera: Long episode.I think it's time to wrap up. As I said, listeners,I'm going to go home and do some research on all the companies I've heard about this week, andI'll talk about whatI've decided to buy eventually, once I can buy it.
Lewis: No rush. Do your research.
Lapera: No rush,exactly. Ittakes me a year to find the perfect pocket knife.I can't even imagine how long it's going to take me to decide on stocks that people have already done about 70% ofthe work for me on.[laughs] But, no,I do have one question which I've asked everyone on the show so far, which is,if you could give one piece of adviceto a beginning investor, what would it be?
Priestley: Read earnings calls. I think itgives you a really good flavor of the management. There'sno better way to thoroughly understand the business and how competent a lot of the people in senior leadership are.
Lapera: That'sabsolutely true. There's been a few times that I've read earnings transcripts, and I'm just like, "Man, that guy sounds sketchy,"and then a few months later some scandal happens and I'm like, I knew, because I read their earnings transcript.
Priestley:When you're in tune like that, definitely read the earnings calls.
Lewis: Wow. Expertjudge of character. Who knew? I think my advice, similar to Sarah's,in the idea of understanding what's going on with the business. Butdon't just look at the number and cite the number. Understand the forces that play into the number, and what might be causing it. So, you get a lot of that color from the commentary on the conference calls. But, early on, whenpeople are learning to invest, you'll see them and be like, "Oh! This is the P/E, so it's undervalued!" And I think that, really,you want to understand all the mechanics at play, and what's driving the business,because you get a much better sense ofwhat's going on that way.
Lapera: Got it. Soit's not just understandingwhat the ratio means,although that's very important, it'sunderstanding what's driving the ratio, and understanding the ratio in context.
Priestley: Thecontext of the industry is probably the biggest thing I learned when I started.
Lapera:Well,thank you guys so much. This has been a very,very substantial conversation.[laughs]
Lewis: Are you wiped after doingfive episodes this week?
Lapera: Super wiped.But I was really pumped when I came into the studio and discovered Munchkins, the little donuts.
Lewis: Gotta love Chris Hill/hate him.
Lapera: The blueberry ones are the best. I know it's a super-fake blueberry taste,and I'm really into that.
Lewis: Are there any left in the box?
Lapera: Oh my God, yeah!
Lewis: Gaby shakes the box. I think, at this point, we can wrap the show?
Lapera: Probably. Do you want to do it, or should I?
Lewis: I'll take us home.Well,listeners, that does it for this episode of Industry Focus. If you have any questions, or if just want to reach out and say hey, you can shoot us an email at email@example.com, or you can always tweet us @MFIndustryFocus. If you're looking for more of our stuff, you can subscribe on iTunes, or check out The Fool's family of shows at fool.com/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 anything based solely on what you hear. For Gaby Lapera and Sarah Priestley, I'm Dylan Lewis, thanks for listening and Fool on!
Suzanne Frey, an executive at Alphabet, is a member of The Motley Fool's board of directors. Sarah Priestley has no position in any stocks mentioned. Dylan Lewis owns shares of Alphabet (A shares), Facebook, and Tesla. Gaby Lapera has no position in any stocks mentioned. The Motley Fool owns shares of and recommends Alphabet (A shares), Alphabet (C shares), Amazon, eBay, Facebook, PayPal Holdings, Shopify, Tesla, and Visa. The Motley Fool has a disclosure policy.