The Trade War's Impact on Banks, and the Best Way to Read SEC Filings
In this week's episode of Industry Focus: Financials, host Jason Moser sits down with Motley Fool analyst Auri Hughes in the latest installment of our Between Two Fools interview series. Then Fool.com contributor Matt Frankel, CFP, talks with Moser about why bank stocks have underperformed the market in the midst of the trade war, the most important things investors should look for in companies' 10-K and 10-Q filings, and what to think about when rolling over a 401(k). All that, plus the latest stocks we're watching, on this week's information-packed episode.
To catch full episodes of all The Motley Fool's free podcasts, check out our podcast center. A full transcript follows the video.
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This video was recorded on June 3, 2019.
Jason Moser: Welcome to Industry Focus, the podcast that dives into a different sector of the stock market each day. It's Monday, June 3rd. I'm your host, Jason Moser. On today's Financials show, we're going to talk about how the trade war is impacting the financials sector. We're going to dig into a couple of listener questions that came across the Twitter feed. As always, we'll have one to watch for you. But we begin this week with another installment of Between Two Fools.
As you may remember, we've recently brought four new analysts onto our investing team here at The Motley Fool. We wanted to take the opportunity here on Industry Focus in Between Two Fools to introduce you to them. In our fourth and final installment of our analyst interviews, I had the good fortune of speaking with Auri Hughes. I hope you enjoy our conversation!
Moser: OK, Auri, first things first here. Tell our members, tell our listeners out there, who are you, and how did you get here to The Motley Fool?
Auri Hughes: Sure. And thank you for having me, by the way! I'm originally from Northern Virginia. I grew up not too far from the headquarters of The Motley Fool in Northern Virginia -- Fairfax area. I've always had a passion and interest in business. In high school, I used to do a lot of marketing competitions and things like that, where you'd come up with proposals. I thought for the first portion of my life I was going to be a marketing executive or a brand manager somewhere.
Moser: Well, we do have a marketing team here if you're interested.
Hughes: But finance was my first love. I was interested in being a stockbroker. What happened was, I was entering college as the recession hit, and I said, I'll do marketing, but I want something a little bit more technical, or maybe a little bit certain in this economy. So I thought, OK, maybe I'll do finance, so double-majored in finance and marketing, and then started off as a financial analyst for a local government contractor. While I was in college, I really got interested in the markets. And I took the little income I had from my part-time job and I would start looking at shares of things I'd like to own and research, and that just bloomed, and then it grew and grew. And last year, I finally said, I really want to be an equity research analyst. I don't know how I'm going to do it, but I made that my goal. I put together a report, started going around, interviewing, and then I discovered The Motley Fool, and the rest is history.
Moser: Well, I can tell you, as a part of your interview in coming here, one of the things that struck us was your passion for investing. That Apple stock pitch that you brought to us, speaking with you, it was very clear that you were doing something you really enjoy doing. That was ultimately one thing that made us feel really good about having you come here and join us. Really, investing is all about that passion and wanting to dig into it every day.
Now, speaking of investing, we like to talk about value investing, growth investing, dividend investing, all that stuff. Identifying what kind of investor you are, I think, is always a bit of an interesting exercise. When I started here almost 10 years ago, I wasn't really sure what kind of investor I was. What kind of investor are you? Do you know? Are you still in that process of discovering that? Or do you have a strong feeling there?
Hughes: I think I identify myself as probably a combination of value and GARP [Growth At a Reasonable Price]. Essentially, I'm interested in businesses that generate some type of free cash flow. That's really important to me because I think about business from a practical standpoint. If I owned a private business, I'd want something that generates cash -- you have a lot of high-growth companies that maybe aren't cash flow positive. Those are the businesses I prefer.
Moser: GARP, I can relate to that. For listeners who aren't familiar with it, that's Growth At a Reasonable Price. I like that one. I've always considered myself a motley investor -- I'll go anywhere where I feel the opportunity is -- but I think I probably fit mostly into that GARP category.
Since you've been here, and it's not been all that long, and you're still going through our investor development program...but what's something you've learned here, in your time here so far? What's something you've learned in regard to investing that surprised you, or something that you weren't expecting?
Hughes: One of the things I really valued out of the analyst development program that wasn't a part of my process before was this whole idea of looking at proxy statements to see how management is incentivized. I used to read the 10-K, which is the document that describes the business in general and gives you the financials. But it's really important to understand if management is incentivized to make the business more profitable to generate free cash flow. Is your CEO going to get bonuses or incentives based on making the business more efficient or more profitable? Those are really important things to me now that translate, I think, to higher stock prices, especially for most businesses. I really value it now, but it wasn't a part of my process before coming here.
Moser: I think that makes a lot of sense. You can see in some of those proxies, if incentive is based on earnings per share, you and I know they can manipulate that earnings number. But if it's based on something like operating income, that's a number you can't really fudge so much. That's a great point there.
What is the best piece of investing advice you've ever gotten? In all of your years, up to this point, anything stand out?
Hughes: I think the best piece of advice falls in line with a lot of the Buffett mantras: the idea of "Would you buy the entire business?" If I'm looking at any company, I start with that question. I don't think about it as just a stock. Is this a business I would be willing to own if the market shut down for 10 years? Things like that [are] where I start. I think that also dictates your risk tolerance; it also determines how comfortable are you with this type of business. So, that's where I start. "Would I own this business in real life in a private setting?" is the starting question for me. I think it's really important.
Moser: We talk to a lot of investors all the time, members and listeners and prospects, people who are asking questions. That whole idea of business-focused investing, that's what that is. View yourself as an owner; would you want to own that business? That'll help you make that decision pretty quickly. Some of them, you'd be happy to own; some of them, you're like, "I don't want to own that thing."
Hughes: I think also, the other thing is, too, do you understand the business? I think that'll be another thing that comes out of that. Can you have a conversation about how it makes money, what things in the environment affect that, as well.
Moser: That's one of those questions you can ask sometimes, be like, "How does this company make money?" It seems such an obvious one, but in some cases, it's not such an obvious answer. That is really a great starting point to figure out exactly what that business is, and if it's even something you understand, or want to get mixed up in. That's good.
OK, going away from investing for a second, talking about Auri the person, what's something that has happened to you in your life? Something interesting, something unique, something you feel our listeners should know about you?
Hughes: I'm an avid snowboarder. I really enjoy snowboarding a lot. I haven't done it as much recently. But once, I was in Vermont, and I got caught in a snowstorm while I was snowboarding. I had to wait it out until I could get back to the lodge. It was a scary experience.
Moser: How long did that take?
Hughes: Maybe 30 minutes. [laughs] The wind was blowing and I had to go behind a shed and just wait it out until I could make it back down to the lodge. It was pretty scary!
Moser: Yeah, I can imagine! Now, I heard a rumor that you're a pretty good ping-pong player, too. Is that right? Did you lay the hammer down on Buck Hartzell? True or false? This is being recorded, it's going out there!
Hughes: Buck has a ping-pong table in his house.
Moser: I know!
Hughes: And we were talking before the match, and he was like, "I have to find my paddle." And I was like, "Oh, gosh, this guy has his own equipment." [laughs] That made me really worried. But I think it was his partner that wasn't as good. I think if he had a partner that matched his skill set, he would have won, in all fairness. So if we make it to the next round, then I could probably start to say we're a good team. But I think his partner held him back more so than my skills of being a ping-pong player. [laughs]
Moser: I don't play a lot of ping-pong; I play more tennis and golf. But I tell you, my first time ever coming here, the day I came here for my interview -- I came in here, the place was a ghost town. And I came to find that the reason why was because it was the office ping-pong tournament, and everybody was over in the game room playing ping-pong. And I thought, "Oh, my God! I have to get a job here!" [laughs] Thankfully it all worked out!
OK, great! Normally, we like to wrap these interviews up with getting a book recommendation from our interviewees. In this case, because you are who you are and you do what you do, I thought it'd be great if you could give our listeners an idea of a stock that you really like today and why. So, tell the listeners out there, what's one stock on your radar today, and why do you like it?
Hughes: Sure. The stock on my radar I'm really interested in is a company called Intuit (NASDAQ: INTU). Intuit is the creator of TurboTax. I think this is a great business just because of the need to do taxes every year. It makes for a great reoccurring revenue for the business itself. They're the leader in the do-it-yourself market for tax preparation. The software is easy to use, it guides you through the process. It's very sticky, so you have users coming back to it every year. The culture, they're always adding things to the product. It's really disruptive and they're always bringing new additions to their products. They also own QuickBooks, which is the leading small-business software for accounting. It has 80% of the market share.
They've also updated these products for the gig economy -- that's people that drive Uber, Lyft. There's been a big need there to understand the accounting in that contractor realm there. The software lets you send invoices, which is really advantageous for small-business owners, and things of that nature. It's one I like a lot. The only thing I'm a little uncomfortable with is the valuation at these levels, but it's a very, I think, attractive company that'll be around for years to come.
Moser: Yeah, I think valuations are a little scary all the way around here.
Hughes: [laughs] Sure.
Moser: I've gotten a little bit picky these days. But, Intuit, I like it. I've used TurboTax myself. And you know what they say -- death and taxes, right?
Hughes: Yeah. [laughs]
Moser: Alright, Auri, thanks so much for taking the time to stop by today! I know our listeners got a great thrill out of meeting you. I'm sure we'll be seeing more of you in the near future.
Hughes: All right. Thank you, Jason!
Moser: Joining me now via Skype is certified financial planner Matt Frankel. Matt, it sounds like you guys maybe had a little bit of a break from the heat there in South Carolina. But it's been kind of warm lately.
Matt Frankel: We did. It's only about 92 [degrees Fahrenheit] here today. Last week, it was about 101.
Moser: Sheesh. Yeah, we were a little bit luckier up this way. It's a high of 72 today. Geez, man! You know the old saying, sucks to be you. I'm glad we're a little further north, but I'm not going to sit here and talk about the weather anymore.
Let's start really giving our listeners what they want, and that is talk about financials and stocks and making money. We wanted to really dig into this first on the show today because it's been brought more to the forefront here lately, as the headlines continue to bat it around -- it's this trade war. It's the trade war, and how this is impacting not only the headlines on a day-to-day basis, but really how it has played out over the financials sector here for the better part of the year.
You were talking about this before we started taping. Really, it plays out in two different ways here. Tell the listeners what you were telling me.
Frankel: The trade war's been going on for about a year now, when you think about when Trump first started threatening all the tariffs on China. But I'd say it'd be fair to say it really just heated up in the past month or so. China tariffs popped up to 25%, and the recent ones with the Mexico tariff threat. Over the past month, banks have actually underperformed the market, which hasn't done that well itself, by about 2%, which is significant. Banks are down about 7% or 8% this month alone, in May.
There are two things that investors need to know. One is that banks are very interest-rate-sensitive. We've talked on the show before about how as interest rates rise, particularly long-term interest rates, banks make more money, because they profit from the spread between what they're paying for deposits and what they're getting for loans. Say when you go to buy a car, the bank loans you money. Now they're charging you, say, 4%, and they're paying a depositor 0.5%. That difference is their profit. So, when rates go up, they make more money. Conversely, when rates go down, they can make less money. That's what we've seen play out recently. In the past month alone, the 10-year Treasury has dropped from 2.54% to 2.11% yield. So there's a lot of fears that these falling rates will cut into bank profits -- kind of how a year ago, we were talking about how rising rates were causing investors to be optimistic.
Moser: Well, you and I were talking a lot about that, because a lot of these banks started trading at very attractive valuations given that potential tailwind. It sounds like that tailwind is maybe going to be on hold for now.
Frankel: Right. Everyone thought the Fed would raise rates a few more times, myself included. That was one of my bold predictions that I can pretty much say at this point I got wrong.
Moser: [laughs] Well, there's nothing like getting out there and embracing the mistakes, Matt. Learning from them!
Frankel: Who could have predicted tariffs on Mexico? I don't know too many people who thought that was coming.
Moser: Yeah, it's a really weird time. It does feel, if you look at President Trump's history before he ever became president, he's always been very fond of dealmaking. I can't help but wonder if maybe this isn't a bunch of that going on. There's no question that tariffs, by their very definition, raise the cost of doing business for virtually everyone. I think anybody can see that. Hopefully this is just some temporary bluster that eventually blows over.
Frankel: Right. Your point brings me to my second point, which is that banks thrive on having a strong economy, consumer confidence in particular. A bank could have all the profit margin in the world, but if consumers aren't taking out loans to buy things, it doesn't really matter. Tariffs not only make the cost of goods higher for American consumers, but leave less disposable income in people's pockets, more uncertainty, which makes people less willing to go out and buy homes, buy cars, take out personal loans, use their credit cards -- things that banks depend on for their profits. So we might actually see some assets fall on banks' balance sheets as people take out fewer loans, especially if all this continues and the China tariffs go to the rest of the Chinese goods -- I think it's another $300 billion or so -- and the Mexico tariffs kick in. You might see a big lack of consumer confidence, which could be really bad for banks.
Moser: Sure. Again, I think this goes back to the advantages of being able to take that longer-term perspective. It's not like we're sticking our heads in the sand and saying, "These problems don't exist, blah, blah, blah. If I can't see you, you can't see me!" It's one of those situations where we may see some very attractive valuations for some of these really well-run banks that, if you can take that three- to five-year outlook and say, "You know what? This is money that I can part with for a little while," it does look like there are going to be some opportunities that come from this.
Frankel: Oh, absolutely! It's bargain-hunting time. My One to Watch today is going to have something to do with that -- just a little preview. The one big takeaway is that few banks have a lot of direct exposure to China or Mexico or any of these affected countries. The majority of companies that have a lot of Chinese exposure are tech companies. The majority of companies that have a lot of exposure to Mexico are [in] the auto industry [or] energy. Financials have very little direct exposure. They have some, but not a needle-moving amount. It's all [these] indirect results of the trade war that are really going to hit the banking sector. But like you said, this is a great time to go shopping.
Moser: Maybe we will devote a show in the next month or so to really dig into some of our favorite ideas that may come from all of this. Maybe we'll put that on the table.
Frankel: I like that idea!
Moser: We'll get that on the agenda. Well, let's take a turn over here to Twitter. We had a couple of questions that came in recently that you and I thought were really perfectly suited for this show. First up, we have Adil. Adil asks: "I wonder if you could do an episode on things to take note of, and how to run through a 10-Q or 10-K to get the most out of it. I'm curious to hear how you guys do your thing, and I'm sure it's a topic many other listeners would appreciate."
Adil, I think that's a very good question! One of the things that we really stand for here at The Motley Fool is being able to help empower the individual investor to go do their own thing. You can find all of that information out there if you take a little time to do it. If you understand what you're looking for, and you can put together a little bit of a framework, you can become your own analyst in many cases.
So, Matt, why don't we start with you? When you're starting to look through a company's 10-Q or 10-K, what are some of the things that you do to get the most out of it?
Frankel: I'll run through my top five. First, I want to make one distinction. A common misconception among investors is that the annual report and the 10-K are the same thing. They're not.
Moser: That's true.
Frankel: The annual report is the chairman's letter. It's about five or six pages long, usually. It gives the state of the business. You see some nice, pretty graphs and stuff like that. The 10-K is the 100-plus pages of black and white that follows it.
Moser: That's the exciting stuff! That's the sexy reading for people like us!
Frankel: [laughs] It separates the casual investor from the educated investor, I'd say. So, step one, I would say read the annual report before you dive into the 10-K, because it's much more reader-friendly. I'd say 80% to 90% of what you need to know is in the annual report. You don't even really need the 10-K for most of it.
Having said that, I'll give you my top five. There's a bunch of different sections in the 10-K. Looking at it to give you an idea, Square's 10-K is 138 pages. It's not practical to read a 10-K for every company you're interested in. So just to narrow it down, the business description is usually about 10 pages long, but it's item one in a 10-K. It's very worthwhile to read, followed by the risk factors, which is the other part of item one. The business and its risk factors are two big, big things that every investor should read before buying a stock.
The section on legal proceedings is very telling, especially in the financial sector. I don't know any bank that doesn't have some type of legal exposure. The management discussion of the operations is my other big one to look at.
One that's not on most people's list, but I like to look at, is executive compensation. I like to know a company's directors have the same interest as I do -- that if I make money, they'll make money -- aligning our interests. I was looking through one company where the CEO only gets his full compensation package if the stock roughly doubled from current levels within a few years.
Right? And this was in the hundreds of millions that we're talking about. This is a big motivation in a lot of cases. And this is an outside-the-box thing to look at. This is buried toward the back of it. It's not usually in people's top few things to look at in a 10-K. But I always make a point to read that before I invest.
Moser: That's all very good stuff. What I will say: It's interesting, having been here for close to 10 years now, and ultimately, having served all of my time here on the investing team, and working as an investor to learn how to get better. One of the things we did -- we went through this program we have called the analyst development program. It was about one year and a half long. We did all sorts of things that really helped us not only learn to be good analysts, but good Foolish analysts. And a lot of it comes down to reading those SEC [Securities and Exchange Commission] filings. The 10-Ks and 10-Qs are always helpful -- the 10-K, which is once a year; 10-Qs are every quarter. Always helpful.
One thing we did in our analyst development class, we started this thing called the 10-K challenge, which ultimately was: We wanted to figure out a way to be able to look at a new company, and determine as quickly as possible whether or not it's a company we wanted to continue looking at. As opposed to sinking all this time into research, and then having to deal with that sunk-cost problem, trying to determine whether it's a company we needed to cut loose or not. We figured if we could give it one hour, comb through the 10-K to get a better idea of the business and whether it's one we really wanted to keep on learning more about, the 10-K challenge helped us do that. We would take literally one hour, and we would get a brief overview of the company, and like you said there, the description of the business, understanding how they make money. And then we would comb through not only that business description and how they make money, but the risks section as well, and any market data that they had, to get a better idea of the competitive landscape for the business, and anything that we might learn there. Ultimately, trying to answer the question: Do we feel this is a good long-term business? Not just from the company perspective, but from the market's perspective in general? Is it a growing market opportunity that we're pursuing?
Trying to answer some of those very basic questions really helped us. It was a way to go through a lot of companies in a short period of time, and figure out whether they were companies we wanted to keep on researching, or whether it's a company we felt like we didn't understand and needed to go in the too-hard pile, or there were clearly things that we didn't like about it.
You also mentioned management compensation. I'll throw another SEC filing in there that you can look at to learn more about that stuff -- SEC form DEF 14A. That's a proxy statement that companies put out usually once a year. It has a lot of stuff in there regarding compensation, management, the boards and whatnot, governance. Another way to learn more about the company, as well.
Adil, I hope that helps. It's certainly a topic we could talk about for an entire show, but we won't do that.
Let's jump into the second question here from Joseph Higgins. Joseph says: "I switched jobs recently. In trying to roll over an old 401(k) from the time of request until I actually received the forms in the mail, my balance dropped 5%. Would you wait until the market rebounds? Or does it not matter since I'll be rebuying at lower prices anyway?"
Matt, as I said at the top of the show, you're a certified financial planner. You run across this type of thing, I think, often in your job. What do you think about Joe's question there?
Frankel: I do. I'll say two points about it. The first one is, pay attention to the date that's on the forms you received. I'll tell you a quick story about a client of mine who called me in mid-February to tell me that he wanted to explore different options because he wasn't happy with his 401(k)'s performance. I asked him what he was looking at. And he said, "Well, I just got my year-end 2018 statement, and it looks terrible." And we know what happened in the market at the end of 2018. By the time he was actually reading his statement in mid-February, the market had gone back up like 15%. So, pay attention to the date on your statement. It doesn't necessarily reflect your current balance. If you want your current balance, try to log into your 401(k)'s portal, if you want to see how you're actually doing right now.
The second thing I would say is that if you're going to reinvest immediately, let's say you're going to roll it into your current employer's plan, don't worry too much about how much your balance went up or down. You'll be immediately reinvesting. If your current 401(k) dropped by 5%, the new 401(k) probably dropped by the similar amount and it's a wash. Now, if you're going to be doing some delayed reinvestment, like you're rolling it into an IRA and then you're going to wait and figure out what stocks you want to buy, what funds you want to buy -- if it's a delayed reinvestment, then it's a little bit of a different story. But the majority of 401(k) rollovers are pretty immediate. You roll it over and you buy a few mutual funds pretty immediately; or if you roll it into your new employer's plan, it immediately gets reinvested. Unless you have some unusual case where you're going to research and buy individual stocks, I wouldn't put too much emphasis into what your plan has done recently.
Moser: I'm glad you mentioned that, because I was going to offer a quick personal experience of mine. I've had a couple of rollovers where I rolled the retirement plan over into an IRA that I have. Ultimately what I did is, I was rolling that money into an IRA where I was thinking of buying individual stocks; I basically was taking on my own little portfolio management role there. I was going to steer away from the funds and more toward the individual stocks. I didn't consider even for a second the timing of the matter. Honestly, the main reason is, when you look at the overall length of time that I intend for this thing to be in action, for me, it really didn't matter.
When it boils down to it, a couple of days here and there, whether it's underperforming or performing well, up or down for whatever given week or month...you can sit there and fight that battle all day, every day. Ultimately, you have to pull the trigger. He made the point, maybe you're going to be buying back in at some lower prices anyway. I think that's a good way to look at it. But I think if you're looking at this generally, and thinking about how long of a time line you've got -- hopefully in this case, we're talking about decades -- that makes it a lot easier to go ahead and pull the trigger, get that thing transferred over. Either way, generally speaking, you have to do it at some point, so don't nitpick too terribly much on the day-to-day machinations of the stock market. We know that pretty much never stops, especially in this environment.
Joe, I hope that's helpful. Good question! Certainly, I don't think there's any one cut-and-dried answer there. But hopefully, we've given you a couple of extra things to think about, ways to look at it.
Matt, let's wrap it up here. But before we do, we want to give our listeners One to Watch. What is a stock on your radar for this week? You gave us a teaser earlier. I have to believe it's a bank, right?
Frankel: Yeah. Like I mentioned earlier, banks have really underperformed the market recently. They've been getting crushed with the trade war, and interest rates going down, so on and so forth. I'm looking at Bank of America (NYSE: BAC). It's performed even worse than most, down about 12% in the past month. It's now trading for over its book value, which is the first time that's happened in a while. It dipped below it briefly in late 2018. But other than that, it really hasn't dropped to this valuation level in a long time.
Bank of America has been doing phenomenally lately. They've gone from being one of the worst-hit banks in the financial crisis to being one of the best-run banks in the country. They keep getting better, they keep getting more efficient, profitability keeps improving. And right now, it's trading at a bargain. Like I said, it's trading for the value of its assets. I think it's a good one to look at.
Moser: Well, there you go. I'm going to go with a company I mentioned before, DocuSign (NASDAQ: DOCU). Earnings are out on Thursday for DocuSign. We will be at FoolFest, actually, on Thursday, all day; I'll be keeping at least one eye peeled on that earnings release.
I think everybody remembers that DocuSign offers the e-signature solutions. It serves all sorts of businesses, from sole proprietorships to large enterprises, and everywhere in between. And I think not only is it really a good product -- if you've used it before, you understand how seamless it can be -- but I think they're doing a good job of taking this business beyond digital signatures, and becoming a little bit more of a full-service provider, and helping businesses manage the workflow that comes with all of these documents and agreements and whatnot. You spoke about profitability for Bank of America. I think that's one of the bigger challenges with DocuSign right now; it is not yet profitable. But it has a good reliable subscription business, and it does seem to be getting a lot of good reviews from big customers. Hopefully this is going to be another quarter of growth. We will see on Thursday.
Matt, I think that's about all we got for this week, right?
Frankel: Yeah, it'll be a fun week with more trade-war drama going through the markets.
Moser: [laughs] We'll keep an eye on it. Like I said, we'll plan for a show here in the next few weeks where we'll start digging a little bit more into maybe some of our favorite ideas that can come from all of this...let's just call it potential carnage. Maybe it's not carnage yet. But hey, listen, man, I appreciate it. I look forward to getting together next week!
Frankel: Definitely! Always fun to be here!
Moser: As always, people on the program may have interest in the stocks they talk about, and The Motley Fool may have formal recommendations for or against, so don't buy or sell stocks based solely on what you hear. Today's show was produced by Austin Morgan. For Matt Frankel and Auri Hughes, I'm Jason Moser. Thanks for listening! And we'll see you next week!
Auri Hughes owns shares of AAPL. Jason Moser owns shares of AAPL, DocuSign, SQ, and TWTR. Matthew Frankel, CFP owns shares of AAPL, Bank of America, and SQ. The Motley Fool owns shares of and recommends AAPL, DocuSign, Intuit, SQ, and TWTR. The Motley Fool has the following options: long January 2020 $150 calls on AAPL and short January 2020 $155 calls on AAPL. The Motley Fool recommends UBER. The Motley Fool has a disclosure policy.