A slow news day means it's time to break out a round of "Yes, No, Maybe So." In this episode of MarketFoolery, host Chris Hill is joined by Jason Moser who shares why he's bullish on Elastic (ESTC -2.03%), why he thinks the thesis has changed for Fastly (FSLY -5.23%), and why he's on the fence about Lemonade (LMND -10.78%). Plus, we dip into the Fool Mailbag to discuss allocation strategies.

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This video was recorded on September 7, 2021.

Chris Hill: It's Tuesday, September 7th. Welcome to MarketFoolery. I'm Chris Hill, with me, it's not Monday, but it's the start of the week on MarketFoolery, so it's Jason Moser, thanks for being here.

Jason Moser: Howdy-howdy, how's everything going?

Hill: Going all right. Hope all the dozens of listeners had a good Labor Day weekend. Shanah Tovah to all those celebrating Rosh Hashanah. We're going to talk about allocation strategy. But first, we're going to do something we have not done in a while, longtime listeners will remember this. It's a little thing we like to call yes, no, maybe so. Three stocks, one is a yes, one is a no, and one stock is sitting right there on the fence and we're going to get through all three of them. Let's start with the yes stock -- Elastic, ticker symbol ESTC. This is if I understand it correctly because I know you've mentioned a couple of times Software-as-a-Service, but it's built around search. Elastic is about a $15 billion company in terms of market cap. Why does this look like a yes to you right now?

Moser: Yeah. Well, you know how I feel about Cloudflare. I think I've been pretty clear about that on these shows. I'm starting to feel that way about Elastic too. Remember Elastic develops software and services that enables users to search through structured and unstructured data for all sorts of consumer and enterprise applications. The thing is when you say Elastic is in the business of search, immediately and rightly so your mind should go to a little company called Google. There is this search engine called Google that does pretty darn well in the Search industry. The interesting thing about Elastic, as I mentioned, is the enterprise application app, Elastic's customers are companies, they're businesses. They're focused on helping enterprises utilize data in search in order to make better decisions ultimately. They had a very focused customer base and therefore market opportunity and we've seen efforts from companies including Google, including Alphabet, to try to gain some traction in the space and they really haven't made too much progress. Now, I attribute that partly to the ongoing success of Elastic, but the technology that they've built ultimately is working very well. 93% of their revenue is tied to subscriptions. As their customers get larger so does their relationship with Elastic.

Just to put some context around that, more than 45% of customers with at least $1 million in annual contract value subscribed to all three of Elastic's core solutions. So I think that certainly indicates not only some strong network effects at play there for the business but ultimately that they're doing something well and ultimately that can result in higher switching costs, which can ultimately beget some pricing power as time goes on. We look at the most recent quarter and the key performance indicators all tell a story of a business that's executing. Total subscription customer count was over 16,000. That was versus 15,000 just a quarter ago and 12,100 a year ago. The total customer account with annual contract value of greater than $100,000 was over 780. That was up from 730 a quarter ago and 630 a year ago and better yet that growth is actually accelerating. We're seeing here just a company that is focused on one particular market opportunity. They are executing very well within that market opportunity. Ultimately, you're talking about a market opportunity that all estimates have in the neighborhood of $50 to $75 billion today. Elastic just seems like a business that is poised to continue capturing a lot of that share based on the metrics that we're seeing today. When you look at their customers, these are big customers. These are customers that folks would recognize. You're talking about companies like Adobe and Shopify, a little company called Microsoft, Etsy, Verizon, Netflix. Elastic is serving all of these businesses to help them use their data, sift through that data, and make better decisions. It just strikes me as a business that's going to become only more relevant here as time goes on.

Hill: When we were talking on Motley Fool Money last week and I was asking you and Andy Cross about what's a stock you would have on a short leash, you talked about Bill.com just because of the valuation of Bill.com. Elastic's not profitable. The stocks, close to a high that doesn't put you off, or do you say all the more reason to have a longer time horizon?

Moser: Well, I would say it is definitely all the more reason I have a longer time horizon. I'm glad you mentioned Bill.com because Elastic, yes, it is still unprofitable stock trading somewhere in the neighborhood of 30 times gross profit today and I think when we were looking at Bill.com last week for the show, Bill.com, on the other hand, was like 150 times gross profit. So even there's a discrepancy there that is pretty mind-bending. I certainly would not call Elastic a steal or cheap or anything like that. But as I've said before, I think when you look at companies that are really tackling big problems; issues where demand for that solution is high. I think that parsing data at the enterprise level, the demand for that is very high. You give them a little bit more leeway to do their thing when it comes to the financials and the valuation. I think this is a business that does require a much longer term outlook there, but that really plays right into how we invest anyway. So the valuation doesn't trip me up too much today. I think it's an indicator that the company is executing well, perhaps it's worth buying this one in thirds, as we talk about. Buy a little bit today and then buy a little bit later and then maybe a little bit later. You don't have to buy it all at once. But yeah, I can certainly understand the valuation concerns there, but that certainly seems to be a very widespread problem in today's market too.

Hill: The stock you've got as a no, it does not have the "problem" of being at a high. In fact, I'm sure there are some people who look at Fastly, which is trading within shouting distance of a 52-week low and they think, "Oh, Fastly could be a value play right here." Why is it not only not a value play for you? It's one where you're like, "No, not interested." Because they're in an industry that is a growth industry.

Moser: It is, there's no question maybe we talk about edge networks and content delivery networks. Fastly has been a name that has bubbled up to the surface for many investors for a while. I think ultimately Fastly is a business I was interested in for a while. I was looking at Fastly and Cloudflare and trying to come to the conclusion which one I liked more. Ultimately, as you could guess, I went with Cloudflare. To me, this is a business where the thesis has changed. I think they were looking at a situation here where their technology is proving to not be a competitive advantage, and in this line of work it really has to be. I've always had concerns with their usage-based revenue model. I felt like that was very limiting and when you compare that with a business like Cloudflare, which had adopted not only usage-based but contractual and subscription offerings they were meeting their customers on all fronts. Not to mention they do more things than Fastly does, anyway, it's beyond just an edge network.

But then, one of the real tells for me, just about a year and a half ago, Founder and CEO Artur Bergman, stepped down and that was in the midst of a business that was starting to witness some headwinds. There was the TikTok relationship that dissolved. That was a big contributor to their top-line. When you fast forward to today, growth has hit a wall. They just recorded 14% top-line growth last quarter. For a business like this that's valued the way it is? Again, one of these newfangled tech companies with no real earnings in the market is taking a little bit of a greater leap of faith with some of these. This is one where 14% top-line growth [...] is going to cut it. Part of that is, I think due to the fact that this thesis has changed a little bit, I think they are succumbing to some of the competition out there, businesses like Cloudflare delivering better products and services. But that growth it's playing out on the top and the bottom line there and margins continue to compress.

So ultimately, when I look at Fastly, I want to make sure listeners are understand. I'm not saying that Fastly is going to zero. That's not what I'm saying here. It strikes me as a business. It's a company that's in need of a suitor and it's not totally clear who that would be. We'd heard some rumors a time ago that Cisco might be interested. Perhaps they're just waiting for another shoe to drop to see if they could get a better deal. But to me, it's starting to feel like Fastly is a business that's ultimately it's looking for a suitor, and we've said on this show many times, the acquisition, it's fine if it happens. Sometimes it's a nice bailout. Don't discount the possibility there, but it's not an investing thesis. I wouldn't buy something like a Fastly today based on the idea that it's going to get acquired. They very well may, I think it probably will, but I think that the competition in this space is ramping up such that given the leadership change and ultimately what I think they're going to have to make a pivot in regard to the revenue model. They're going to have to get away from that usage-based model. I think that does hold them back, but when you put all of that stuff together, to me it feels like the thesis has really changed here and investors need to be aware of that.

Hill: You look at the 25-year track record of the acquisitions that Cisco Systems has made and I guess if you're a shareholder, take comfort in the fact that if they end up buying Fastly, they've overpaid far worth for other businesses in the past couple of decades.

Moser: Yes.

Hill: Let's move on to one that, when you and I were talking this morning and you were like, "I'm on the fence on this one." I was like, "Oh, my God, so am I." Which is why I'm really happy and excited to talk to you about Lemonade, ticker LMND, the insurance business similar to Fastly, has got about a $5 billion market cap, Lemonade a little smaller, about $4.7 billion. This is one I literally have written down on a post-it note with a question mark, because a lot of people we work with like this business, are big fans of it both as consumers and as investors. I am right there with you on the fence.

Moser: I got a good chuckle out of that. This morning we were talking because obviously, we did not put our heads together before that meeting. You're right, it is one that a lot of folks here at The Fool like, my partner in crime for the Monday Industry Focus show, Matt Frankel, he's a fan, he's definitely talked about it a number of times on the show, and I understand that. To me, it is truly one which I'm totally on the fence about. I can't really make up my mind. I like the idea and concept. Lemonade is utilizing artificial intelligence, a machine learning method, to ultimately make better decisions. That really is what the insurance business is all about. Making good decisions regarding the business that you write. It is a massive market opportunity. Worldwide, you're looking at insurance as a $5 trillion industry. It's very legacy written. It's just that they've been doing it the way they've been doing it forever. It's like, why do you do it that way? Well, this is just the way we've always done it.

Maybe there is a way to do it better and that seems to be what Lemonade is trying to exploit. But what we've seen certainly throughout our time here on these shows and with our services here at The Fool, insurance is a very hard business. It seems simple in concept, but to run an efficient and effective insurer to where you're pleasing your customers, you're making it happen for investors. Now obviously, so many companies focused on really ultimately making the world a better place and looking out for all stakeholders, which I think is great, those are all things that you have to take into consideration. When you look at the numbers, a year ago in the second quarter of 2020, their customer base was primarily renters. They sold renters insurance. That represented about 75% of the business. Then homeowners accounted for the balance of that. Now they've done, I think, a tremendous job in diversifying away from that renter base. By the end of the first quarter of 2021, that renter's share was down to 56% with homeowners representing 30%. But then they've also introduced pet insurance, they've introduced life insurance. You've got pet representing 13% of business last quarter and they're going to continue to roll out new offerings. Automobiles is going to be another opportunity for them. It sounds like customers, for the most part, like the interface, like the brand. It seems to be fairly frictionless, easy to access mobile, digital, those are great things.

You look at their business model on the other hand, and it makes you wonder at least a little bit. Because ultimately, the way they run their business is that they take 75% of the premiums they collect and then they purchase reinsurance ultimately to handle the insurance. They're a middleman in that regard. The other 25% is set aside to cover operating costs and hopefully generate a profit. They also focus on donating excess funds to charity, great, I think. Now, when I mentioned that 75% number, that to me, I start thinking, OK, well, if their business is ultimately depending on purchasing insurance from other insurers, well then that puts a lot of the power in those other insurers' hands. They can start to dictate a little bit more pricing as they see fit. Now, the flip side of that is that Lemonade is working to change that. They did note in their most recent quarter that they are reducing that portion of premium that they see to those reinsurers. That 75% number is now more like about 70%. I think over time they're ultimately aiming to bring that number down significantly. That could be good assuming they know what they're doing. It seems like they do, but again, insurance is a very hard business. All of that together, it just leaves me with a big question mark. I just don't know. I haven't been able to really fully make up my mind here.

Hill: I don't know about you, but I'd take a little bit of solace in the fact that the market as a whole appears to be right there with us, because you look at the one-year chart of Lemonade, it's been as low as $44, it's been as high as $188 million. There are a lot of people who are trying to make up their minds about this business.

Moser: Well, I think this could be one of those generational plays. Maybe this is a concept that's resonating more with the younger audience. Gen Z-ers and beyond, maybe this is the way insurance starts to work for those younger generations as they come up into the workforce. They start driving, renting, buying homes, or whatnot. That ultimately remains to be seen, but at the end of the day, it really does seem like it boils down to how good their tech is, the AI and the machine learning. Is that ultimately helping them make better decisions? Because if it does, and they are able to wean themselves off of that reinsurance model, that could work out very well for them. We've seen good, well-run insurers do very well over long periods of time, they're wonderful long-term investments. It's just really trying to get a grip on whether these guys have the staying power, the brand equity, and ultimately the technology to be able to disrupt what has obviously been a very difficult industry to disrupt at this point.

Hill: Before we wrap up, our email address is [email protected]. We got an email from Charles, who writes, "New to the show and very new to investing. I'm wondering if it makes sense to invest in two or more companies that provide the same product or service. For example, Volta and ChargePoint? I'm a big fan of MarketFoolery and Motley Fool Money. You all provide a wealth of information. It is much appreciated. Thanks. PS, I must have the man behind the glass as DJ at my next shindig. The music selection on Motley Fool Money is second to none." I can't help but agree. We've gotten so many emails and tweets over the last year about the bumper music that Dan Boyd picks for Motley Fool Money. By the way, Volta, interesting timing on Charles' email. I got a press release sent to me this morning about Volta just striking a deal with Six Flags amusement park.

Moser: Oh, wow.

Hill: Now, Volta is going to be the charging station at Six Flags. I don't know about you. The first thing I thought when I saw Charles' email was the war on cash basket. The second thing I thought was that two of the more recent stocks I just bought are head-to-head competitors, Home Depot and Lowe's.

Moser: Well, the short answer to the question is yes. I like this idea, particularly when the market opportunity seems really, really big, and so you said it. The first thing that came to my mind is the war on cash basket. That's ultimately why we built that thing in the first place. You and I were sitting there talking about MarketFoolery after MarketFoolery, but how well all of these companies and this payments industry were doing. It didn't make sense to really try to pick one winner when it was pretty apparent there are going to be a number of winners. When the market opportunity seems like it's pretty big, that's why I think this strategy works out even better. Then just the same point with your Home Depot and Lowe's example there, but just a massive market opportunity in housing. Now, not speaking particularly to these two businesses, Volta and ChargePoint, I think it was? Because I haven't dug into these businesses, but from what I can gather, they ultimately are building charging stations right there. They're facilitating the electrification of our transportation industry, which is ultimately a very good thing. I think Tesla gets all of the headlines, but we have to recognize the fact that Tesla is not going to own this market 100%. They're going to be one of, I think, a number of companies that help us ultimately make this transition. It seems to me to be an attractive market opportunity.

That's where it may make sense to consider owning a couple or three or four of the businesses that you think are really going to lead the charge, so to speak, no pun intended, sorry about that. Investing is rarely a zero-sum game. We like to make it sound that way when we're talking about these businesses, we're bullish or bearish or we're picking one over another. But the fact of the matter is that investing is rarely a zero-sum game. I too own a number of companies that on the surface, maybe they compete with each other to an extent, but they are really playing an ultimately what is a very large sandbox. To me, that's a very sensible strategy.

Hill: Let me just go back to two companies we talked about earlier in the show, Fastly and Cloudflare. If you went back a year and said cybersecurity, I'm going to buy a basket of stocks and you picked those two along with Datadog and CrowdStrike, that's a basket that as a group is doing very well. Now, Fastly is down about 40%, CrowdStrike has doubled in the past year, Datadog is up 70%, Cloudflare is up nearly 300%. But again, if you take the basket approach, you got three winners that dove the pain of seeing Fastly down 40%.

Moser: Yeah, I can help you catch a few more wings at night and that's a good thing.

Hill: Jason Moser, great talking to you, thanks for being here.

Moser: Thank you.

Hill: As always, people on the program may have interest in the stocks they talk about and The Motley Fool may have formal recommendations for or against, so don't buy or sell stocks based solely on what you hear. That's going to do it for this edition of MarketFoolery. The show is mixed by Dan Boyd. I'm Chris Hill. Thanks for listening. We'll see you tomorrow.