In this podcast, Motley Fool analyst Asit Sharma discusses:

  • Sonos (SONO 0.74%) being "underrated" as a business.
  • The key Sonos metric to watch.
  • Why taking the long view in stock investing is so important.

Motley Fool contributors Jon Quast and Ryan Henderson talk with Reggie Fils-Aime, former president of Nintendo (NTDOY 0.27%) of America, about finding great business leaders and the future of consolidation in gaming.

To catch full episodes of all The Motley Fool's free podcasts, check out our podcast center. To get started investing, check out our quick-start guide to investing in stocks. A full transcript follows the video.

This video was recorded on May 12, 2022.

Chris Hill: [MUSIC] We've got an inside look at the gaming industry and why more consolidation is on the way. Motley Fool Money starts now. I'm Chris Hill. Joining me today, Motley Fool Senior Analyst, Asit Sharma. Thanks for being here.

Asit Sharma: Chris, thank you for having me.

Chris Hill: Sonos like most companies, is talking about the impact of supply chain problems, but Sonos', second-quarter revenue was higher-than-expected. The demand for high-end audio products seemingly is there. This morning you and I were going back and forth. You said this is a company that you think is underrated. How so?

Asit Sharma: I think that investors have been trained to look for companies that are really really capital-light over the last few years. If you can avoid investing in a manufacturer, do it. Find the equivalent software-as-a-service model, invest in that. It's going to have higher margins. It's a company you will be able to ride for long-term growth. That always great in a lower interest rate environment but as interest rates have ticked up, investors are starting to second guess some of the thesis around only owning those fast growers. Just like in real life, if you go to a basketball game, a pro game or college basketball game, and the best player on the opposing team has a bad night. Everyone is chanting, overrated. [laughs] But there's is no underrated chant. It's not like the best player on your team, who is the role player and is having a great night. It's not like everyone jumps up and starts shouting underrated. But sometimes I want to get out my seat, out of my chair for companies like Sonos and just chant underrated.

Chris Hill: We're seeing the stock move up today and have been saying this a lot lately, off of what was a 52-week low earlier in the week. Let me ask you the question I've asked to others. Do you look at movement like this as enough investors saying, OK we get it. Maybe it was overvalued before. Maybe it was overrated before but this is a business making things that some not insignificant number of people want. So we're going to build this one up.

Asit Sharma: I see that, I mean, this is a company that would've increased its top-line even more as you mentioned if not for constraints, the demand is there. They're just trying to supply as much product as they can. They've run into supply issues in China as almost every other manufacturer has but it's also a company that has a phenomenal brand. If you look at charts of home installers, professional equipment installers, favorite choice for audio equipment for new homes. It's Sonos by a mile and that beats companies like Apple, like Bose.

If you read their earnings call transcripts management, especially Patrick Spenser CEO constantly talks about the fact that their best marketing is word of mouth. Here you have a product that can shine in all weathers. It is high end. They have a nice profit profile. It's diminished somewhat this year because they are fulfilling the demand and they're taking a hit to gross profit to do so. But over time, those margins will pop back. You have this dependable high-teens grower. The other thing I like about it is there still taking on Alphabet's Google in court saying you stole our technology. So far preliminary court cases agree with Sonos. There may come a time in the next couple of years where the courts finish their adjudication and say, hey Google start paying this company some royalties. Which would be a nice add-on to that margin profile. I wouldn't include that in your investment thesis, but it's an overhang that could be a nice lift for shareholders. That's also there to think about when you consider investing in this company.

Chris Hill: I'm glad you mentioned Apple because I don't remember exactly what year it was, but I remember when they came out with their version of the smart speaker. They clearly priced and look Apple, I'm not going to argue with Tim Cook and his team and their strategy of having high-priced products that has worked out very well for Apple and for Apple shareholders. But I remember at the time talking with analysts at our companies saying, boy, I get what they're trying to do. They are going right at the Sonos and the Bose of the world. Sonos and Bose, this is all they do, but this is their area of expertise. I think if I'm an Apple shareholder, I'm not banking on a lot of profits off of these high-end speakers because they're going up against really good competitors.

Asit Sharma: You nailed that, Chris. Apple is amazing at product design but in terms of acoustical design, in terms of being true audio nerds, as are the engineers at Sonos or Bose, they really don't have that element in this product as much as resources they have. Unlimited R&D spending budget, unlimited ability to mold a product in a visually pleasing form. But what they lack, I think, is the true passion and audio that this company has exhibited since its inception out the original founders moved out of that ownership structure but there are many long-term employees and many members of management who just truly love the product, love to innovate. That's hard to compete against overtime if your heart isn't in that space. Apple's heart is in phones in those types of devices and they have gradually let Sonos and Bose and other companies, remain competitive and capture more and more market share.

Chris Hill: Last thing before we move on, what is the metric to watch with Sonos going forward?

Asit Sharma: That's a good question. I feel like the best metric to watch here is the most obvious metric, and that's the revenue growth. This is because again, you go back to what the quarter could've been, if not for supply constraints. They project in over the long term, this mid-teens growth, but it potentially as a conservative estimate. If you're a shareholder, I would watch over the next quarter whether they start to lift up that long-term cadence as conditions improve. That will tell you a lot about their ability to be a successful investment because the bottom line is already in place. They've got great unit economics. They keep their overhead to a very disciplined level. I think this more than looking at numbers of products sold or how some of the non-product service type businesses doing is the best metric to look at. Sometimes the biggest metric is the most obvious, but the best.

Chris Hill: Our email address is [email protected]. Got an email from Mike in Ohio. Writes, when I dropped my son off at school, I have to time my drive so I don't get stuck in the Starbucks drive-through traffic that backs out onto my street. My wife has the time her trips to Target to ensure she can park at least within a quarter mile of the store and I don't even go to Lowe's or Costco on the weekend anymore because I can't get a card and I don't want to wait in the checkout line for 20 minutes. I can go on and on but if everyone is shopping and buying and being good capitalist consumers, why do I feel like the world's falling when I open my brokerage account? Thank you Mike for listening and for the question. I think part of what Mike wrote lays out the case for businesses like Amazon that just delivers stuff to your home. But I get where he's coming from. I had a similar thought yesterday evening. Just walking around Old Town Alexandria and just seeing the hustle and bustle of people in restaurants and shops. Just all of this consumer activity going on, on a Wednesday night and just thinking to myself along similar like boy, if all you looked at was the stock market or your individual brokerage account, you'd be forgiven for thinking, as Mike says, the world is falling apart.

Asit Sharma: Yeah, it's such era of cognitive dissonance, we're a consumption economy and by that measure, things look great and I agree. The Costcos of the world, the Targets of the world, they're all very busy, restaurants, etc. We've been getting out more. There's pent-up demand from the last few years of pandemic. I think you saw this in MasterCard's result because they are a good barometer of consumption and their volume was way up. People want to get out, people want to travel, go to restaurants and spend. I think the dissonance part of it is investors who are like, I know that these companies are going to make more, they're going to rake in more cash because I can see the people too with my own eyes but I'm worried about what it's going to cost these companies to supply those goods.

I'm worried about the rising price of food, for example, which will cut into restaurant margins. I'm worried about the rising cost of gas, which is part of what's happening in Costco if you try to get in. People always try to get in and get gas from Costco when times are bad, which makes it hard on the shoppers. Worrying about the commodity inflation part of earnings is a large part of what's hitting the market. The other two is so much of the market success has been tilted toward those SaaS-type companies and tech companies I was mentioning a few minutes ago. Those are based on future dollars. A lot of them don't have earnings and substantial cash flows now. So in a low interest rate environment, folks are OK with waiting for those cash flows to come in. But when interest rates start to rise, inflation starts to rise, the value of those dollars in the future, they don't look as great. First is profits you can get right now from other types of companies. As those companies have sold off, it's dragged the market down. Now we're getting slow rotation into the types of stocks that our listener's talking about. I think Starbucks is a good example of that, they're down. They've got other problems, some unionization problems and sketchy management over the past year. But this is one of the reasons that Starbucks is down, say 40 percent over the last 12 months. It's because of worries about inflation, rising costs for them.

Chris Hill: We were talking earlier about the supply chain. It seems like most of the past 10 years. Let's just put aside the pandemic for just a moment. I realized that the big thing to put aside, but let's just put it aside for the moment. But if you think about the factors that are out of control of any company's management. In the same way that we poke fun a little bit, once a year there will be a big winter storm and retailers will talk about the impact of it. You can always count on at least one company that wasn't really affected by the winter storm, but they throw that in there as like one more reason why their quarterly results didn't work. What's happening in China is having a real impact on so many businesses.

Eventually, we're going to get past that. You talked about pent-up demand for travel for going out to restaurants, that thing. That's another version of pent-up demand where at some point the supply chain is going to be unclogged and then hopefully all of these businesses that have been rightfully, I don't blame them, rightfully citing the global supply chain is a challenge. Hopefully, they've got all their ducks in a row for when it gets cleared up. Because when that's no longer an issue, God help the companies that can't perform once that's cleared up.

Asit Sharma: That's why there's so much magic in trying to be objective during the pain of a time like this in the markets. Because if you're able to identify companies that are adapting to present conditions and still investing for the future. You do have some companies that are on sale. I'm fond of pointing out that during recessionary periods, if we do go into recession, some of the greatest companies have come to market because they've been answers to higher interest rate, high-inflation environments.

Walmart is an example, McDonald's is an example but it doesn't have to be that model. It could simply be companies that understand, we have to change the way we work a little bit, shift some things around and be very proactive here. I think what you're pointing out is absolutely true. On the backside of that, you are a more vital company, you are stronger so the profit start flowing again and that's when as investor you see the returns on that patience. But it is painful right now. You just got to remember this is a good time and in some ways to invest if you can hold onto stocks as we say ad nauseum here at the Motley Fool for at least a five-year period. I say that with all the love for that concept that did I can have and I do love it.

Chris Hill: Asit, really appreciate the perspective. Thanks for being here.

Asit Sharma: Thanks for having me, it was so much fun, Chris.

Chris Hill: [MUSIC] The gaming industry is bigger than the Hollywood, so why aren't traditional media companies making video games? Reggie Fils-Aime was the President and Chief Operating Officer of Nintendo of America and author of the book Disrupting the Game From the Bronx to the Top of Nintendo. Reggie joined Jon Quast and Ryan Henderson to discuss how he identifies great business leaders, the future of consolidation in gaming, and why a company like Disney has had a tough time jumping into this industry.

Jon Quast: Of course, at The Motley Fool, we're all about investing, finding great companies that we can invest in for the long haul. As I hear you talk, one of the things that is really rising to the surface for me is the fact that leadership is so important in a company and how the culture is formed and how everyone under the leadership performs and how the business ultimately does. I'm just curious, maybe an insight from you. I hate to put you on the spot, but what separates a leader who is visionary, even thinking outside the box, but it's a good vision and then a leader who's just going off the rails. What is something that you look for in a leader, maybe something that you admire in other leaders?

Reggie Fils-Aime: I believe that great leaders surround themselves with people who bring different points of view. People who are unafraid to challenge the leaders' thinking. It creates an environment where positive discourse is happening looking at the business, looking at the opportunity from a variety of different ways in order to move the business forward. I would absolutely agree that the hallmark of not only great companies, but companies that can overcome adversity, companies that can overcome challenges in the marketplace. Typically what you'll find is yes a great leader, but a great leader that's cultivating a great management team that is driving the execution and is driving that overall performance. Look at the management team.

Just don't look at the CEO, look at the management team. I now serve on three public boards. The other piece I would share from an investor's mentality is look at who is on the board and look at who is active on the board and helping the company make the right strategic decisions in moving the business forward. If you look at a company that has a bit of a paper tiger board, they're not very engaged, it's been the same people for 20 years. You will typically find a company that can get itself into trouble. Just to pick on one company in the gaming space. Look at Activision. Activision board largely has been the same people for over 10 years. A company that has stumbled on cultural issues many times with no apparent reaction or no apparent remedy put forward either by the leadership or the board. Now, it's a company that finds itself on the verge of being acquired. It's just an example where looking hard at the leadership, looking hard at the board can give you insight as to whether a business is going to be there for the long term or not.

Ryan Henderson: A follow-up on that, and you talked about the acquisition or the potential acquisition of Activision Blizzard, and we started to see a lot of consolidation, I guess in the video games space. This is something that Jon and I have talked about before. I'm curious whether or not you think that's something that's going to continue, whether we're going to see more bigger acquisitions in the future, or is it potentially a lot of smaller studios? Is there room for that?

Reggie Fils-Aime: In my view, the answer is both. Here's what I mean by that; I do believe that there will be more consolidation among the video game companies. Especially as companies make what I would call strategic acquisitions, bringing a critical skill base or a critical capability to the company. Take-Two's acquisition of Zynga is a perfect example of that. Take-Two, a company with a number of very effective, strongly performing assets, but a company that has not done well in the mobile space. Zynga, very effective in the mobile space. They are bringing some key capability to a company that has some very strong intellectual property. I do believe there will be those types of acquisitions.

However, I also believe that as those acquisitions happen, some very smart, very capable executives, predominantly creators, people in the creative side of these businesses are going to opt to leave and start their own studios. I believe what this is going to create is a magnificent time where smaller studios are going to be born. These are going to be highly innovative companies, people that are creating content that's new and different, taking risks in their content that will bring new innovation into the industry. When you look at some of the top-performing games today like Fortnite and then battle royale approach didn't exist five years ago. It's a brand new area that's been brought forward not only by Fortnite but other games that are similarly in that space. I think we're on the cusp of that type of innovation again, as senior executives leave some of these mega-mergers and go start off their own studios and do things that are unique and highly creative.

Ryan Henderson: I've another question that I want to get your take on it. This is another idea that we've kicked around, where I think that there is beginning to be a bit of a blend between traditional linear media and interactive media. I think we saw that with Sonic, just released a really good movie. I know that Nintendo has plans for their Mario movie. Is that something that you see, maybe these interactive entertainment companies become more and more entrenched in movies as well, and maybe is there room for maybe traditional ones like Disney to move into gaming?

Reggie Fils-Aime: I'll answer your question in two parts. I do believe that strong IP holders will look to take the franchise in a variety of different places in order to best monetize those franchises. I see it as three different pillars. There's a physical play or physical manifestation of the intellectual property, there's the digital manifestation, and then there's the video-based manifestation of that intellectual property. I do believe effective companies are going to explore all the three. I sit on the board of a leading toy company called Spin Master, and their strategy is exactly that, to exploit their world-class intellectual property like PAW Patrol in the video-based space. They successfully launched a movie last year that did incredibly well to leverage it in the physical space. Which they've done historically quite well with physical toys for young kids. Now, they are exploring how to leverage that in the digital space. All three are going to come to bear, and it's going to be those companies with great intellectual property that drive that forward.

The second part of your question though is, if you think about some traditional video-based entertainment companies, what's their ability to enter the digital space? The challenge there is you need to have knowledge and skill in order to do this effectively. Disney, as an example, has been in and out of the video game space for years and years. They got to a point where they were essentially doing deals, working with external development partners because their ability to stay on top of development capability within the video game space was just something that they weren't able to do. I do see that type of activity. Will they themselves recreate an internal studio focused on development for their intellectual property? I think it's going to be tough.

They may do that better by doing a large-scale acquisition and bringing those game development capabilities in-house versus trying to grow it from scratch and do it themselves. Netflix obviously is also experimenting in this space. They've done a number of small acquisitions to start building that type of capability. I think that type of execution is certainly possible, but it's going to take time because it's a very different industry. Ask Amazon who historically has tried to get into this space and only recently has had some success. Ironically, with a game that first launched in South Korea and then was tailored for the Western audience. It's not as easy as it looks to just say I want to be a games company and to do that effectively. [MUSIC]

Chris 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. I'm Chris Hill, thanks for listening. We'll see you tomorrow.