Is This Peloton's Turning Point?

In this podcast, Motley Fool senior analyst Asit Sharma discusses:

• Peloton's second-quarter revenue surprising to the upside.
• A sluggish digital ad market hurting Snap's fourth-quarter results.
• How Snapchat+ could be a potential lever for management to pull.

Motley Fool senior analyst Jason Moser and Motley Fool contributor Matt Frankel discuss the 30th anniversary of exchange-traded funds and how stock investors use ETFs today.

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 February 01, 2023. 

Chris Hill: We've got two stocks going in different directions and special anniversary shout-out, Motley Fool money starts now. I'm Chris Hill joining me today are Motley Fool Senior Analyst, Asit Sharma. Thanks for being here.

Asit Sharma: Chris, I appreciate you having me on.

Chris Hill: Once again, we are in the position of recording before the federal reserve makes its announcements regarding the rate hike and people are listening to this after that news has broken. We're going to talk about the Fed and interest rates later in the week on this show and you and I are just going to focus on earnings results. Let's start with Peloton because shares are up nearly 20 percent because second-quarter revenue came in higher than expected. Next week marks the one-year anniversary of Barry McCarthy being appointed CEO. He called these results a possible turning point. I'm not a shareholder, but I hope he's right.

Asit Sharma: It could be a turning point, Chris. Here we see a company that's cut its cash burn down tremendously just two quarters ago. Peloton burn 547 million in cash. That's negative free cash flow. This quarter it came in at negative $94 million. McCarthy has done, I think a lot of your basic turnaround playbook in pretty convincing fashion. He has changed the go-to-market strategy so forming relationships with companies like amazon.com and Dick's Sporting Goods. He's focused on reducing the inventory that was so bloated and has emphasized that subscription revenue. Subscription revenue this quarter came in at 411 million bucks.

That's more revenue than they took in from selling equipment at $380 million. Why that's important? Well, number 1, it's a trend for the last couple of quarters. Number 2, they actually make money on subscriptions. We have positive subscription gross profit of 278 million bucks. You have a cash burn in gross profit on the equipment side, the connected fitness products side of 43 million. If this trend continues, then conceivably that subscription gross profit can make this a positive business. McCarthy said today, if you strip away some of the extraneous cash flow items, we really weren't breakeven on cash flow or slightly positive if you'd just any number enough, of course, you can get positive as we both know, Chris. But he's got a point there. Yes, this potentially is a floor in all the bleeding we've seen in Peloton over the past several quarters.

Chris Hill: I went back and looked at my notes from a year ago when McCarthy was appointed CEO. Bill Mann was on the show at the time. One of the questions I posed to him was, had you think they brought this guy in to sell the company? In summary, Bill said, "No, I don't think." I think that you look at McCarthy's experience at Netflix and at Spotify, he's, someone who's been brought into try and turn the business around. I'm not a shareholder but I'm glad the results turned out the way they did and the stock is reacting the way it did. In part because even with the pop today, shares are basically trading at half of where they were when McCarthy came in as CEO. I think if they didn't have this a glimmer of light in their quarterly results, I think we would be talking about OK, McCarthy he's on the job for a year. He's done what he can, but it might be time to sell this company to someone else.

Asit Sharma: I think some large companies are still interested, at least sniffing around at Peloton. But he really is managing this company not just to present it for sale, but to make something of this business. Look, Peloton is still a market leader in the connected fitness industry. It's still a really strong brand among consumers. There's no reason that this couldn't be a successful business, whether the stock ever fulfills the promise that it had when it IPOed. There is a bigger point here in that every manufacturing business which this is, has to find its equilibrium point, has to find that profitable equation. It looks like Peloton 2.0 is going to do it by not bleeding so much cash on the equipment and finding a way to keep pushing those subscriptions. They still have a pretty decent base of Connected Fitness subscribers. Subscriptions are over three million unique subscribers. There you go, Chris, like I said, I think there's something here in this business and I think McCarthy, as you pointed out, isn't in the hottest seat now that the seats cooled down some let's see if he can continue this performance over another year.

Chris Hill: Absolutely, three months from now, it's going to be interesting to see if this is a trend or if this was the positive version of a speed bump. Let's move on to speaking of speed bumps, let's move on to Snap. It's shares are down to 13 percent because fourth-quarter revenue was a little lower-than-expected. Average revenue per user was lower-than-expected and probably not a surprise given what we've seen over the last few months in the digital ad space from companies like [Alphabet's] Google that are a lot bigger than Snap.

Asit Sharma: Snap, I can't be the first analyst to have said that. But you have a point, Chris. There's a really pronounced pullback among middle market companies, among enterprise companies to reign in their advertising. That directly affects companies like Snap. Snap itself is more of a targeting advertising company. When you have this double whammy of Apple instituting it's privacy changes and companies just not wanting to spend as much on targeted advertising, I think Snap finds itself in this uncomfortable position. They're already burning cash. Their business model has never yet realized its potential to be a this hugely positive operating model. What we have here is a company whose balance sheet is getting slimmer. You look at it's working capital versus its convertible debt and there's not much room there.

Not much breathing room. You also have a company on the other hand, which keeps increasing its daily active users. Those increased 17 percent year-over-year in the fourth-quarter. They still dominates a certain demographic. They're starting to compete with TikTok. They have an alternative offering and they also have a burgeoning AR business, which something could be a revenue generator in the future. I don't want to try to pull out too many silver linings here because there aren't a lot in this report except to say that Snap has the user base, it's got the engagement over time. Maybe the numbers were a bit off this quarter. The question is, how do you make this model profitable and cash flow generative on per user basis?

Chris Hill: Well, and we've seen this story before within the alphabet empire. For as strong as YouTube is there's a very healthy stretch of time where that was the question around YouTube. People looking at it and say, how can YouTube be as dominant as it is as a video platform and it's still not really the profit machine that Google search is? You said there aren't a lot of silver linings to Snap, and I agree with that. I would also add as one more thing that is not a silver lining is they're still not technically offering official guidance, but they are talking openly about what they refer to as their internal forecast. That forecast is projecting a drop in revenue.

Asit Sharma: Which can't be good for their cash flow. They're few leavers to pull. Let's just briefly talk about one. Snapchat does have a subscription service. It's called Snapchat plus they now have two million paying subscribers. You mentioned YouTube, Chris, that's something that YouTube has done to increase the monetization of its business model. This is an area where potentially they can stabilize revenue a bit, but it's just not growing quickly enough to cover the shortfall. When you talk about a decline in revenue for a company that is barely generating free cash flow, that worries investors.

Because as I mentioned before, it looked, the balance sheet is a little thin, it's 3.7 odd billion of convertible debt on their books at the moment and they're working capital, which I referred to has only an excess of about $300 million. What if the company is subject to this weak economy doesn't have that lift now that Apple's pulled back on its privacy changes? At the same time, you can't grow the other parts of the business quick enough. You can't pull up the subscription-based. You can't get enough monetization out of the VR venture. It's just hard to see where this business starts to gain its momentum unless and until the economy as a whole recovers, then you can maybe see a little bit of breathing room here.

Chris Hill: Yeah, and maybe on some level there, it doesn't make sense to talk openly about this, but perhaps privately, they're just crossing their fingers. The TikTok just gets banned in the united states across the board. That seems like that would be a boost.

Asit Sharma: It would be a boon. I bet a lot of companies where TikTok so probably market share are hoping the same thing.

Chris Hill: Let's be clear. Snap is not the only business crossing it fingers that TikTok just gets banned in America.

Asit Sharma: That's true to the consternation in dread of millions upon millions of teenagers on up and, and some people, even RH, Chris. 

Chris Hill: Asit Sharma, always great talking to you. Thanks for being here.

Asit Sharma: So much fun, thanks a lot, Chris.

Chris Hill: The first exchange-traded funds celebrated its 30th birthday this year. What started with just a few million dollars of capital is now a $10 trillion industry. Jason Moser and Matt Frankel look back on the history of the ETF and how stock investors use them today.

Jason Moser: Hey, Matt. It's great to catch up with you again. We say a lot on these shows, but it's always worth reiterating. We're big fans of index funds and I know that seems maybe a little out of sorts given that we focus primarily on individual stocks here at The Motley Fool for the most part. But our ultimate goal is to help people achieve their financial freedom. Index funds are a great way, a great part of that overall strategy. Index funds, ETFs, exchange-traded funds. Those are just great ways for investors to achieve that overall strategy.

This year marks a special occasion for a special fund, the SPDR, the SPDR S&P 500 ETF exchange traded fund trust, just turned 30 years old this month, Matt. Now I'm older than that fund, I think you are too. But, hey, listen, they grow up so fast. We thought it would be a good chance to dig a bit more into exchange-traded funds, ETFs, dig into their history, what they are, why they are often a great option for investors, both passive and active. To kick this conversation off, let's just start with the very basics. What is an ETF and who started this?

Matt Frankel: Yeah. The first part, an ETF, it's a way for investors to buy a whole bunch of stocks with one single investment. If you buy an S&P 500 ETF, you're buying all 500 companies that make up that index. They trade on major exchanges just like shares of stock, that's the biggest difference between them and mutual funds. You mentioned index funds a lot. Most ETFs are index funds, meaning that they just passively track an index, but they don't have to be. There's a lot of active ETFs out there as well. The Cathie Wood, the ARK Invest ETFs are a really good example of that. They are a mutual fund alternative, if you will, that just trades like a basic stock on the Stock Exchange.

Jason Moser: You said the word, they are getting a lot of people are very familiar with and that is mutual, mutual funds. I grew up in the age of mutual funds and I'm sure they were very popular offering early on in your investing career as well. We've certainly seen a pivot here over the last several years away from mutual funds toward more index fund investing, exchange traded fund investing. Let's talk a little bit about the advantages and then the disadvantages. Let's go with the bad news first. What are the disadvantages to actually investing with exchange-traded funds? Or are there any disadvantages?

Matt Frankel: Well, first of all, mutual funds are still very popular. There are about three times as much assets invested in mutual funds as there are in ETFs even today.

Jason Moser: Wow.

Matt Frankel: The big reason is that's the main choice of retirement plans and things like that. Those are mostly in mutual funds still. But there are some disadvantages as opposed to individual stocks. Most exchange-traded funds are just designed to match an index's performance, not beat it, which is the goal of investing in individual stocks. There's always some expense or fee that comes with it. Now with a lot of index funds that's very small, but it's still more of a few than you're going to pay to develop your own portfolio from scratch in a brokerage account.

There are a few disadvantages. Another one is that most ETFs are weighted, meaning that they can be very top-heavy. The S&P 500 ETF that you mentioned has 20 percent of its assets in just seven companies. It could be very top-heavy. You're putting a lot more of your money in the biggest positions in a given index fund. But those are just minor disadvantages. For the most part, these are actually really great investment products.

Jason Moser: Well, what are some of the advantages with them? Because it feels like you run across every day a new theme. As we see new themes develop the investing world, I think a lot of that is dictated by technology, but it does seem as if we see new ETFs coming online every day that are following some theme. At least one of the advantages to me, it strikes me at least that maybe there's a little bit more choice for investors in the thematic investing. You have a little bit more opportunity to chase the things that you're really interested in, and that choice didn't really exist before. Is that a fair assessment?

Matt Frankel: Yeah. That's definitely an advantage. The biggest advantage in my mind is that you don't have to worry about your investments as much as with individual stocks. This whole episode is about the history of ETFs. I want to give a one-minute history lesson.

Jason Moser: Okay.

Matt Frankel: ETFs as you mentioned, started in 1993, they just turned 30. But they didn't really gain steam for the first decade or so. The reason that they ultimately wound up getting popular is because of the dot-com crash. Investors didn't want their money tied up, all invested in one or two or three individual stocks. They wanted to buy the tech sector for a long-term investment. We went from having about 80 ETFs in 2000 to 2,700 ETFs today.

Jason Moser: Wow.

Matt Frankel: That momentum really took off after the dot-com crash, and it's because it has that benefit of you're not investing too heavily in any given stock. You're just trying to match the market or the sector's performance over time, which after a big crash like that really showed its appeal.

Jason Moser: Yeah, no kidding. Well, how do you recognize, you mentioned earlier the expense side of things. I just want real quick for investors to be able to, if they're interested in looking more into the expenses that are involved with something like this. How do you find out the expenses associated with investing in a mutual fund versus an ETF? What is that called where we look for that information?

Matt Frankel: They're both pretty easy. There's two main ways to do it. Number one is you could go to the ETF providers page. If I go to Vanguard's website, and type in Vanguard S&P 500 ETF, it gives me a whole fact sheet and one of the top lines on there is the expense ratio. The alternative is just log into your brokerage account, type in the ETF's ticker symbol, or just look for it in the search tool, and you can find the expense ratio that way. It's usually like I said, one of the top things listed just because it is a big differentiator between different funds and ETFs.

Jason Moser: Yeah. Well, it does feel I mean, they started the segment here I did mention. We focus a lot on individual stocks right here at the Motley Fool, it's what we do for the most part. But by the same token, I would be willing to wager that all of us on the investing team, we like ETFs. I think most of us do. I think probably most, if not all of us actually own ETFs in some capacity too. They are excellent parts of your overall portfolio. They give you that instant diversification and can help you sleep at night, which is what we often say is like you want to own stuff that helps you sleep at night. But ultimately, do you feel like ETFs are a better option than individual stocks? Or is this really, you need to have both? Every money should own them along with individual stocks. Is it one or the other or really should we be focused on the activity?

Matt Frankel: Both. ETFs can be a great way to create a backbone to a portfolio. I feel more comfortable having money in individual stocks if certain percentage of my assets are just in an S&P 500 index fund.

Jason Moser: Sure.

Matt Frankel: But they're also better than individual stocks in certain senses and specifically to invest in things you're not necessarily comfortable with analyzing individual stocks. I can give a personal example is I have no idea how to evaluate biotech companies. I use an ETF to invest in that part of the market. They could be better than individual stocks in that way. As opposed to going outside of your circle of competence and investing in things you're not comfortable with. I liked them for that reason, bonds, especially. Who wants to go buy individual bonds? The ETF round is actually better than the individuals in that respect.

Jason Moser: Yeah. I'm glad you brought that up. It reminds me of a recent piece of content I published in my next-gen super-cycle service, the 5G service. I'll pull the curtain back a little bit here. I don't think I'm giving too much away, but we have a radar stock feature every other month. I introduce a radar stock feature, it's not a recommendation, but it's a stock that's on my radar as something that I'm interested in. In this past month, I actually introduced an ETF as a radar stock that was focused on cybersecurity.

The basic idea is listen man, cybersecurity is tough. I am fully not an expert on it. In furthermore, it feels like that's a market that just is constantly changing as the threats constantly evolve and as tech constantly evolves. I saw that ETF as one way for investors to consider investing in cybersecurity without having to try to place all of their chips, so to speak, on one horse. I don't know, it just seems like it's a very difficult space to pick one winner when you probably have a few that are going to help drive performance there.

I found, again I didn't recommend it, maybe I will, but it did seem like an ETF in the cybersecurity space was perhaps one way for investors considering getting some exposure there. Speaking of exposure, I guess before we leave today, I wanted to just ask you, are there any recommendations out there? Do you have any recommendations for ETFs beyond the SPDR, beyond this S&P index fund that's celebrating its 30th birthday? Is anything out there on your radar? Anything? I'm sure it's probably something real estate-related, but I'd figured, I'd check.

Matt Frankel: I don't know why you would think that. I'll give you three. Two Vanguard funds in particular like the VYM, which is the high dividend ETF. It's above the average dividend payers, companies like Exxon, and Microsoft, I think is one of them. Companies that pay above-average dividends, if you want yield plus growth potential, that's a good one to look at. The VNQ is the real-estate one that you just mentioned that invest in the rate index. It could be a great way to diversify your portfolio away from stocks, just because real estate and stocks don't really correlate too well.

Third is a ticker symbol called RSP. It's an equal-weight S&P 500 ETF. The benefit of that, as I mentioned, that a lot of ETFs can be very top-heavy. If you buy an S&P 500 ETF, like the SPDR, 12 percent of the assets are in Apple and Microsoft alone. What an equal weight fund does, it takes your money and invest it equally in all 500 companies, eliminates the top heaviness. That's one to look at if you don't like the concentrated nature of weighted ETFs.

Jason Moser: I love it and I'm not going to leave listeners hanging. Just so that we're clear here the radar ETF that I announced last month and the services, the NASDAQ First Trust CTA Cybersecurity index. It's a mouthful. The ticker is C-I-B-R. Again, not a recommendation, but certainly something I'm digging in a little bit more to as far as looking at the cybersecurity space. 

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.