In their latest episode of the VALUE: After Hours Podcast, Tobias Carlisle, Jake Taylor, and Alex Morris discuss:
- Energy Drink Wars: How Celsius, Monster, and Red Bull Target Different Audiences
- Dollar General vs. Dollar Tree: How Are They Handling Today’s Economic Pressures?
- What Bears Can Teach Investors About Surviving Market Crashes
- The Hidden Danger of Weekly Data in Long-Term Investing Strategies
- Lessons from Wall Street’s Four Great Bottoms
- Is Home Depot’s Recent M&A Strategy a Game-Changer or Just a Trend?
- ScottsMiracle-Gro’s $1.5 Billion M&A Misstep
- Floor & Decor’s Expansion Strategy
- The Benefits of Less Frequent Financial Reporting
- Can Fever-Tree Become the Next Monster?
- ScottsMiracle-Gro’s Cannabis Bet and Its Future Potential
- Energy Drinks Under Pressure
You can find out more about the VALUE: After Hours Podcast here – VALUE: After Hours Podcast. You can also listen to the podcast on your favorite podcast platforms here:
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Transcript
Tobias: This meeting is now livestreaming. That means its Value: After Hours. I’m Tobias Carlisle, joined, as always, by Jake Taylor. Special guest today is Alex Morris,-
Jake: THE-
Tobias: -Science of Hitting.
Jake: -Science of Hitting.
Tobias: How are you, Alex? Good to see you again.
Alex: Hanging in there. I was a little scared a week ago markets were– I thought we were done for, but we hung on. We’re still alive.
Jake: [laughs]
Tobias: What was the cause?
Alex: I have no idea. The markets started going down and then they went up again. So, we’re fine. It’s all good now.
Tobias: Well, we’ve got that inversion coming up at some point in the future. [laughs]
Alex: I feel like I’ve heard about this before. I’m ready.
Tobias: Yeah.
Jake: Are we still un-inverted now, Toby, or did we reinvert? How’s that work?
Tobias: I hesitate to talk about it, because-
Jake: Oh, come. No.
Tobias: -it’s made me look so silly for so long, but still inverted. Longest inversion in the data.
Jake: I thought we un-inverted.
Tobias: The 10:2 un-inverted. That’s the sparkling white wine of–
Jake: That’s not the-
Tobias: It’s not champagne.
Jake: -champagne. I got it.
Tobias: 10:3 is champagne.
Jake: And that one never did.
Tobias: It hasn’t come close. It’s still very wide. I had a look at the two legs of it. I had a look at the yield curve, and the yield curve is still pretty inverted. But they just seem to have come down a little bit with all this recent talk about a cut. Who knows?
Jake: The frontend has come down.
Tobias: The front has come down, so is the 10. I don’t know what’s going to happen. [crosstalk] I’ve sworn it off a little bit. I feel bad about talking about it so much. It’s probably going to un-invert, and everything’s going to collapse and then I could have been right, but I got no idea. [crosstalk]
I don’t even understand the bottoms up. Actually, we’ve got some good topics for today, because Alex has done some research in energy drinks. There was a great tweet from– I don’t know if it came from Ian Cassel’s account or if it came from one of his other accounts, but he had a good insight into Monster, which Monster had this– Everybody knows Monster had this famous run.
Jake: Monster run.
Tobias: Monster bene– Yeah. [chuckles] When I first met my mother-in-law, and this is a long time ago now, maybe 20 years, when she had the Hansen’s Natural beverages, which is what it used to be, and I was drinking those. If I bought it at that point, I definitely wouldn’t be doing this now.
[laughter]Jake: There’d be no podcast.
Tobias: But I’d have sold Monster at every single point along the way too. So, it’s not like I would have bought it and held onto it either, but he pointed out in this tweet that the two founders, after they– It was dead money for 11 years, and it went on this little run, and they punched out like most of their shares at that point, because they were worried like everybody else was. Coke’s out there, Pepsi’s out there. You finally got a little win, you got to take it. And then, it’s run up 14,000% since then.
Jake: Oh. And they knew exactly what they had the whole time, right?
Tobias: It couldn’t have been closer to it than they were.
Jake: It’s a hard game.
Tobias: It’s a tough game. Yeah.
Jake: Jeez.
Tobias: On that, Alex, let’s talk about energy drinks. What do you think? What’s happening?
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Energy Drinks Under Pressure
Alex: Yeah, on that point, I think one of the fascinating parts of the story which definitely ties into Celsius is the deal that Monster ended up doing with Coke in 2014, where there’s a quote from a Coke exec, I think was at 2012 or 2013 conference, where he effectively said “Those big drink guys had started to play in these other categories, and their ability to actually do it successfully either organically or through M&A was definitely not proven. I think they finally came to the realization that their distribution system and their core businesses where they should play and they should find other routes to participate in these categories.” In this case, specifically, Coke now owns 20% of Monster. I think the deal at the time was 4%. Just shy of 17%, but they’ve held on through share purchases over time.
So, long story short, they own 20% of something that’s worth, I think, $50 billion or so. It really was an evolution of the approach that they had taken previously. And now, you’re at a point where Celsius has somewhat of a similar setup with Pepsi that people were very, very excited about when it happened. And now, we’re going through a part of that relationship that’s a little bit more challenging in terms of stocking issues and some other stuff.
But a lot of it ties into, at the end of the day, in my opinion to the end market dynamics that are happening. Monster put it well in their last call where they effectively said, “In terms of what we’re seeing in the US, we’ve seen two periods that were as tough as this. It was basically COVID and the financial crisis. And outside of that, this is really unprecedented in terms of the energy drinks category.”
What exactly is driving that is somewhat difficult for me to understand. I can appreciate for a certain segment of customers, which is probably where Monster is more referring to where they play, but it’s also being felt pretty generally in the category, if you look at scanner data and things like that. So, it’s a fascinating time.
If you look at Celsius, the stocks at low 30s, I think, and it was at, I want to say, 90 or so not too long ago. Monster’s come under some pressure, but they’ve also been pretty active in terms of repurchasing stocks, something north of $3 billion in the last couple of months. So, there’s a lot of movement happening right now. If you can figure out the answers going forward, then you’re going to make some money.
Tobias: We’re going to solve them right here, right now.
Jake: Yeah. So, people aren’t buying as many energy drinks right now is what you’re saying?
Alex: Yeah.
Jake: Okay.
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Energy Drink Wars: How Celsius, Monster, and Red Bull Target Different Audiences
Alex: There’s tons of competition in the category for one. I think what they’ve said specifically is that C-stores are the ones that are showing the most pressure at the moment, which again, you can obviously think about what’s a purchase at a C-store and what’s the consumption occasion for that versus what’s the purchase at a Costco or a BJ’s or a Sam’s? What are the different dynamics that play into that? So, it certainly feels like there’s some macro pressure on the lower to middle end that is having acute pressures there right now. We’ll see if it expands further over time.
Jake: It’s a K-shaped argument or like bifurcated economy argument.
Alex: Yeah. The other hard part of it too is Monster has a portfolio of brands which partly gets back to the Coca Cola deal. One thing that I’d argue they’ve not done great at is figuring out how to play in the sugar-free category and really a brand response to something like Celsius. They have two brands in Reign and Bang that compete there, but those have not been particularly successful. And now, you’re seeing Alani Nu, which I would say probably plays closer to that category than Monster, is starting to take some share. So, there is a portfolio specific risk for them that I still think they’re not totally well positioned in terms of where the category continues to go.
Tobias: Why does somebody drink Celsius versus say Red Bull versus say Monster?
Alex: I think a lot of it is just branding and how their position includes packaging, includes what’s communicated to the customer in terms of the brand attributes, whether it’s– For example, Reign uses clean energy as the brand tagline that they use, which is in my mind very much trying to compete with the Celsius brand positioning.
Monster starting play– getting back to what you were saying 20 years ago, they’re starting playing in the US market was, “Hey, we’re seeing Red Bull is very successful with these–” I guess they’re probably nine-ounce cans. They were like, “Our cans will be double the size and comparably priced.” So, that was their kind of brand positioning. Just get a lot for your money. Obviously who they targeted with that brand has evolved more over time, but it’s a very different audience than Celsius or some of these other brands.
Tobias: Celsius, an office worker? Is it white collar?
Alex: Yeah, I think they skew– [crosstalk] They’d probably skew more college graduate type of thing. They skew more female. Yeah, they have a certain skew to who they go after that is probably pretty close to the opposite of the Monster brand to the extent that you can say that within the same category.
Tobias: Do you know if the whole category is growing, or is there some cyclical contraction as we’re going through, whatever we’re going through, a little bit of weakness or something?
Alex: Yeah. No, the whole category has come under pressure as of late. So, I have some data on my most recent write up, but I think it was the categories basically flat in Q2, which again is just something that has not been seen in the energy category for quite a while outside of effectively COVID.
Tobias: The way that is people just not spending as much money or going into something else where there’s just too much competition. Well, that doesn’t answer that question.
Alex: Yeah, I think a lot of it is– This is partly a conclusion drawn from a lot of the other companies I follow, Dollar General and Dollar Tree being two examples. But many others, I think there’s just a certain segment of the customer base that the pressure of inflation and broader macro factors has potentially just hit a breaking point where can’t handle anymore. It’s showing up in terms of somewhat discretionary purchases, something like pulling into a gas station at 08:00 in the morning and paying 3 bucks for an energy drink. Maybe you skip that once a week where you wouldn’t have previously. I think it’s probably something like that.
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Dollar General vs. Dollar Tree: How Are They Handling Today’s Economic Pressures?
Tobias: What do you see when you look at Dollar General, Dollar Tree?
Alex: I think it’s a very interesting situation for both of them. I think you can start with– We’ve come through a period where I think objectively, if you shop at either of those stores, which I do as much as possible– It’s easier for me to shop at Dollar Tree than it is at Dollar General, given where I live. There’s been a move towards the consumable side of the business, and there’s also been pressure in terms of how much volume moves to these stores, and then as a result of that, how much they can invest in whether it’s maintenance, CapEx, labor, etc., which obviously all that has an impact on shopping experience, how they’re responding to that and what’s happening at this moment.
Again, I think if you take them at their word, I think Dollar Tree CEO specifically said– He was the former Dollar General CEO, by the way, back in the, call the, early 2010s. He basically said, “This is the most challenging period that they’ve ever seen for their poor customer.” Dollar General’s commentary is very similar to that.
If you compare it to a period like, call it, 2007, 2008, 2009, which I did in my most recent write up, my conclusion from looking at that period is you do have an interesting starting point in that window where these guys results roll over a little bit or become weaker somewhat unexpectedly and unexplainably, particularly when you look at–
Someone like a Walmart was still putting up fairly decent results at that time, but then as you saw that roll through their perspective of, “Hey, we win,” as people trade down, as things really get difficult. We may get hit on the frontend, but we can benefit in some ways as that expands further to a different consumer base. That showed up during call it the financial crisis period. Whether or not this is similar to that, obviously, we’ll see over time.
But it is interesting. If you just look at that starting period and call it mid to late 2007, these guys started to see their results get hit in a way that was a little bit different than certain other retailers. So, again, we’ll see if there’s any correlation between those two things. It’s hard totally understand exactly what drove that, but it is what happened last time around.
Tobias: You see those guys as canary’s in the coal mine potentially?
Alex: Dollar General talked about an average household income of $35,000 to give you context what we’re talking about here. Especially, as Walmart’s done better on things like omnichannel, either delivery to your home or buy online pickup and store in the parking lot. They’ve moved up the income levels where they play at.
I personally think it’s fair to say that they serve a different consumer than what Walmart does on average. But again, as always, you can point to macro stuff when macro may be a part of it, and there could be competitive stuff going on as well. It certainly serves your narrative better if it’s just a macro issue as opposed to a competitive issue.
Tobias: Yeah.
Jake: Yeah. Or, [Alex laughs] internally screwing something up. “That wasn’t our fault. That was–”
Alex: Weather a macro are a lot easier to blame than something that you’re doing. [chuckles]
Tobias: I’ve tracked large cap, mid cap and small cap earnings since COVID. It’s definitely the case that large cap suffered along with everything else, but then bounced and found new all-time highs pretty quickly and really hasn’t looked back–
Jake: Earnings wise?
Tobias: Earnings wise, yeah.
Jake: Okay.
Tobias: Also reflected in the stock prices, but
Jake: Yeah.
Tobias: -did certainly, in the earnings and the margins. Mid has gone sideways and small is really down. They got whacked in COVID, and then hasn’t really got off the mat, still trending down. I think that all that is reflected in the stock prices. The stock prices are high at the high end and squashed at the low end.
Jake: Yeah. I know interest expense definitely mattered more for the low end.
Tobias: Yeah.
Jake: They borrowed shorter and just didn’t lock in long-term like the S&P 500 did.
Tobias: Not locked in. Got to get locked in.
Jake: Got to get locked in.
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Can Fever-Tree Become the Next Monster?
Alex: Yeah, I see it at a company. It’s not totally this, but a company that I own, Fever-Tree, basically a small, call it, mixer business, a drinks business. But just purely in terms of what they went through during the pandemic and the supply chain issues that they faced and the input cost pressures that they faced, and thinking about where their production is and how they get product from where its created to where it’s actually sold, you just appreciate– And again, we’re talking four years later now.
You get a real appreciation for how managing that business versus how Coca Cola has to navigate that situation in terms of, “Okay, hey, we’re getting word that there’s a shortage of cans.” Well, [chuckles] I think that supplier knows whose call they’re taking first and whose call they’re taking last.
Jake: Yeah. More Coke. You’re taking the call.
[chuckles]Alex: Yes. Their ability to deal with things regionally or otherwise is also very different obviously given the breadth of the business that they have. It just really helps you to appreciate how challenging it can be to go through something like this. I think the other reality of it all is these things are somewhat– They come in different versions, but these things are somewhat more common than we to believe at times. So, it’s– [crosstalk]
Tobias: You still hold Fever-Tree?
Alex: Yeah. I still hold Fever-Tree.
Tobias: My wife is a big fan of those mixes. Is thesis still intact there or you like it where it is?
Alex: Yeah. One of the hardest parts of thesis is, again, we’re four years past the breaking point or something close to the breaking point on the margin story. The margins remain well below where they were, call it, five years ago. Profit margins are, even if you’re looking at next year, still well over 1,000 basis points below where they were in, call it, 2018, 2019. Part of that is–
Jake: What’s eating up the margin there? Is it like–?
Alex: I think they’ve become a much bigger business in the US and their position historically was in the UK. But again, as they built that out, you have the question of, “Okay, well, how do we actually do this? What was that look like?” For a longtime it was produced in the UK and shipped. They got absolutely demolished on that in terms of the cost structure during COVID. I think since that’s happened, they’ve batted around what’s the right answer to this? The tricky part of it all is its partly dependent on how big the business is going to be over time. You have to balance these different variables.
So, in terms of their consumer mind share, market share position and the core business, it continues to be pretty strong. They have some smaller competitors who if they’re going through this, you can only imagine what somebody who’s maybe a third of their size is going through. So, that part of it all is, I think, potentially workable. Again, we’re four years on and there’s a lot of recovery left to still be achieved.
Now, the other part of it is they become more focused over time on, one is premium adult soft drinks for lack of a better definition, and then also Cocktail mixers, like Margarita mixer, Bloody Mary mix, Espresso, Martini, like that type of stuff where again, in my mind, the brand translates really well to those categories, but it’s still an issue of those might be different packages, they might be different pack sizes and you have to address all these issues again and you have to build– You’re still building brand awareness in the core range, let alone these things that are tangential to that. So, it just gives you a lot of appreciation in my mind for being small, and trying to become large and the world that you’re playing in is, it’s very difficult.
It helps you to appreciate why if you’re Monster and you have these fantastic stock returns. Well, go back to 2005 and read the annual report and think about what it was like owning it at that point in time and how confident you were that they were going to even do well over time, let alone generate absolutely massive returns. So, I think it all makes sense when you step back and look at it through that lens.
Tobias: Appropriately discounted at that point.
Alex: Yes, hopefully, this is the next Monster, but I’m not going to hold my breath. [laughs]
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Floor & Decor’s Expansion Strategy
Tobias: What about something like Floor & Decor? I’m interested in talking a little bit about that housing market generally, but what are your impressions?
Alex: Yeah. I think my main impression of Floor & Decor is I find it fascinating. I don’t totally understand that the stock. I mentioned this earlier. The company had an investor day in 2022, and they set profitability targets for– They had it in, I believe it was early 2022 and they set profitability targets for 2022, 2023 and 2024. As we were now getting towards the back half of 2024, the guide for this year on profitability is, I believe, it’s right around half what they projected the profits were going to be this year. If you look at the stock price, I think it’s actually up a little bit from the day that they held that investor day. So, obviously, you can–
Jake: And good news, your valuation doubled. The bad news, your earnings– [chuckles]
Alex: Yes. Or, the market really, really, really did not believe them when they gave that investor day. That would maybe not be a good interpretation though. But I think the market to some extent is willing to look through what’s currently happening and is still confident, I guess, on the broader housing story and the ability of people over time to make those investments in their homes. As someone who lives in South Florida, and looks at what’s happened with prices here and thinks about the cost of buying versus renting and things like that, thinks about what that would mean if you were making $50,000 a year or something, it’s incredibly daunting to think that someone is in a position to buy even if prices were 10% lower or something like that.
So, I don’t know. We’ll see how it shakes out from here. I don’t do too much investing based on like, “Hey, here what’s going to happen in the macro stuff.” But I look at their setup and I wonder how it can get significantly better in terms of the backdrop, but maybe I’m missing something.
Tobias: So, what’s the Floor & Decor story?
Alex: The main story is basically that they looked at a Home Depot type of setup and go, “Hey, you have two aisles of flooring here. Let’s just make a whole store of that and we’ll have much more selection. Over time, we’ll have basically better scale. We’ll have the ability to service that customer in a way that Home Depot basically can’t.” Home Depot will be fine with that, because Home Depot, that isn’t their business effectively. They’re playing a much broader game. Flooring is like– I post a chart every once in a while. It’s like 6% or 7% of their sales and they are probably happy to sell whatever 50 SKUs or something that they have in the store.
Floor & Decor has 20 times as many SKUs and they can serve a bunch of different uses that Home Depot doesn’t want to and can’t serve. And then, they also compete with independents who, generally speaking are probably going to have a tough time over time competing with someone like that on price. So, they see themselves as a category killer and they think there’s an opportunity to open a lot of stores over time. Then you run into the reality of a situation like this where the financials are a little more pressure than they were previously, and it makes sense given what you’re seeing in housing turnover and things like that, but that all starts rolling through, “Okay. AUVs are under a little pressure, margins are under a low pressure, the store growth strategy is going to slow down a little bit from here.”
I see this in other retail names that I own that unfortunately, unlike Floor & Decor, they all go down a lot when this stuff happens. Floor & Decor just hangs in there, but that’s all right. But yeah, it’s the normal thing that happens when you have this type of slowdown. But yeah, the market continues to be confident that this company is a category killer over time and is playing in a good spot, which I think maybe true. I think the question that’s relevant to me is what is normalized even look like here and how do you get there? How long does it take to get there? The answers that people were saying 12 to 18 months ago have been proven wrong so far. But we’ll see from here.
Jake: Where were people getting all of their flooring needs met before? It’s not like flooring’s this new thing that we just invented?
Tobias: Don’t forget the Decor.
Jake: And Décor. Sorry.
Alex: [laughs] Yeah. Home Depot and these guys have had, again, they have a decent sized business there. Floor & Decor is still fairly small. I don’t know off the top of my head, but I want to say they have like 200 stores. So, they’re still fairly, early in their journey and there’s a bunch of independents and other things that have ceded a good amount of share over time.
Jake: So, the mom and pop are you the ones suffering from relatively?
Alex: Yeah. There’s still a good chunk of them in the market. Obviously, as you can expect as we’re just talking about on something like a Fever-Tree, you can imagine what life was like for them during 2020, 2021, 2022.
Tobias: What does that business look like through a cycle? It tends to go with the housing cycle, people spend the most time?
Alex: Yeah. Don’t quote me on this, but I think they say the variables that they’re most exposed to are turnover, which has obviously been killed. And then, I believe they would say something like mortgage rates or other– I guess, factors that would really just play into that at the end of the day. So, that’s where a lot of their remodel activity comes from. They’re still seeing it now. But they say things like what used to be a project of X size is now just one smaller room or something where it’s 20% of the size of what it would have been before. Obviously, that flows through the business over time.
Tobias: Because it’s been this weird market where people can’t sell their existing homes, so the home builders have had a bit of an advantage, because they can buy down, do whatever else. And so, they’ve been doing fairly well. Floor & Decor doesn’t sell to those into those guys. They sell to people who are doing their own– [crosstalk]
Alex: Yeah. It’s more so existing. They have some commercial businesses. As far as I know, it doesn’t play a ton in the new residential build market. That’d be more of a commercial relationship that they would play into there. But yeah, it’s fascinating. Again, as someone who’s in South Florida and seen this from an interesting perspective–
I had friends who were trying to buy four years ago or three years ago and they felt like they were super late and prices are probably 25% higher than they were then. It’s been insane. But I don’t know how the marginal buyer does it from here if they’re “normal person,” but I don’t know.
Tobias: Lower rates, lower prices.
Alex: Those would help. [laughs]
Tobias: Higher incomes.
Jake: Something’s got to give, right?
Tobias: That answer is easy. Ask me a hard one.
Jake: Yeah.
Alex: [laughs] Yes.
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Tobias: Let me give some shoutouts to all of our listeners. Make this podcast sound much bigger than it actually is.
Jake: All 10 of them.
Tobias: Bellevue. Nova Scotia. Miami. T-dot. Arlington. Dubai. Toronto. Santo Domingo. What’s up? Savonlinna, Finland. Lausanne, Switzerland. Haifa, Israel. Tallahassee. Cincinnati. Mendocino. Jupiter, Florida. Brandon, Mississippi. San Diego. Cromwell, New Zealand. Nashville, Tennessee. Petah Tikva, Israel. Milton Keynes. Billy’s in the house. Bogota, Columbia. [chuckles]
Jake: Brew dawg.
Tobias: Dickshooter, Idaho. Do you guys know that place? Ballynamullan, Ireland. Ciaran McCoy. Jhapa, Nepal. Edinburgh. Old Trafford, Manchester. Some good spread here. Boston. Valparaiso. Mac in Valparaiso. What’s up? Queenstown. Gothenburg. Andhra Pradesh, India. Winter Park. Philly. Pete Snohomish. [chuckles] Poland. That’s amazing. Palestine. Amazing. Oh, it Samson. You’re in Dubai. Amazing. What a spread. JT?
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What Bears Can Teach Investors About Surviving Market Crashes
Jake: Should we just do veggies? Yeah.
Tobias: Yeah.
Jake: Let’s do it.
Tobias: Let’s do veggies.
Jake: Let’s do it. All right. So, given that we are an investment related show, and that people seem to enjoy the veggie segments that are about animals the most, for some unknown reason, it’s surprising to me, at least–
Tobias: The sperm whales one.
Jake: The sperm whales, mostly. Yeah. It’s quite surprising to me that we’ve never done a segment on bears before. So, we’re going to fix that today. There are eight species of bear in the world. These include the American black bear, the brown bear, polar bear, Asiatic black bear, sloth bear, giant panda, Andean bear and the spectacled bear, which I had to look that one up. It’s in South America. It looks like a cross between a bear and a raccoon.
So, each species has adapted to its environment in different ways and leads to a very wide range of behaviors, diets, physical traits, etc. Bears are omnivores. As everyone knows, they eat plants and animals, and fruits, nuts, insects, fish, small mammals, the occasional human, but not too often.
Some species, like the polar bear, primarily eat meat. The giant panda mostly consumes bamboo, so quite the range. They possess remarkable physical strength. Grizzly bear can lift over 500 pounds, yet still run at speeds up to 35 miles an hour. So, basically, a bear could catch and eat Usain bolt while also lifting two and a half times his weight. So, it’s rather impressive.
Not all bears hibernate, but those that do, like the American black bear, can enter a state of torpor where their body temperature drops, their heart rate slows down to eight beats per minute and they could survive without eating, drinking or excreting for months. Of course, this is a crucial adaptation for when resources are low, typically in the winter. We’ll tie back into this a little bit later.
Bears communicate with each other with a variety of sounds, including growls, grunts, roars and even moans. I’m not sure you want to be around when that’s happening,-
[laughter]-because they probably could have their way with you if they wanted. But they also use body language, like posturing and facial expressions, to convey messages to each other. Of course, they use pheromones to mark trees and signal their presence to other bears. Bears have an extraordinary sense of smell, like one of the best. It’s seven times better than even a bloodhound, which is pretty far off the charts. They can smell food up to 20 miles away, which is 21,000 times better than you and I, our sense of smell, and maybe even more than that if you had COVID and lost your sense of smell.
So, they’ve got excellent long-term memories. They can recall locations of food rich areas even after they haven’t been there for years. Of course, they come in a variety of sizes. The smallest is the sun bear, which weighs between 60 and 150 pounds, while Kodiak and polar bears can weigh up to 1,500 pounds. In the wild, they live typically for 20 to 25 years, but sometimes more. In captivity, they can live even longer with fewer threats and more regular food.
So, all this bear talk was inspired by a book that I reread recently by this financial historian named Russell Napier, who’s actually one of my favorites to listen to. It’s called Anatomy of the Bear. It was written in 2005. What he does is examine what it’s like in the heart of a bear market. Including he takes a bunch of clippings out of the Wall Street Journal and assembles them so you can put yourself into what the news flow felt like in real time during these historical periods when, obviously, none of us were around for probably the 1921 one.
So, he specifically looks at four different bear markets, 1921, 1932, 1949 and 1982. He chose those four, because they produced the best subsequent returns in the century. So, I figured it’s probably, psychologically easier to study bears while you’re still riding a bull, and before there’s something goes wrong, and you have something that’s super strong and fast scratching at the door.
I thought it’d be interesting, before we get into the anatomy of the bear, to explore a little bit of what Napier does is he gives you some context of what came up before the bear market started. And so, we’ll look quickly at the 1920s boom, and maybe give you some stuff that you didn’t know about that as an example of what’s in the book. So, specifically, he goes through the economy, the corporate earnings and the Dow in this case. Effectively, he’s teasing apart the changes in the underlying fundamentals and markets over the roaring 1920s.
So, I’ll give you some narrative with these numbers. Commodity prices actually fell a lot due to technical advancements and coming off of the highs of World War I demand. So, there was a lot of demand for really everything when you’re creating war material. So, the total value of mineral products, so basically, like all physical production during this 10-year span in the 1920s shrunk by 19%. But the total volume produced increased by 43%. So, basically, like, volume up but prices way down. This caused the wholesale price index to fall by 5% per year for the decade. So, imagine that. Your purchasing power growing by 5% every year. The Keynesian horror of it all. [laughs]
Real GDP grew 4% per year, which is quite good historically. What did that GDP look like? Like, what are we talking about? Basically, we all started really generating a lot of electricity, building houses, pumping oil, driving cars, smoking cigarettes and trading stocks. So, a little bit of like– Here’s the 10-year CAGR numbers for those things. Electricity production, 8% per year, which is a double over a decade. Housing starts 8%. Crude oil production, 10%. Vehicle registrations, 13%. Cigarettes produced 11%. Stock market volumes, 11%. Corporate earnings, quite strong at 7%.
But the enthusiasm for those earnings as expressed by the price of the Dow Jones industrial average was the fastest growing of all the data in the data series at a 25% CAGR from the 1921 low to the 1929 high. So, as always, people took something good, and then they extrapolated it too far. Interesting to note though, the government spending during that time period and public deck actually went down in the decade. I didn’t even know that was an option that we could do.
Tobias: [laughs]
Jake: All right. So, here are the seven hallmarks of these four generational bottoms that Napier explored. Hopefully, maybe this can help you to recognize if we find ourselves in another one. This is what the height of the bear looks like.
So, number one is cheapness. He references the Q ratio, which is basically looking at the price versus the replacement value of the assets. It fell below 0.3 times in all four of the bear markets that are studied. Basically, there’s a bunch of 30 cent dollars laying around. He also looked at the CAPE ratio, but it has a wider range. 4.7 in the low of 1932, 11.7 in the 1949 one. So, not quite as like definitive as like a 0.3. Equities become cheap slowly. This might surprise you. On average, it took nine years for equities to move from PQ ratio to trough. 1929 to 1932 is the outlier in that whole thing. Like, it moved really quickly there.
So, if you take that out like the other three, is more like 14 years on average to go from peak valuation to trough valuation. We really haven’t experienced a true grinding bear market that makes you want to hibernate for a decade. That has just not been any of our lived experiences so far. But that is what they look like in the wild.
Economic expansion continues even during a bear market, which might be a little surprising. Real GDP on average expanded by 52% over the course of those three long bear markets. Corporate earnings growth in real terms is relatively muted, but it does have a wide range, so there’s not much of a signal there. There’s a material disturbance in the general price level that’s a catalyst to reduce equity prices. So, it can either be inflation like 1982, or it can be deflation like 1921 or 1932.
This makes some sense and maybe were seeing some of that now, Alex, with some of your businesses, that if it’s rapidly changing the unit of account for a business, in commerce, it creates a lot of corporate uncertainty. Like, how do you enter into long term contracts when you can’t really trust the currency? So, maybe everyone starts pulling back and that then leads to economic slowdown. You’re like, when you mess with the unit of account with the currency, you get some unintended consequences.
This is obvious. All four bears bottom during economic recession, so the market is tied together with the economy. But what’s interesting is that prices stabilizing and especially the commodity prices and especially copper correlated with the eventual bottoms. So, once you got price stability, then things could start to go back to more towards normal.
In all four of these mega bears, the recovery in the auto sector specifically preceded recovery in the equity markets. So, I don’t know if that’s still true today, but a bit of a canary there. It’s a common misconception that its nothing but bad news at the bottom, but Napier actually shows through ample samples of these Wall Street Journal articles that the bear market bottoms– There’s an increasing supply of good economic news that basically just goes completely ignored by the market. It’s constantly good news even at the bottom.
And then, finally, many people believe that there’s a final big flush, like a capitulation at the bottom where everyone just throws in the towel and like, “Ah, I can’t do this anymore sell everything more to more.” But that’s actually not true. The market actually declines on very low volumes and eventually it starts rising again on higher volumes. So, anyway, hopefully, all this bear talk helps you get ready for a difficult stretch of track, which if were being historically informed, it’s really a matter of when, not if, we’re all going to have to deal with this again.
Tobias: If you look at some of the names, like Tesla, for example, topped out in 2021– When I look at the earnings for the S&P 500, they topped out. The top print is December 31, 2021, they’re up about 13% or 14% then even though the stock market itself was up 19% over that period. It feels to me like there’s a slowdown. I thought there was a slowdown last year that just didn’t get– wasn’t declared by the NBER, but there definitely was a slowdown. And now, we’ve maybe reaccelerated a little bit. Did you feel like we’re in one or is that–? What about the early 2000s? That wasn’t a long bear market?
Jake: He wrote the book in 2005, and he didn’t count–
Tobias: Too early to say.
Jake: Yeah. Well, too early to say that great returns came from that time period. So, that was why– He left 1973, 1974 out, for instance, all for that same reason. That’s fifth place, that would have been the next one to include in the book, he says. Especially, on a real return basis, you didn’t have good outcome even from 1973, 1974 for most investors.
Tobias: On a real basis, it was worse than 1929, right? 1973, 1974. That’s my understanding.
Jake: I don’t know if it was worse-
Tobias: Peak drop, anyway.
Jake: -but it was brutal. It was like one of those 70%, 80%. You got like 91% down in, or 89%, I think, in 1929 to 1932.
Tobias: He’s talking about stock market performance there too, isn’t he? So, when he says there’s no flush, like, there’s clearly associated with all of those– There’s been pretty big stock market crashes. It just happens at the start or what does he mean, there’s no flush?
Jake: I think it meant like huge volumes, like a flush at the bottom.
Tobias: Okay.
Jake: That was the flush part.
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The Hidden Danger of Weekly Data in Long-Term Investing Strategies
Alex: One thing that came to mind for me, as you’re saying this is and I’m thinking about the hibernation comment, and also, this wall of continual bad news over days, weeks, months, potentially years, it has me thinking about, in certain businesses, energy drinks is a great example where there’s this weekly scanner data that’s really reliable. Every single week, you’re getting another data point in terms of what’s going on in this business.
I can’t remember if I pulled this out of my latest write up or not, but the funny thing about those businesses, it makes the access to really good short-term reliable data makes thinking and acting long-term so much more difficult. It’s almost like you’d rather the data not exist. You’d be forced to hibernate for lack of a better term in terms of the data that you’re actually getting. But it’s more information. It’s having more knowledge. But it’s hilarious that it’s ironic that translates into being able to think and act in long-term is so much more difficult in that situation just as a result of how that’s set up.
One other thing I thought of too, is as you were saying, I haven’t read it in a long time. I need to reread it, but there’s a book called The Great Depression: A Diary, and it’s from a gentleman who lived– I remember it, because my family’s from Youngstown, Ohio, and he was in Youngstown, but he details on it–
Jake: Benjamin Roth.
Alex: Yeah, there you go. So, it’s like day by day as I remember it, or at least weekly type of thing. It’s fascinating to read stuff like that where– Again, you can do this anytime for a stock, like zoom out. You can’t even see that random 30% drop in there over a six-week period. But if you owned it during that period, you sure as hell remember it when it happened. [chuckles] It feels very different when it’s happening versus zooming out and looking at the long-term Monster stock chart.
Tobias: It’s funny looking at it at a market level. You see the same thing. 2007 to 2009, it’s a blip.
Jake: Well, there’s a huge difference between behavioral time and chart time. Like, actually living through something versus looking at it on the chart.
Alex: It makes me think too of you think about corporate actions most notably in terms of repurchases and whether or not– They almost certainly would benefit from self-imposed hibernation or some thoughts on. This is incredibly difficult to do for a ton of reasons. One, just even figuring out the number, but two, also the outside pressures that you have as a CEO of your average, whatever public company. You would think that makes some sense to have some sense of, “Here’s normalized profitability or cash flow when we go up or below that in a very significant way, we should adjust our behavior accordingly,” which is much easier to say to do than to actually do, but you see what the outcomes look like when you don’t do that and just lean into what the tides are giving you at any given moment, it leads to very bad outcomes on average.
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The Benefits of Less Frequent Financial Reporting
Jake: So, Alex, on the reporting of periodicity and you’re getting weekly updates, let’s say, on scanner data– Let’s say you owned a private company entirely. How often would you want to see financial statements ideally to get your best behavioral outcome?
Alex: Yeah, Fever-Tree can be in some of the scanner data. I don’t know if this is just a normal practice for European companies, but they just report once every six months.
Jake: Right. Kind of better.
Alex: It feels like plenty of information in terms of– Again, comparing it to some long-term thesis of what’s their role in the mixers category, what are they doing in these emerging categories? Like, really good information on a handful of questions every six months or even every year would be plenty. It would, obviously, give you less opportunities to trade one way or another baseline information. But if you’re really talking about owning it, I think that would be sufficient basically.
It’s the way I’ve always felt about Berkshire in terms of people having certain complaints about the level of data that’s given on any certain business or segments. That’s just not at all how I think about the bet. I think the high-level data that you do get is more than sufficient to make a long-term investment decision. But if you’re trying to make a different decision, then maybe you do need different information.
Jake: Yeah.
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ScottsMiracle-Gro’s $1.5 Billion M&A Misstep
Tobias: Speaking of it being difficult to separate yourself from the business cycle, let’s do ScottsMiracle-Gro.
Alex: Yeah. It’s a fascinating– I’m sure most people know the core businesses, a number of strong brands in the lawn and garden space that you’d buy at Home Depot or Lowe’s primarily or Walmart.
Jake: Do they sell bullshit? Is that literally–?
Alex: [laughs] There you go. So, that’s their core business, which has been relatively steady, generally speaking outside of COVID which every business, at least most of the ones I look at, seems to have a massive impact, and that flowed through in terms of purchases and revenues, but it also impacted things like inventories and working capital, etc.
So, anyways, outside of that core business, the company started in 2014, I believe, was the first year, which they blanketed what the business actually did given the point of time that we were at in 2014, which is funny to think about, but it effectively became a supplier to marijuana, cannabis growers, some of the CapEx stuff like lighting, for example, but also consumables, nutrients and other things that are needed for growing.
So, they built it through M&A. Over a period of time, they spent somewhere on the order of $1.5 billion in M&A. By 2021, the business was doing $1.5 billion in revenues, which it had been low hundred millions, two, three years earlier. It grew crazy. Some of that was M&A, but there was also organic growth.
The company had an investor day at that time where they effectively said, “Hey, look at–” The investor day almost entirely focused on this business, by the way, not the core- [crosstalk]
Jake: The core moneymaker.
Alex: -garden business, that is their entire legacy and generates the majority of their earnings power. As typical of an investor day, they gave some high-level targets for where they thought things were going over time and they said, “This business, we can’t say if it’s a 10% a year grower or a 25% a year grower, but we do think this is going to continue to grow double digits on annualized basis.” That was in 2021 at $1.5 billion in revenues. And now, we’re in 2024, and the business is going to put up about $300 million in revenues this year, down 80% where it was.
Yeah, the CEO is very– He isn’t afraid to say what he thinks, and he curses quite frequently and he’s effectively said that this has been a complete disaster and the company is trying to figure out what to do from here. They had talked about, “Effectively we need to find strategic alternatives. We got to get this outside of ScottsMiracle-Gro, basically.” Their latest update was, “There’s not really anything that we can do with it that’s actually going to be worthwhile versus keeping it in here.”
So, yeah, long story short, it’s been a strategic diversion that’s– As you look at the report card at the end of it all, it’s like a 5, 10-year setback, if not more than a setback. It reminds me in some ways of Dollar Tree and the Family Dollar acquisition, which is not really their core business, and has been a weight around their neck for almost a decade now. It’s just fascinating to see these things where M&A in particular can take you so far off track and set you behind for so long.
But as with most things investing, like what you see on a spreadsheet or what you can dream up in your mind as a banker. When that goes poorly and you’re actually running the thing, the decisions from there are very, very difficult. Dollar Tree’s tried to turn Family Dollar around. They’ve now gone the opposite route where we’re just going to get out of this business. Like ScottsMiracle-Gro with Hawthorne, the price tags that they’re going to get offered for that are going to be quite a bit different than the price tag that they paid a decade ago. So, I think it’s just fascinating to learn from these businesses on again M&A or repurchases or other things, how you think about capital structure. It’s very, very interesting.
Jake: How much have they written off that $1.5 billion?
Alex: A lot. [chuckles] I can’t remember the number, but a lot. [chuckles] It’s funny.
Jake: So that earnings [crosstalk] totally smoked then.
Alex: What I dug into on the most recent update, which I didn’t totally grasp on the initiation is how it’s subsequently impacted the strategy at the core business, primarily in terms of they had inventory buildup coming out of the crisis, and they really needed to focus on cash flow and debt covenants and things like that. As they went into negotiations with retailers, I think they’re basically, explicitly telling you at this point, “We were not in a position where we really could push for price and cover our cost.” That’s worked for us in terms of market share and sales and working through that excess working capital, but what it’s done on the back end is their gross margins are down about 1,000 basis points from where they were five years ago.
So, it’s just funny to think, again, this completely unrelated thing of M&A in new business. At the end of the day, I think you can draw a straight line to their strategy in their core business, which we’ll see if there’s any longer-term effects from– If you have a ton of promotional intensity in the retail channel and your brands, well, just turning that off is easier said than done. So, we’ll see if it has any impact going forward in terms of the realized pricing that they can get.
Tobias: If you’ve already made the mistake and you’ve taken a lot of the medicine. Why reverse out of it? Why not just say, “Well, here’s where we are. We’re coming off a low level, let’s see if we can do better”?
Alex: Yeah, for one–
Tobias: Too distracting.
Jake: [crosstalk] what’s into your play.
Alex: -the CEO’s son running it. I think that’s part of the consideration. You’re saying they took their medicine, but I think turning around and selling it for $200 million would be deemed as taking even more. Actually, I’m not even saying that would be the number. Maybe it’d be lower. Who knows? But actually, realizing it, it would probably be taking even more your medicine.
I think at the end of the day, they still have an idea that this is a business that should have a reasonably bright future, which, again, when you look at the end market and where it could presumably be in 5 to 10 years, I don’t even really necessarily disagree with that. At least in terms of just demand, in terms of pricing and the actual attractiveness of that business that they’re a supplier into. That’s somewhat of a different story. But they’re the view that, “Hey, we had decent cards.” I think they explicitly use this example, “We had decent cards. The flop was really, really bad and now we have this hand that we are going to try to play out,” which may or may not be the right lesson in terms of what a poker player might tell you to do in that situation, but- [crosstalk]
Jake: Cost buyers, for sure.
Alex: -that’s what they’re saying for now. I think it’s very, very difficult. Again, I think this might be similar to Dollar Tree blowing out of it, what does that actually mean? Who’s there to buy it on the other end? There may not be many parties that are truly interested in owning this business.
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ScottsMiracle-Gro’s Cannabis Bet and Its Future Potential
Tobias: It feels like cannabis is such a hot story for a long time. It attracts a lot of capital, and clearly, the end– well, not the end user, but the end producer who was a consumer. The Hawthorne stuff, they overbought– Everybody’s come back to reality a little bit more, the business isn’t going to be quite that big at this point. But the prospect for it over the next 10 or 20 years should be pretty good, shouldn’t it? That seems to be like the rest of the world is opening up and liberalizing in relation to cannabis?
Alex: Yeah, I think that’s all reasonable. That’s where it gets tough. I think people should, if they have time, go listen to their Investor Day specifically the part with– His name is Chris Hagedorn, the CEO son, where he talks about this business. It’s like 15 minutes long maybe. The two main takeaways are outside of the poker story I just told you a second ago. He basically says, “We have two mandates in this business at this point, basically, don’t lose any more money and don’t invest any more money here,” which–
I can get why you say that, but also to your point, if it actually is something that you’ve made it through to the other side and it’s an attractive business long-term, maybe that’s exactly the wrong answer. Maybe now is the time to continue playing this hand.
The other thing that he then says after he says, “We’re not going to invest any more money here, we’re not going to continue to lose money,” is “We think there are interesting opportunities on the actual leaf touching side, the growing side of the business and next step down the value chain from where they’re at.” This partly gets into some investments they have there already.
So, he could really just mean through that vehicle versus SMG itself. But it is a weird thing to start talking about immediately after you say, “We’re not going to invest any more money here or lose any more money in this business.” I think that my point is I don’t think the company has total clarity itself on what they want to do here going forward. I think that’s especially true when you talk about the CEO. That makes it difficult as a minority shareholder in terms of like, do these guys actually– Do they even want to be in this business? Should they be in this business? It’s a hard question to answer. It’s come a long way from where it was three years ago where it accounted for 80% of the Investor Day or something.
Tobias: That’s amazing.
Alex: I’ve never seen something like this before, by the way, in terms of the projections and where it actually ended. If you can think of anything more extreme, I’d love to hear about it. But I’ve never seen anything like it before.
Jake: Are they showing you that the WeWork chart where-
[laughter]Jake: -it looks a bottom and then a horse after that?
Tobias: Was it like a winged, was a Pegasus? What do you call them? [Alex laughs] So, we need a mythical creature to pull us out from here. Got our best R&D guys on it.
Jake: Today is the exact bottom also. It’s all inflection upward from today.
Alex: There you go.
Tobias: [laughs] He’s got to say something positive I guess, if they’re going to sell it. You can’t just say-
Jake: This is [crosstalk] please. Who wants to buy it?
Tobias: -“We don’t want to lose any more money. We’re not going to sell.” But it’s got lots of good opportunities ahead for another management team. The people who are running it are idiots.
Jake: Yeah, get them out.
Tobias: This thing is easy to run. Just put prices up, sell more.
Jake: I feel like that has a bit of the common thread here, Alex, what you’ve said, reporting from the ground up is like, “Boy, business is hard.” Where are the easy businesses? Like, what’s the–? [laughs] Or, if you’re looking at things that are cheap, is visually cheap based on multiples or whatever, you tend to have to sort through a lot of hard businesses?
Alex: Yeah, I would say. I wouldn’t necessarily describe them as easy businesses, but some of the businesses that clearly look like they have some more sustainability, potentially some wider moats and some growth opportunities. I think a fair pushback is, go back five years ago or pick some time and look at what those price differentials were. It’s been like a constant push of that trade off question becoming more and more challenging to answer from the person who’s on the side of the– just own the great things and hold on. So, you have to figure out how to navigate that.
It’s very, very, difficult. It’s very, very difficult. I think it gets into position sizing and a bunch of other things. It also gets into your personal preferences. If you’re going to be someone who can hibernate and go away for a little bit and be okay with that versus someone who’s going to be watching this every day and being like, “Holy crap, I thought that thing was ‘overvalued,’ and now it’s down 15% in a month.” You got to figure out where you land there. The unfortunate thing is sometimes I don’t think you figure that out until after that one-month period has gone by and you’re down 15%. So, it’s not the easiest game in the world.
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Is Home Depot’s Recent M&A Strategy a Game-Changer or Just a Trend?
Tobias: Any thoughts on HD? I know you’re not a holder, but just brief thoughts on HD, Home Depot?
Alex: To me, it strikes me as somewhat similar to Floor & Decor, but probably not as extreme. Some of the recent M&A that they’ve done, I’m not very well versed on the direction they’re trying to go in. But I think it makes sense in terms of what they’ve generally said about their position in the marketplace and how they can serve a pro customer more effectively than they have in the past. I think that all makes sense. My dad’s a plumber, so I have some insights in terms of how he thinks about these things.
But again, it’s a situation where you have this crazy comp chart after COVID, and now you’re in this weird period where is it actually going to get back to a reasonably good-looking algorithm, or is it just continue to be pressured on comps, on margins, on things like that?
One of the things I noted a couple of years ago when I wrote about them was, they increased the dividend at a point in time where to me it just seemed like that decision wasn’t really totally supported by the actual business. They were trying to signal something as opposed to this actually being the right thing to do. It had put them well above the payout ratio that they had spoken about, call it, 5 or 10 years earlier. I think that pressure there has just continued.
So, to me, it feels very similar to F&D in terms of like– I don’t totally see how this really surprises to the upside in terms of the business results from here relative to any reasonable expectations. But now that I just said that out loud, I’ll probably be wrong.
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Tobias: [laughs] On that note, we’re coming up on full time. If folks want to follow along with what you’re doing or get in touch, what’s the best way to do that?
Alex: Yeah. TSOH Investment Research, thescienceofhitting.com and over at Twitter, @tsoh_investing.
Tobias: JT, any final words?
Jake: No. Have a good week. Stay safe, everybody. Be good to each other.
Tobias: Alex Morris, the Science of Hitting, thank you very much. Folks, we’ll be back next week, same time, same channel. See everybody then.
Jake: Thanks, Alex.
Alex: Thank you.
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