Car Buying Dilemma, Boomer 401(k)s, and Stock Picks

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I mean, you think about how we bought cars forever. It was, you assumed you'd go in there, you'd haggle a price down, you'd buy it for some multi-thousand dollar discount. Well, right now when there's no inventory, there's no discounting.

Hello and welcome to the Barron Streetwise Podcast. I'm Jack Howe, and the voice you just heard is Daniel Imbrough. He's an automotive analyst at Stephens, and in a moment we'll hear from him about available deals on cars and car stocks. We'll also speak with a money manager about his top stock picks now, and we'll tackle a listener question on what happens to stock prices as the baby boomers spend their retirement savings. Listening in is our audio producer Jackson. Hi Jackson.

Hi Jack.

We have been talking about car prices now for what, couple of years, couple of few years.

Oh, yeah.

Yeah.

We'll do the old car episode every 6 to 9 months.

When are they going to come down? It seems like it's always right around the corner and they haven't come down much. Right. And I saw this thing from— you see the thing from Edmunds?

Yeah.

About the extinction event in vehicles. They say that the $20,000 vehicle is nearly extinct. $20,000 can't do a new vehicle. They say the $25,000 new vehicle is next in line. It says critically endangered, critically endangered species for $25,000 and under. They say just 4% of new vehicles sold were in that range in March. That compares with if you go back just 5 years, it was 24%. So there's been this plunge and just the opposite for these expensive vehicles, for large SUVs. You know, everybody wants to buy the big SUVs now. They say that 94% of large SUVs sold were over $60,000. That compares with just 54% 5 years ago. I feel like if you spend $60,000 on a vehicle, it should come with a good school district for your kids. So there's the Edmunds report. And this coming week, we're going to get earnings from CarMax, the used car chain. So I'm interested to see what's going on. In the industry. And hey, look, I don't want to make this about me, but I did just get a call from the dealer, and what they said was I have to make a decision on this car that I've leased. I did lease a car. I do lease a car every 3 years. We have talked about this before, but if you've got tips for me on why I'm spending too much money and I could do better, I know, I know, I know, I know about the car math. Um, we treat ourselves to a new car every 3 years because, A, I don't have extravagant tastes and A, we don't have cars. We have a mid-market, sort of midsize SUV. And B, we make do with one car. We were city people up until just recently, and now we're suburbs people, but we do okay with one car. So we save a lot there. And am I up to C or D? Well, both of those are that we have young kids that, you know, from time to time will just dump a milkshake right in the back seat. And I feel like every 3 years I just want to I want to clean the slate. I want that to become someone else's problem. And I want something new and nice. And I never want to deal with repairs. And I always want the new safety features. And so I just allow myself to get a new car every 3 years.

I think you've thoroughly explained yourself. OK. You get a pass.

All right, so our vehicle is— when I leased it in September of 2020, it was a $40,000 vehicle. That was the purchase price. And the deal was at the end of the lease, you could buy the car. The value at the end of the lease is $26,000. So we are over our miles by about a skajillion miles, roughly. So there would be— I would have to pay a few thou— you know, things have gotten crazy with the sports and the kids and everything. So we— I would have paid to pay a few thousand dollars in overcharges. But that's not the biggest thing. The biggest thing is when I look at this exact car with the number of miles I have on it and the same similar trim level, and I say, what would it cost me to buy this thing now? I find cars listed for $33,000 to $34,000 for the same one that I'm able to buy for $26,000. That's just a huge differential. And that experience matches pretty much what I see when I look at the new and used car indexes. New car prices since September 2020. That's when I started my lease. New car prices since then are up 21%. That is humongous relative to what they were doing just before that. Over the 14 years leading up to that point, car prices, new car prices rose in total just 3%, pretty much flatlining for almost a decade and a half. Used car prices now, since I leased my car, used car prices are up much more than new car prices. They're up 36%. So What's happening is the car makers aren't able to make as many cars as they'd like. We've kind of been saying that we're starting to suspect that maybe they do like it like this because the margins are better when they don't overproduce. Whatever the case, they're making fewer cars than they used to. Prices on new cars are up and leases, the number of people who lease cars, that's way down because residual values have gone bonkers. No one is sure whether to trust them and you have to, to be confident in what the residual value on the car is gonna be at the end of the lease period in order to write a lease. And also a lot of consumers in the same situation as me, they had a lease, they were about to go in for their new lease, but they're finding that they've got this sort of positive value on the vehicle that they've leased. In the option world, in the world of stock options, you would call that an in-the-money option. That's what they've got. And so they say, you know what, let me just buy this thing out. And so because so fewer people are leasing, That's where used cars are born. When you go to the used car dealer, you wonder where all those cars come from. Some of them are trade-ins, but a lot of them are just people turning cars in at the end of leases. We don't have many of those now, so the supply of used cars is way down. People are still getting chased to used cars because new car prices are so high, and that has pushed used car prices up even faster in percentage terms. Does any of that make sense, Jackson?

Does it mean it's high time for new cars? Is everyone just dancing in the profits right now, those new car dealers?

They're doing better. The new car dealers seem to be doing better than the used car dealers, but let's come to that now. I wanted to get an overview of the industry and figure out what to make of the stocks, so I reached out to an automotive analyst. His name is Daniel Imbrough. He's at the investment bank Stephens. So, uh, nice to meet you, Daniel. Thanks for making a couple minutes to speak with us.

Yeah, happy to. Thanks for having me, Jack.

I asked Daniel whether we're in an unusual period for vehicle pricing now, or whether it was unusual before and this is where it's supposed to be. What should we think about pricing from here?

I do think longer term we work back into higher inventory than we have now. You've seen some of the big manufacturers— GM has come out, said they want to run 20 to 30 days lower supply than they used to carry, that would be great. That would be beneficial for both sides of the equation. But I think we're far away. The way we think about it is I think even if the OEMs want to overproduce, you know, we're still a few quarters away from global production really catching up, specifically led by some of the Asian manufacturers. They've said pretty publicly, you know, that it's going to be at least till the fourth quarter of this year before someone like a Toyota can fully produce vehicles back to how they used to. So even if all the OEMs want to go back, we think we're probably into 2024 before inventory levels fully recover. I mean, if I look at inventory on the ground, we used to carry 3.5 million cars roughly in this country at dealer lots. You know, we're below 2 million today. It's a great debate. And if the OEMs, you know, do what they're saying and we don't make too many cars, it could continue this earning period for longer.

What about the relationship between new and used car prices, between leasing and buying? I asked Daniel where he thinks the best deal is now.

From a consumer standpoint, I probably think it's a better time to be looking at a new car really for the two reasons. That used and new gap has closed. We've seen used prices reaccelerate this year. They're up almost 9% according to Manheim through mid-March. So we've seen used prices tick back up so that value gap's closing. The other piece of it is at the new car dealership, you could see some of these captive finance companies, which are finance companies owned by the OEMs, they will typically step in with below market interest rates to help fund new car sales. So if you're a consumer, going to buy a used car, you may pay whatever the bank's going to give you as an interest rate on that finance. If you go to a new car dealer, franchise dealer, you may be able to get, at the right credit score, a below-market rate from that captive finance company. So I think that tips the favor of value towards new cars, especially when the gap between them is this narrow. Leasing is actually a fascinating discussion. A lot of historically lease incentives were funded by these captive finance companies. In the last few years, when there's no need for it because not enough inventory, we've seen lease incentives pull back. So the cost of financing has been better than the cost of leasing. So you've seen lease penetration go down. It's gone from about 30% of cars to a shade under 20% last year of cars were leased.

Okay, so what about the stocks? I asked Daniel for his favorites.

From, from here, I do think, you know, with this backdrop, you know, who your OEM mix is, if you're a dealer, matters. You know, you want to be exposed to someone that's not overproducing, that's managing incentives well. I think someone like a GroupOne, GPI is that ticker, I think they are positioned to continue performing very well. They have a good German luxury mix in their UK business that's been very disciplined. The US business, they're very Texas heavy. That's an economy that's doing well. Someone like Asbury has been one of our favorite dealers for a while. They have been a very good operator over time, very good cost controls. And I think about what investors are looking for heading into a potential downturn is who's going to control costs and who's going to execute well. And then the third dealer we've been recommending would be someone like Penske. Penske in the US here, they're by far the most luxury exposed. From the supply side, the German luxury manufacturers have done a pretty good job being disciplined on production. But on the demand side, there's a real case to be made that those buyers are probably more insulated from these broader inflationary headwinds at that higher premium luxury price point. So I think those are 3 of the dealers. Within the rest of auto, there are some other derivative plays. ACBA would be a 4th one I'd flag. It is an auction company, but essentially they auction excess dealer cars. So if the thesis the next 2 years is that OEM production picks up, dealers have more cars in the lot, that's a thematic way that volume will begin to improve in the wholesale auctions. And that becomes a winner in that environment as well.

Since I will soon be driving my first 3+ year old car in some time, I'm probably going to need to familiarize myself with some more maintenance. What do you, what do you do when you get, let's say, over 50,000 miles, Jackson? What's, what are your priorities? Go ahead.

Listen, it's about time to replace the rear and front differential oil.

Rear and front differential. Go ahead.

Yeah, you probably want to continue by getting an oil change, maybe new tires.

I just got them. Yeah.

At the 100,000-mile mark, you're going to want to do the timing belt tensioner levers.

I'm doing that one myself. Yeah, I'm doing that myself.

Brakes, if you haven't done that.

Brakes. That sounds important. Yeah.

Yeah. The rotors, too.

I don't know if that last one's real.

Well, the—

is that— is that on a helicopter?

Rotors?

Yeah. Moving on. What does this mean for the auto parts and service chains? I asked Daniel. Do you cover the aftermarket, you know, the parts chains and service chains?

I do. So the O'Reilly's, the AutoZone. I do.

Yeah. What do you think of them, their stocks right now?

Yeah, I think O'Reilly and AutoZone are our two overweight in the space. Those are our two favorites. And it really comes down to a few things. Obviously, from a macro standpoint, fantastic businesses during downturns. I mean, comp positively in the early 2000 recession, organically grew through '08, '09, '10. Really three main reasons. During a recession, people hold their cars longer, they're more likely to fix that car later into its life cycle, and they have a lot of pricing power. It's a needs-based products. And so with that needs-based product, there's a decent inflationary protection. They've shown that last few years, they can take a lot of price when they need to. Those two specifically, they've gained a lot of share last few years. They put a lot of the capital back into the supply chain. I would say they've furthered the gap in service to some of their peers. And so I do think names like that can continue to outperform despite a really strong last couple years of performance.

All right, well, thank you, Daniel Jackson. How about we take a quick break here? We come back And we speak about 401(k)s and baby boomers and stock picks.

Sounds like a plan.

I gotta check my rear differential, if that is one of the differentials.

Gotta stay on top of the fluids.

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Welcome back, Jackson. Let's hear a listener question. There's some— there's a listener out there. There's a lucky listener who has sent us an audio file of their question. Little do they know that they're about to hear their own voice, making them an overnight celebrity and the envy of their friends and family.

Among millions of entries, we have selected Matt from Los Angeles.

All right. Pause for balloon drop.

It's been about 50 years since the introduction of the 401(k) as we know it, and Americans hold over $10 trillion in retirement plans like IRAs and 401(k)s. At this point, it's safe to assume that the overwhelming majority of these plans are invested in the US stock market. In addition, the first generation that has had access to 401(k)s for the majority of their employment years, the baby boomers, are now retiring. So first, is there any evidence to show that the massive amount of money in 401(k) plans contribute to an artificially inflated stock market? Second, do you see any potential negative outcomes for younger investors as baby boomers continue to retire and draw down those 401(k) funds invested in the stock market?

Thank you, Matt. Your question, it's a two-parter. Has all the money that's been going into 401(k)s over the decades skewed stock market valuations higher? And as the baby boomers retire and begin spending some of that cash, will that be a drag on returns? I put both of those questions with a bit of an emphasis on index funds to a money manager I spoke with recently. His name is Richard Ryszkalski, and he's the chief equity analyst at Sandhill Investment Management, which oversees close to $2 billion out of Buffalo, New York. You're also going to hear Rick talk about 3 of his favorite stocks right now. They are Tyler Technologies, TYL, Palo Alto Networks, that's PANW, and TransMedics Group. That one is TMDX. We had a question from someone who listens to the podcast the other day, and it was about 401(k)s, and it was kind of this subject, people just, you know, piling money into their 401(k)s, which is, which is a great idea, but they're all putting it in the, in the same index funds. And he wanted to know whether, whether that was making the market expensive, which it sounds like you agree with. And also whether, you know, since this is the since the baby boomers have been doing it, whether we're going to reach some point where they begin pulling their money out in retirement and that becomes a real headwind for stock returns.

Yeah, no, it's a great question. I think there's multiple parts to that. So, you know, talk about baby boomers and this massive generational shift that we're going to see and potentially opposing that. You know, I've got 401(k) plans and auto enrollments, you know, going on. And I think you have these opposing views where if you're looking at this shift that we're seeing now with younger investors, younger employees that are coming into the workforce now and being put on some of these auto-enrolment plans, we're seeing phenomenal participation rates where if you aren't forced to auto-enrol, participation rates are closer to 28%, where if you're being auto-enrolled, participation rates are 91%. And you're seeing legislation like this SECURE Act 2.0 that's going into effect that's going to require businesses that are adopting new 401(k) plans to automatically enroll these employees. And that's, at the end of the day, better for everyone because we're going to have a healthier financial profile of the overall American population. And that's opposing this shift that we're seeing currently with the baby boomers. And really, I think probably started back in 2011 when the baby boomers started to retire. And really, that shift is going to go till probably 2030 or so, when you really get, you know, the meat of that cohort moving through retirement age and starting to really draw down on some of their assets. So I think at a high level, both of those somewhat oppose each other and will probably, more so than not, net each other out to somewhat of a wash. So I think the question is maybe less about, is this propping up market valuations, and more of a question of market correlations. As these assets in these 401(k)s continue to shift towards passive index investing, you're seeing all these stocks all trade together, especially in market crashes, everything's dropping. All at the same rate. And you're seeing a bit of a baby with the bathwater, you know, effect here. And that gives, you know, guys like us, these stock pickers, some really great opportunities.

Well, tell me about those opportunities then. So what kinds of things are you looking for when you shop for stocks? How do you tell a great stock?

Sure.

So, I mean, at the start of it, it all begins with, does the business have some type of sustainable competitive advantage, right? Is there some moat around the business that in doing what they do, they ward off competition. And that gives them pricing power, long-term growth opportunities. And then from there, what we're really looking for is there some type of catalyst or something that can help propel them over the next handful of years, which is our time frame for investment. So I guess a direct opportunity that we were holders of— Tyler Technologies, for instance. Ticker symbol is TYL. Tyler is the 800-pound gorilla for software solutions that are sold to local governments and municipalities. Not the sexiest of industries by any means. Think applications to renew your fishing license online or pay your water bill.

I thought you said they weren't sexy. Renewing a fishing license, come on, that's as good as it gets.

Hey, public park reservation systems.

I just paid for the, the town pool pass and all the different sports camps for the kids.

It was like a—

it's like a million dollars for sports camps this summer, but I bet they're all— it's all done online now for our little town here. So I guess that must be that type of thing.

Well, I mean, it's, it's no, no surprise to anyone that governments are generally running on, you know, extremely antiquated software to run the behind the scenes. So often Often these systems are decades old, so they either break or when that person who knows how to manage them retires, that local government's basically forced to upgrade their systems. And that's, that's what propels someone like a Tyler and where their moat comes in and that competitive advantage. What makes them a good business is Silicon Valley is not focused on trying to create that, that next great app and then figure out how to sell it to the 88,000 local municipalities that are out there. So there's no one else focusing on it. And Tyler is somewhat in a prime position to roll up that industry and maintain the leadership position that they're in.

Well, now you've told us about one stock you like, which means you have to— it means you're obligated to tell us about two more. Stock picks, of course, have to come in threes. Can you think of two others that you really like right now?

Sure, sure. More than happy to. All right. So I guess one other one where we see phenomenal long-term trend and theme behind it, cybersecurity. Palo Alto Networks, we love. PANW is the ticker. They are the preeminent provider of network security, cloud security, security operations software to help these enterprises detect and respond to threats in real time. And what we really love about the business, and this is a trend that we've seen somewhat throughout all of software, is there's this shift from multiple point solutions and this consolidation down to a smaller number of vendors who have a broader platform. Right, so this explosion of software over the past decade has left these CTOs, Chief Technology Officers, at these large enterprises basically with their heads spinning on how do I manage all of these solutions, how do I get all of them to stitch together? And then as we move towards this economic slowdown and companies are scrutinizing their spend more, this shift to these platforms is happening even faster, and that benefits a player like Palo Alto. On top of the broader idea of that, cyber threats from foreign entities, whether it's small hackers, large governments, that's not going to stop. And with the larger attack surfaces, right, you no longer just have your own internal network, you've got cloud-hosted data, you have all these employees working remotely on multiple devices, a huge attack surface. It just leads to a very long-term secular growth opportunity for the industry and Palo Alto in particular.

Okay, what, how about a third?

Lastly, a little bit different from the first two, which are, you know, more larger, more established, nice growth opportunities. This one's a bit got a bit of a sexier, you know, bend to it a little bit earlier on in their growth cycle is a company called TransMedics. Ticker is TMDX.

Let me guess, TransMedics, it's something transmissions and medical. They put, they install transmissions into people and turn them into cars. I don't know, Transformers. Go ahead. I have no idea.

You're close. They're all about revolutionizing organ transplantation.

It makes a lot more sense. It makes a lot more sense.

Very early on, but so, so incredible is every year you have thousands of otherwise viable hearts, lungs, and livers that are unused from organ donors simply due to the limitations of the current system, right? Cold storage is what they call it, basically an ice cooler, right? So we have incredibly high-tech medical systems throughout the country with remarkable advancements in medical devices and medicines, Yet these transplant procedures are involving putting this organ on ice and transporting it in a cooler from hospital A to hospital B. It's, it's astounding how far behind the times this system is. And so TransMedics has this now fully FDA-approved device to keep these organs alive outside of the body, right? Your heart's beating, your lungs are breathing, which allows them to significantly increase the distance that these organs can travel as well as the time that they can be from clamp to clamp, from donor to recipient. And it also allows the doctors to monitor the vitals of the organ. So we think there's a massive opportunity to increase the utilization of, of more and more organs via transplantation over time.

Thank you, Rick and Matt and Daniel, and thank all of you for listening. Jackson Cantrell is our producer for just a little while. Jackson, you want to tell them the news?

Yeah, I'm moving to Los Angeles to—

you son of a— go ahead—

to find my fortune.

How dare you?

And go with my wife to her medical residency.

Something's not adding up. Sounds very suspicious. No, congratulations. Best of luck. Thank you very much for your work on this podcast. And, uh, you know, we're going to hear from you over the summer.

We'll be here next week and, uh, you may hear from me over the summer and we've got other podcast producing arrangements coming up.

We'll talk about that in a future episode. All right. Very good. Well, let's all have a cry over it this week and you'll be back here on the podcast next week for your final farewell. So we don't have to cry now. We'll cry then. Right. Bring tissues, everyone. Subscribe to the podcast on Apple, Spotify, wherever you listen. If you're already subscribed, tell your friends to subscribe. If you don't have friends, Jackson, what do you do? Number one tip for making new friends quick.

Get a dog. And then people get a dog, come up to you in the park.

You're helping people right now. Thanks for listening.

See you next week.

See you next week, everyone.

Whoa, whoa, whoa, whoa, whoa.

You, you, you, what do you say? See you next. I'm the see you next week guy. You're saying see you next week now.

Just thought I'd change that.

All right, you know what? Go ahead. Go ahead. See you next week.

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