Robo-Mowers and Inflation

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There are a lot of open jobs and labor rates are going to have to go up. So I think we're going to have on top of this material inflation, which has been the issue so far, we're going to have, I think, significant labor inflation as well. And, you know, once you get the labor inflation, then it's hard to contain the prices in the end markets.

Welcome to the Barron Streetwise Podcast. I'm Jack Howe, and the voice you just heard, that's Jim Lorry. He's the CEO of Stanley Black Decker. The toolmaker. And that puts him at the center of some themes of great interest to stock investors right now, including inflation and wages and the housing boom and the dawn of autonomous driving, or in Jim's case, autonomous mowing. So let's talk tools and high finance. I'm going to wear my steel-toe boots with my knee-high black dress socks. Safety first, fashion a close second. If you enjoy economic indicator drama, May is shaping up to be your month. A little over a week ago, we saw the biggest jobs miss ever. It's for the month of April. Economists and analysts had estimated that about 1 million new jobs would be created, but the actual number of jobs created was only about one quarter of that. That's like predicting beach weather and getting a foot of snow. And then this past week, The inflation rate, the rate at which prices are rising for ordinary goods and services, that came in at 4.2% for the month of April versus a year ago. That's the fastest inflation since the summer of 2008, back when the oil price spiked to more than double today's level and then quickly collapsed. Now, Wall Street had been watching for faster inflation in recent weeks, but not quite this fast. Many investors find economic indicators a less interesting topic than, shall we say, Tesla stock or Bitcoin, or even just where the stock market's headed next. But you can draw a straight line from the two measures I just mentioned to the stock market and all those rocket ship emoji investments that make Robinhood traders swoon. See, the massive bull run for assets of all sorts over the past decade can be traced to ultra-low interest rates. And rates have been held this low by central banks. In the US, that's the Federal Reserve. And the Fed isn't keeping rates low to see if Dogecoin will go to the moon. In fact, the Fed has what's called a dual mandate. For interest rates, we want to see labor market conditions consistent with maximum employment. We want to see inflation at 2%. It's supposed to try to keep people working and to keep prices from rising too quickly. Those two things are seen by many as being locked in a trade-off relationship. If you hold interest rates low, the thinking goes, that'll spur borrowing and risk-taking and economic activity, and that'll be good for jobs, and the unemployment rate will fall. But eventually, that'll lead to faster inflation., and you can counteract that by raising interest rates. And if you draw a chart of this inverse relationship between the unemployment rate and inflation, you get something called the Phillips Curve. It's named for New Zealand economist William Phillips. He's no relation, by the way, to Oregon businessman Henry Phillips, who in 1935 bought the patent for a screw head with a recessed cross and then pitched it to the car industry, which is why today your toolbox has both a flathead screwdriver, but also a Phillips head. See, tools and finance, they're intersecting already. And I don't wanna give you too many Phillips asides, but I have one more that's just too delightful to pass up. William Phillips, the economist. He might be best remembered for that Phillips curve, but the thing he's definitely next most remembered for is building, right after World War II, a hydraulic computer made partly from parts of old bombers. There were transparent tanks and pipes and pumps and floats and counterweights and fluid designed to represent the flow of money through the British economy. It was both for teaching students about macroeconomics and for calculating how and whether to apply economic stimulus. And this hydraulic money computer It was called moneyac. I feel like I need a hydraulic computer to keep track of the narrative thread here. Storyac? Where was I? Ah, yes, the Fed. It doesn't use fluids to decide where to leave short-term interest rates, but it does use economic modeling and theory and a close watch over new data. And basically, it's been able to keep rates this low for this long because there's been little sign of inflation. And whatever effect those low rates have had on the economy, they've created a massive rally in the price of risky assets like stocks by suppressing yields on safe assets like Treasury bonds. So if in fact inflation is really finally heating up, the Fed might eventually have to respond by raising rates, and just the thought of that could cause investors to dump stocks. One last point on those economic measures. The most important thing for investors isn't where the numbers are, but where they're headed. And to guess that, we have to first figure out why they are where they are now. And that's difficult. Take that huge jobs miss, for example. If we're not creating as many jobs as we thought because the economy isn't as strong as we thought, that's not great news. But it's the kind of bad news that could send the stock market higher if investors believe it will cause the Fed to keep interest rates this low for years longer. But there's widespread agreement that the jobs miss wasn't a demand problem. Lots of companies say they want more workers, but they're having trouble getting them. So why? One theory is that a raise in unemployment benefits during the pandemic is keeping the jobless from taking jobs. That's a contentious and politically charged issue, but it's also one that could affect policy choices. Officials in South Carolina and Montana, for example, are taking steps to block some federal unemployment benefits in an effort to fill job openings.

Well, now South Carolina and Montana are opting out of the additional weekly benefit, with Montana even offering a $1,200 bonus to return to work.

There's a competing theory that holds that there's a mismatch between the skills workers have and the jobs for which employers are hiring. Whatever the reason, there's some concern that the big jobs miss, which sounds disinflationary, is actually inflationary because it will take higher wages to get workers into jobs. Strategists at Deutsche Bank say the best predictor of inflation is the quit rate. Which shows how many workers are voluntarily leaving jobs and gives a sense of their bargaining power. And right now, the quit rate is elevated. Now, that's the jobs number, but there's plenty of debate over inflation too, which we've touched on already in recent weeks. Lumber, construction metals, grains, oil— they're all up sharply in price. But is that merely the jolt of the economy reopening combined with supply disruptions left from the pandemic, Or is it something more lasting? To learn more about that and to get an update on the tool business, I checked in with Jim Laurie. How are you? Jack Howe from Barron's.

Nice to meet you.

I'm ready for some tool talk. I've been breaking out the ratchet set lately. I've been ordering stuff, putting stuff together in the garage. I bought a big cart to carry around my wood chips back and forth and putting that together with my ratchets. I've got tools on my mind right now, so I'm ready to talk with you.

You and 360 million other Americans.

Jim Lurie has been CEO of Stanley Black Decker for nearly 5 of its 178 years. The company traces its roots to 1843, when a man from New Britain, Connecticut, Frederick Stanley, began making bolts and hinges and other hardware for locals. In 1920, Stanley Works would merge with Stanley Rule and Level, founded by Frederick's cousin Henry, also from New Britain, to create Stanley Tool Works. Totally unrelated to this, there was a 10-year-old machine shop in Baltimore at the time that had developed something new: a drill you could pick up and carry around and use like a gun. The first portable power tool. The machine shop's founders, Duncan Black and Al Decker, secured a patent for the drill's pistol grip and trigger. Now, there are a lot of tool brands that Stanley Black Decker owns today that date back to this era. Some carry the names of their founders, like DeWalt, after Raymond DeWalt and his radial arm saw invented in 1924, and Porter-Cable, founded in 1906 by two men named Porter and one named Cable to make power lathes for woodworkers. And some of the brands are just made-up names, like Craftsman, registered by then-retail-giant Sears in 1927. Just know that there's been a lot of deal-making in tools, culminating with Stanley Tool Works combining with Black Decker to create Stanley Black Decker in 2010. And the company is still based in Frederick Stanley's hometown of New Britain, Connecticut. Jim joined Stanley Toolworks just over 2 decades ago, and as I said, he's been running Stanley Black Decker for nearly 5 years. We talked about the early days of the pandemic. Sales plunged at first, not because people stopped buying tools, but because stores stopped ordering inventory.

And Jim says it was scary. And one investor asked me, you know, if revenues go to zero, how many months can the company survive?

So it was really a tense moment, but that's not a question you're prepared for generally as a chief.

I wasn't prepared for it. I had the finance people calculate it afterwards for me.

It turns out the answer was 15 months. Fortunately, Jim saw continued strength in what he calls the POS, or point of sale. In other words, shoppers were still buying his tools at stores. This is a small but important detail. If you buy, let's say, a DeWalt drill from Home Depot It counts as revenue for Home Depot, not Stanley Black Decker. But when Home Depot orders more DeWalt drills to replenish its stock, that counts as revenue for Stanley Black Decker. Obviously, the two transactions share a cause-and-effect relationship, but there can be a difference in the timing. Jim says that when he noticed how strong point-of-sale activity was, he began putting in big orders with his suppliers in anticipation of stores needing more inventory soon.

I asked him how it's going keeping up with demand. Well, so here's where we are, you know, with 45% organic growth in the first quarter and the point of sale pretty much at the same level. All we're really able to do right now is keep up with the point of sale, but the customer inventories are much lower than they would like.

Supply chains for global manufacturers can be long and complex. Jim says the company was fortunate in that it was already in the process of bringing some manufacturing from China to North America. So it's building 3 new plants, 2 in Mexico and 1 in Texas, which will be open by the end of the year. I asked about inflation. We've seen prices for materials shoot up. We're beginning to see that make its way to prices for consumer goods, and a lot of investors are wondering, will faster inflation be a passing phenomenon or will it stick?

Here's Jim. It may be here to stay. At first I thought, oh, it just has to be a transitory supply chain related phenomenon. But based on what we're seeing in the inflation, you know, with the labor shortages, even though I know the unemployment number and the jobs number was a disappointment, there are a lot of open jobs and labor rates are going to have to go up. And, you know, once you get the labor inflation, then it's hard to contain the prices in the end markets.

If you're a stock investor, Jim's expectation for inflation might get you thinking about whether interest rates will have to move higher at some point and whether the anticipation of that could dampen market returns. But it should also get you thinking about which companies have pricing power, the ability to pass their own higher costs on to customers in the form of higher prices.

I asked Jim about his pricing power. We do have pricing power. And in particular, I think in this era we will have pricing power because, you know, we've pretty much held the line on massive price increases at this point. And you go shopping for building products these days and you find, you know, lumber 4 to 6 times more expensive than it was a year ago and, you know, that sort of thing. So my point is, I think the markets are somewhat accustomed to paying more for building products. And so I don't think it'll be that difficult to pass on prices. It's easier when there's big slugs of inflation because then you have a really good case.

Sometimes the small inflationary fires are, uh, it's harder to recover price. Jim says Stanley Black Decker has 4 main end markets: DIY or do-it-yourself, construction, automotive repair, and industrial. The company is expected to report sales and profits this year that are much higher than they were not only during the pandemic but also before it. Jim says a lot of the action now is in DIY and construction.

Housing starts are up in the 20% range this year. This has been, you know, something we've waited for for a long time, uh, with the lack of household formation that occurred, you know, during the heart of the millennial generation.

But at this point, I think the pandemic has catalyzed a pretty significant movement in household formation. I asked Jim about whether demand has recovered too far too fast, and he says the inflation winds are troubling and that he worries that if the Fed has to respond, it could bring an end to the market cycle. He also says there's been a generational shift in end-user behavior, and his market has grown during the pandemic— not just home buying, but also repurposing homes for work and repurposing commercial space for new ways of working. All of which requires tools. His hope is that when growth slows from fierce levels, it will get back to normal levels, 4% to 6% a year. And Jim's goal is to outperform that market growth by a percentage point or two per year. And he says the company has a long record of gaining market share and that there is, as he puts it, a lot of runway ahead. I asked Jim about competitive advantage. He says, as you might imagine, that he has the best brands and that he pushes for of innovation. He also says Stanley Black Decker has built an e-commerce business that's 3 times the size of its competitors. A lot of the company's online sales flow through Amazon, and in Latin America, MercadoLibre, and in China, Alibaba, and in Russia, Yandex. I said to Jim, there's a tug of war right now between brands and stores to see which has more power. Are you ever tempted to go more directly to customers? He says that's part of the strategy in markets where Stanley Black Decker is underrepresented, like China, India, Japan, and Germany.

But in North America, the company is happy with its relationships with home improvement chains and Amazon. I know a lot of people that say that, you know, Amazon is difficult to do business with. We have not had that experience.

We, we think they're, you know, so far they've been great. Okay, let's talk about competition. UBS analyst Markus Mittermeier, who's bullish on Stanley Black Decker, wrote recently that it and Tektronik Industries, or TTI Group, have been the two major market share gainers over the past 5 years, and that handheld cordless tools in particular might be turning into a two-horse race. TTI is listed in Hong Kong. If you haven't heard of it, you might know some of its key tool brands. Like Ryobi and Milwaukee. Now, some people have fierce loyalty to particular tool brands, but not me. For hand tools and gas-powered tools, I have plenty that are Jim's Brands and plenty that aren't. But for battery-powered tools, I stick with one brand, and it has nothing to do with loyalty. It has to do with the batteries, which can be swapped from tool to tool. Whatever else the push toward electrification is changing, I have a feeling it's going to make customers more likely to pick a brand and stick with it for many of their tools. Jim says he expects outdoor power tools that run on battery power to be one of the company's big growth drivers. Stanley has a stake in a company called MTD, which controls well-known riding mower brands like Cub Cadet and Troy-Bilt, and some brands that are maybe less well known for now. Like Robomow. That's right, I said robo and I followed it with mow. Anyhow, Stanley's deal gives it the right to buy the rest of MTD at a reasonable price, and Jim sounds like he likes that idea.

It's a wonderful combination. Somebody's got to do this. Somebody's got to electrify that market, and it's going to be us. And then we also have—

they have a great pipeline in semi-autonomous and autonomous lawn mowers as well. Autonomous lawn mowers? We're just going to set them out there and they're going to mow our lawns for us? Yeah. I need an autonomous chainsaw, but I'm staying inside while it goes to work. Rob Wertheimer, who covers Stanley Black Decker for Melius Research, estimates that electrification of lawn and garden tools could add 1 to 3 percentage points to the company's yearly revenue growth through the end of the decade. Jim says Technological developments like brushless DC motors are making battery-powered tools more powerful and efficient. He says he's working on an approach in riding mowers that's taken from both the automotive world and the handheld tool world, and that there'll be more details on that to come.

He says outdoor tool electrification presents an opportunity to make money while doing some good for the environment. And I can tell you the impact on climate and emissions, carbon emissions, is very, very positive, you know, from electrification. These small gas engines are very big polluters because they don't have emissions controls like, you know, more expensive vehicles would have.

And so we're gonna be doing a lot of good here for society as well as hopefully making a few bucks along the way. They're also whiny. You should hear it around here in leaf season in the fall when they start up with a two-stroke engine over there and a two-stroke engine over there, it just hits you.

It always seems like when I get my week or two off, you know, to go to my condo in Florida, and I get down there on the chaise lounge at 10 o'clock in the morning, all of a sudden the landscapers come with their gas-powered equipment, and it's just like I might as well stay upstairs.

Now I see where the passion for battery-powered tools is coming from. Since we're on the subject of lawn and garden tools, let me mow through a quick listener question. No, no, too loud. Let's switch to the battery mower. That's better. Let me just hike up the old dress socks and I'm ready. Hello to Yuval from New York who asks, if leveraged ETFs that track the stock market produce 2 or 3 times the return of regular ETFs, why shouldn't he invest in them long-term?

If the S&P 500 goes 10% up, you'll be 30% up. So times 3, right? My father-in-law, he sometimes shared with me his knowledge about finance and he said, "Use for trading, but not for investment." Long story short, I would appreciate your thoughts on that.

And thank you and Meta for putting together such an amazing show every week. Thank you for listening, Yuval. Your father-in-law is right. Leveraged ETFs stink as long-term investments. The fees are too high and the mechanics are a bad fit for savers. Take the example of the UltraPro S&P 500 fund from ProShares, ticker UPRO. The expense ratio is 0.93%. That's around 10 times what cheap index funds cost, and that's with part of the fee waived for now. If you've held the fund since the end of 2019, just before the pandemic, you've made about 38.5%. That's 7 points better than the S&P 500, which sounds good, but keep in mind you've taken 3 times the risk of the S&P 500. And by the way, what happened to the triple returns? As ProShares points out, the fund seeks a 3x daily return, not long-term return, and that is a crucial distinction. See, A typical margin investor has their leverage increase automatically as stocks fall because their asset base shrinks while their debt stays the same. But leveraged ETFs seek to maintain constant leverage. In the case of UltraPro S&P 500, 3x leverage. That means they have to reduce index exposure as the index declines, and that can have the effect of locking in part of the losses when the market dives like it did early on in the pandemic. That fund might be fine for an aggressive trader who wants to get in and out in a single day, but the last thing savers want is to pay high fees and take extra risk while clinging to losses and limiting long-term gains. So how about just applying lots of leverage on your own to a brokerage account where you own regular index ETFs? I wouldn't do that either. Stocks tend to produce healthy returns over long time periods, but part of the deal is that you have to be able to hold on during dire short-term drops. And if you make those drops even more dire, you might be hurting the chances that you'll hold on and make it to the long-term reward. I recommend you skip the 3x funds, Yuval. Instead, save 3 times harder. Maybe ask your father-in-law for 3 times as many tips. Thank you, Jim at Stanley, for the Tool Talk, and Yuval from New York for the question. And thank all of you for listening. Subscribe to the podcast on Apple Podcasts, Spotify, or wherever you listen to podcasts. If you want to find out about new stories and new podcast episodes, or if you just want the recent picture of me wearing chainsaw chaps, you can follow me on Twitter.

That's @JackHough. H-O-U-G-H. See you next week. At CLA, we're in your corner and on it. We coach tax strategies and Little League first base. We help you adopt AI data tools and we adopt rescues named Buddy. We walk your factory floor and jog the local 5K, though sometimes we walk that too. Wherever you're coming from, we're right there with you. Wherever you're going, we'll get you there. CLA—CPAs, Consultants, and Advisors.

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