Wayfair Inc. Produces a Solid Quarter, but the Market Still Has Its Doubts

Owning Wayfair stock gives you exposure to all five brands. Image source: Wayfair.

The bears have long had their doubts about e-commerce home furnishings specialist Wayfair (W 0.43%). How could it compete with Amazon.com? Who in the world would want to buy their furniture online? Can they even turn a profit?

On the first two questions, this week's earnings release -- coupled with the company's history -- makes it clear that management knows what it's doing. On the final issue of profitability, there's still some trepidation, which might account for why the stock dropped as much as 15% in pre-market trading after earnings were announced Tuesday.

Just the numbers

On both the top and bottom lines, Wayfair came in ahead of expectations.

Data sources: Securities and Exchange Commission filings, Wayfair.

It's key to note that Wayfair is still in the early stages of its life as a public company. Much of its cash is being plowed into building out its logistics network to ensure a seamless customer experience. Analysts don't expect it to turn an annual profit until 2018 or 2019.

Still, when losses mount this quickly, it's not hard to see why some are pessimistic. Perhaps more concerning, free cash flow came in at $35.3 million during last year's third quarter, and it dipped to a loss of $14 million this year. Heading into the earnings release, a whopping 40% of Wayfair's float was sold short, according to The Wall Street Journal.

Digging in to see what really happened

We Fools, however, are a long-term bunch of investors. So it's worth digging beyond the headlines -- and the big stock moves -- to see what's really going on with the company. There are a lot of metrics you can use to gauge just how well (or poorly) Wayfair is fulfilling its mission to "transform the way that people shop for their homes."

Below, I've included three that I consider to be most important and how they've changed since the beginning of 2013.

Data source: SEC filings.

To put these numbers in perspective, active customers, revenue per customer, and annual orders per customer have grown by 61%, 9%, and 3%, respectively, over this time frame. Clearly, as far as meeting a desire that customers have, Wayfair is doing a good job.

The problem: Will it ever be profitable?

Of course, fulfilling your mission to customers is half of the job. Making sure that you can pay your employees and satisfy your shareholders is the other half of the equation. While revenue grew by 45%, expenses outpaced that growth, rising 65%.

That growth comes almost entirely from increased head count and a focus on logistics. Consider that expenses for customer service and marketing increased 61% and 79%, respectively, mainly due to hiring new employees. Meanwhile, operations, technology, and G&A grew by 93%, due to a combination of hiring new employees and working to further build out the company's logistics network.

All of these pieces are crucial to Wayfair's long-term success. But there's a lot of risk involved: If Wayfair is unable to continue winning over new customers at the pace that it has been, it will be left with little to show for shareholders.

At the same time, there's also concern about the company's coffers. At the end of 2014, it had $496 million in cash and equivalents on hand. As of the end of the third quarter, that number had dipped all the way to $335 million. That's a drop of 33% in just seven quarters.

That being said, Wayfair is making the moves it needs to make if it wants to fulfill its vision. Co-founder and CEO Nirah Shah said, "We continue to gain significant market share... [and] we are excited to enter the holiday season with our strongest offering ever -- and remain very enthusiastic about our long term growth and profit potential." 

There's no question the momentum is there. It's just a matter of if/when profitability will come.