Did Stitch Fix Knit Itself Into a Knot?

Stitch Fix (SFIX 0.69%) reported its first quarterly earnings as a public company, and the stock is down a whopping 11% as a result. In today's episode of Market Foolery, analysts Chris Hill and Tim Hanson explain why the market is running away from this company, whether Stitch Fix might be going the way of Blue Apron (APRN), and how the fashion subscription company might turn things around.

The guys also talk about what sent shares of FedEx (FDX -1.69%) to new highs and unveil the first annual Timmy Awards. Tune in to find out who gets the prestigious and highly sought-after Timmy for Best CEO of the Year, Worst CEO of the Year, Best Irony of the Year, and Best Quote of the Year.

A full transcript follows the video.

This video was recorded on Dec. 20, 2017.

Chris Hill: It's Wednesday, Dec. 20. Welcome to Market Foolery! I'm Chris Hill. Joining me in studio today, investor at large, Tim Hanson.

Tim Hanson: Happy holidays!

Hill: Happy holidays to you!

Hanson: Thank you.

Hill: Are you traveling for the holidays?

Hanson: Yeah, we'll be visiting my folks, who live in New York.

Hill: Is this prior to Christmas?

Hanson: For the holiday, yeah.

Hill: All right. There's still news. There's still news!

Hanson: The world never stops.

Hill: The business world apparently never stops. We're going to get to your awards in a little bit, which I'm very excited about.

Hanson: First annual. [laughs] 

Hill: First annual. What are we going to call these? The Timmies? I'd like to hand out the first annual Timmy. Let's start with FedEx. Shares of FedEx are hitting a new high. Second-quarter profits and revenue both came in higher than expected. Daily package volume was up over the last year. I'm not trying to hate on FedEx, but was there anything negative in this report?

Hanson: No, it's a great report. And that's to be expected. As physical brick-and-mortar retail declines and people are doing more and more shopping online, an obvious beneficiary is FedEx. It's a big time of the year for them. They make a lot of money this time of year, and they reported they were making a lot of money and expected to make more money. Period package volumes are very robust, which is not surprising.

Hill: Two questions here. One, do you think FedEx is a bellwether stock? And two, maybe the more important question is, do you think any stock is a bellwether stock? In the way that we traditionally think about, if you want to look at a stock and say that's a pretty good indication of how the U.S. economy is doing, FedEx is as good a stock as any?

Hanson: Yeah, I think you can make an argument there, because certainly, the amount of shipping they do is a direct reflection of economic activity. I think going forward, what will be interesting, and I was actually talking about this with some of the guys on my team yesterday with regards to how we do sector classifications right now. Right now, The Motley Fool is very bullish on technology companies and more bearish on things that are not technology companies. But what's interesting about where the world's going is, technology right now has become a catch-all sector. Amazon is totally different from Google, which is totally different from hardware makers, and so on and so forth.

At some point in the future, and I think there are already some plans in the works to do this, you're going to see things like telecom go away. Think about that. Telecom is now something you do on Facebook, because you're using Messenger. I think you're going to see a lot of these sectors go away and technology get broken apart into different subcategories or new sectors, maybe consumer technology and information technology and communications technology. Who knows what they're going to end up doing?

It's a long-winded way of saying, I think as more and more activity moves online and technology becomes more and more dominant, things like Wal-Mart and FedEx are going to become less of bellwether stocks because they won't be representative of as much economic activity as they are today. And obviously FedEx has a clear tie into e-commerce. That's one reason why, A, the stock has done so well, why the business is doing well, and why it continues to be a reflection of economic activity.

Hill: I like the idea of updating the classifications of different industries, in part because, at some point, what it will mean is, retail just becomes retail. It's not, let's break up e-commerce and this and that. No, it's all retail.

Hanson: Yeah, retail technology. Who knows. Think about energy. Energy, historically, has been oil companies. And as renewables come into play, you could make an argument that part of Tesla is actually an energy company, and there are going to be more companies like that in the future. I think there's a real interesting landscape shift that's going to happen over the next decade or so, and it has interesting implications for things like index funds and portfolio allocations and so on and so forth.

Hill: Stitch Fix, which is the online apparel company, issued their first earnings report as a public company. I guess if you want to look for a silver lining, the good news is, they appear to have more customers. That appears to be may be the only silver lining, because shares are down 11% today.

Hanson: This company fascinates me for a number of reasons. I got interested in it because, when I saw it come public, I saw a lot of things that rhymed with Blue Apron, which turned out to be a very productive thing to be negative about over the last couple of months. Online business, customer churn, marketing costs, so on and so forth. But Stitch Fix is really fascinating for another reason.

One of the projects I work on here is building algorithms that can pick stocks. So, obviously, it's funny -- we have algorithms that pick stocks, and when you send them to analysts who have to pick stocks, never do they say, "Oh, great, I'm going to put this in my recommendation this month." Most of the time, they don't use the advice, or they go in, double-check it, and do all the work again.

Why that's relevant to Stitch Fix is, for people who don't know, it's an algorithmically driven wardrobe styles service. So you go and fill out a profile, and then every so often they send you a box of clothes that are hand-picked for you, curated for you. But the way it works is, their algorithm actually matches you first with a physical person, a stylist, who looks at what the algorithm thinks you should get and then picks the items.

Hill: And the more items you end up buying, the more data they have about, these are the clothes that this person picked, and it presumably makes the algorithm smarter.

Hanson: Right. And they make more money. But what's curious is, the algorithm is making these recommendations, and the stylist, generally speaking, is someone who's working and paid by the hour. That's one of those systems where the incentives seem all screwed up. If you're the stylist and the algorithm gives you five things and you go, "Great!" and check the box and send it out, you only worked for a minute, and you basically told the company that you don't add any value. So as a stylist, you take the results, then you hem and haw for a while, you change a bunch of them, and then send it out.

And I think why that's relevant to Stitch Fix as an investment case is, one of the reasons they're down is their costs were up pretty sharply, both customer acquisition costs and also the cost of paying their talent. So I think the open question for Stitch Fix, and I don't know which side of it I land on yet, is, as they grow customers, do they scale incrementally on the profits? Or do they end up having to hire more people while their algorithm works together with the people? It's really fascinating, and it'll be a really fascinating thing to watch unfold.

Hill: That's because that is a decision that almost seems like -- businesses don't hinge on a single decision, but that seems like probably the most important decision facing that management team. If they can figure out -- and maybe it's "Hey, let's up stop paying these people by the hour; let's put them on salary, and let's figure out the best way to scale their talents and incentivize them on volume." And I don't know how to build an algorithm, but it seems to make sense to me that the more people buy, if I am a Stitch Fix customer, the more I'm buying from them, right there they have more data on me, so presumably that gets smarter. But, yeah, that seems like almost everything for them.

Hanson: Like I said, it's fascinating, as someone who's interested in automation and the interplay between humans and automation. It has clear bottom-line implications for the company, but you can sort of see both sides. One of the things customers get for their $20 styling fee is a handwritten note from the stylist. That's the kind of thing -- you could have a computer churn out a note, but it probably doesn't make the same emotional connections. Then the question is, how important is that emotional connection? Can they test out of it? It's interesting.

Hill: A couple of housekeeping notes. First, the folks at fool.com have put together a collection of some of the best stuff from our site over the past year. They're calling it Fool.com's Recommended Reading for 2017. That's about as straightforward as it gets. If you want the list, you can email [email protected], and they will send it to you. [email protected] for the recommended reading for 2017. Also, thank you to Bill Kern, who's a Stock Advisor member in Hawaii who sent a very thoughtful card and some fabulous treats from the Aloha State. We still have some upstairs.

Hanson: I need to try that.

Hill: Yeah, you do, because they're fantastic. You got some awards you want to hand out? The CEO of the year is always an award that comes out, and the CEO of NVIDIA got it this year from Fortune magazine.

Hanson: That's a worthy choice. I went for the Timmies. Is that what we're --

Hill: Sure. Is that with a "y"? Or an "ie"? 

Hanson: I don't know.

Hill: You've never been called Timmy in your life, I'm guessing.

Hanson: My mom calls me Timmy. Usually not when she's talking to me, but when she's referring to me to other people, she'll be like, "Oh, Timmy just had ... ".

NVIDIA CEO, award of choice. I went with Jeff Bezos, though. I thought Amazon had a monster year. It's my son's favorite stock holding. I thought what's interesting is, among the big news they made this year was when they acquired Whole Foods. There was a lot of doubt and criticism at the time, they don't have an integration plan, so on and so forth. And it seems like they're integrating it pretty well. It's exciting to see what they're going to do next. So, Jeff Bezos.

Hill: I think you were the one that showed me, I think it was the day after that announcement came out, Bloomberg had a heat map of ... Amazon warehouses and fulfillment centers overlaid a map of the United States, and then Whole Foods locations. And once you look at that map, you think, "Oh, now I understand the acquisition a lot more."

Hanson: Yeah, the customer overlap. I think they're going to roll out a loyalty program at Whole Foods if you're a Prime member. I think there will actually be a lot of benefits for both sides there. Amazon is just ubiquitous and continues to become more so. It's incredible.

Hill: Yeah. What else do you have?

Hanson: Worst CEO of the year. With honorable mention to Evan Spiegel of Snap, who had a tough year but remains in his job, so he couldn't win.

Hill: That's kind of a philosophical question. And I haven't looked to see if anyone else -- I'm sure there are columnists handing out worst CEO of the year, and I'm not sure where I come down on that. If you're the worst CEO of the year and you're still in your job, I don't know.

Hanson: Well, I give him the award for worst CEO who's still in his job. The next three are all out of a job. One honorable mention, would have gotten it if he had been CEO of a public company, Travis Kalanick, but Uber remains private. Talk about a tough year. And poorly handled.

Hill: Yes. Yes.

Hanson: And Steve Ells, your favorite CEO, also now gone from Chipotle after mishandling what now seems like a never-ending crisis.

Hill: Gone from the CEO, but not gone from the board.

Hanson: And probably still cashing checks. Very hefty checks. So it was a tough field, but I think the winner, [laughs] and I mentioned the company before, Matt Salzberg from Blue Apron who led a failed IPO that railroaded off into a ditch and then was ousted as CEO after just five months of being public. [claps] Slow clap for that.

Hill: I posted this question on Twitter. I think Blue Apron had been public for less than a month, maybe it was just over a month, and it was yet another day early in Blue Apron's public life that the stock was down double digits, and I posted the question on Twitter, and I wasn't being snarky, I was genuinely curious about this: What is the fastest a company has gone from IPO to being no longer public? And that's either, you've gone bankrupt, you've been taken private, I don't know.

Hanson: Someone's going to need to fact-check me on this, but I believe this is a true fact. I believe that Blue Apron's best day as a public company was the day that Matt Salzberg was ousted as CEO. In terms of single-day price increase.

Hill: I think that's right.

Hanson: So yes, opposite, the inverse Bezos, goes to Matt Salzberg. Then I had quote of the year. This is from a research paper that just came out called "Rate of Return on Everything."

Hill: That sounds comprehensive.

Hanson: Yes. Despite its hefty title, it's a very interesting read. And the quote of the year I'm going to take from that, which they conclude, after having looked at the rate of return on everything from 1870 to 2015 in 16 markets, they conclude, and this is going to blow your mind, that residential real estate, not stocks, has been the best-performing investment of modern history.

Hill: Really?

Hanson: Yes! It edges stocks ever so slightly. And on a risk-adjusted basis, based on using standard deviation, significantly better returns. Blew my mind. My entire career has been based on the idea that equities are the best-performing investment. And they find it not to be true, globally. Now, in the United States, equities outperform. And obviously, if you are a buy-and-hold investor, the maintenance costs on owning equities are much lower than owning real estate, and you have to rent the real estate out, and so on and so forth, so there's a hassle factor there. But yeah, that was a paradigm-changing insight for me. I don't know what I'm going to do with it. It may give me the justification I need to go out and buy a beach house. I'm still mulling that over.

Hill: [laughs] I think that might work.

Hanson: But it's a fascinating paper, and I enjoy it.

Hill: Is that publicly available? Is that something we can link to?

Hanson: Yeah, it is. It's on the Social Science Research Network. It costs $5 to download, but it's worth it.

Hill: Send me the site, and I'll tweet it out on the Market Foolery feed.

Hanson: And my last category was irony of the year. The irony of the year for me, and I hope I'm using the word "irony" correctly here, is that Richard Thaler of behavioral-economics fame, won the Nobel prize the same year cryptocurrencies became the world's fastest-growing asset class ever.

Hill: I think you are using the word "irony" correctly.

Hanson: It's like Richard Thaler's entire career has been ignored by cryptocurrency. Blows my mind! That was the irony of the year for me.

Hill: So later today, I'm interviewing Dan Ariely for Motley Fool Money this weekend, and he has a new book out, and one of the things I'm going to ask him about is -- I'm going to ask him a bunch of questions about his book, but one of the questions I'm going to ask him that has nothing to do with his book is about bitcoin, because I'm just curious about what he thinks when he sees this, and maybe this is an overstatement, to use this word, but, mania.

Hanson: I don't think it's an overstatement. There's literally a coin called CryptoKitties, where you mine for unique cats. And it's worth hundreds of millions of dollars. It's like Beanie Babies online using blockchain, kind of. My mind is blown! Congratulations for Richard Thaler! [claps]

Hill: [laughs] And congratulations to the Winklevoss twins.

Hanson: Until they get hacked.

Hill: Until they get hacked or bitcoin is outlawed, the Winklevi are doing well.

Hanson: They had a nice year.

Hill: They had a good year. Tim Hanson, thanks for being here!

Hanson: Thank you, sir!

Hill: As always, people on the program may have interests in the stocks they talk about, and The Motley Fool may have formal recommendations for or against, so don't buy or sell stocks based solely on what you hear. That's going to do it for this edition of Market Foolery. The show is mixed by Dan Boyd. I'm Chris Hill. Thanks for listening. We'll see you tomorrow.