What happened
Shares of online clothing-subscription service Stitch Fix (SFIX 15.71%) jumped sharply in early trading Friday, rising as much as 10% before gravity regained hold of the stock. By the time trading ended for the day, however, Stitch Fix stock was firmly back on earth, giving back all its gains -- and even a bit more.
Stitch Fix stock ended the day down 1.7%.
Image source: Getty Images.
So what
So what explains the early bounce, and what might explain investors' failure to stick with the stock?
The first part is easy. Early Friday morning, investment banker Goldman Sachs announced it was upgrading Stitch Fix to buy.
"Product innovation, operational efficiencies, and geographic expansion, combined with the increase in retail store closures (particularly in apparel)" among Stitch Fix's competitors "represent significant opportunities for further outperformance," argued Goldman. It assigned a $38 price target to the stock. Goldman was particularly optimistic about Stitch Fix's expansion into offering plus-size apparel and children's and men's clothing, as well as its expansion into the U.K. market.
As for why Stitch Fix couldn't hold onto its gains even with Goldman Sachs' endorsement, that one's a bit trickier. I presume it had something to do with Stitch Fix's 63 price-to-earnings (P/E) ratio -- and the fact that, based on the latest analyst estimates of a likely 2020 earnings decline, Stitch Fix is selling for more than 90 times forward earnings.
Now what
Assuming I'm right and that Stitch Fix's valuation spooked investors, I don't think there's really any cause for worry. Although it's true that Stitch Fix's earnings aren't as strong as one might like to see when judged by the standard of generally accepted accounting principles (GAAP), data from S&P Global Market Intelligence confirms that free cash flow (FCF) at Stitch Fix continues to outperform GAAP earnings handily -- $57 million to $48 million, respectively.
Valued on these cash profits, Stitch Fix is selling for an enterprise value of about 44 times free cash flow. Assuming analysts are anywhere close to right about Stitch Fix's ability to grow profits at 53% annually over the next five years -- also according to S&P Global -- a valuation of 44 times FCF seems not just reasonable, but even potentially cheap.
