We live in a subscription economy. It's estimated that as many as 12,000 stores could shutter this year, but in the meantime, subscription services are booming. Between 2012 and 2018, subscription-based businesses saw revenue climb about five times faster than the average company in the S&P 500 index. 

Stitch Fix (NASDAQ:SFIX) was founded in 2011, and the subscription clothing service has enjoyed explosive growth. Revenue has more than quadrupled over the last four years. It hopes to do for clothing what Spotify Technology has done for music, and so far, it's going according to plan.

So, what's in store for the next decade? Is Stitch Fix a home run stock in the making? Let's take a look.

A woman holding style cards from Stitch Fix with an open box full of new clothes laying on the floor.

Image source: Stitch Fix.

Plenty of choices

Some investors may not realize that Stitch Fix has plenty of competition. There are countless companies offering to send you a personalized box of clothes, which makes Stitch Fix's performance to this point look more impressive.

Just to give you a small sample of its competitors, some of the more well-known subscription clothing services include Rent the Runway, Le Tote, Bombfell, Fabletics, Her Fashion Box, Trunk Club, Trendy Butler, and ThreadBeast. 

One thing that sets Stitch Fix apart is that, unlike some of these other services, which require you to maintain a monthly subscription, Stitch Fix allows you more flexibility. If you don't want a shipment every month, you don't have to pay for it. The client can line up a fix anytime, which makes Stitch Fix less like a subscription and more like a stylist-on-demand service.

Some of these other services also cater to a specific clothing style, such as athletic wear, streetwear, or high-end fashion. Stitch Fix is trying to be an apparel service for all types of dress. It covers plus-sizing and kids, in addition to men's and women's clothes for just about any occasion.

Data, data, data

What really sets Stitch Fix apart is its obsession with data science. It has a growing list of 3.1 million clients sharing a lot of feedback, including sizing, likes and dislikes, and much more. Some customers share very personal data with the company, such as what parts of their body they like to flaunt or cover up, which goes a long way to strengthening the relationship with the customer. 

There is a powerful network effect at play here. As more customers sign up, it collects more information about their needs, which makes the company better at predicting which item a customer will like. Stitch Fix is working hard to get that first shipment right, because customers who decide to keep at least one item in their first shipment tend to become repeat customers

But there is also a financial incentive for Stitch Fix to learn as much as possible about each client. In the most recent quarter, gross margin improved 1.5 percentage points year over year to reach 45.1%. Management credited the improvement partly to lower clearance activity, which reflects the company getting better at understanding its customers' likes and dislikes. The more items customers keep, the fewer returns Stitch Fix receives, which cuts down unsold inventory and ultimately strengthens the bottom line.

Management also credited its expanding assortment in the men's category for the gross margin improvement. Stitch Fix has received a lot of feedback from men who want more choices in activewear and tailored outfits. In the last quarter, the company reported that the efforts to respond to men's feedback over the last few years led to a higher keep rate, meaning that Stitch Fix is getting better at hitting the mark with its male clients, who are returning fewer items.

Stitch Fix looks like a winner

As Stitch Fix attracts more clients (the total client count increased by 17% year over year in the last quarter), its competitive moat will only get stronger. The effort to constantly improve its predictive algorithms to tailor the exact look and fit each customer wants will never end. Management is very focused to invest in ways that will continue to improve margins and profitability over time, and that's why I believe Stitch Fix should be a good investment.

In fiscal 2018, the company earned a 4% operating margin, but management is targeting 10% to 12%. Performance on the bottom line has been lumpy, but that reflects management's long-term approach to running the business. It wants to maximize profitability for down the road, not this year.

It has been a bumpy ride for the stock, but the shares are currently up 33% since the IPO in 2017. The company is relatively small, with only $1.5 billion in trailing-12-month revenue, so there is plenty of upside if it can continue to gain new customers and increase wallet share with existing customers. At the rate the company is growing, coupled with the trend toward subscription services, the stock could be trading at a much higher price in 10 years.