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5 Things Investors Get Wrong About Stitch Fix

By Brian Withers – Feb 4, 2020 at 11:03AM

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Understanding more about this disruptive company might just have you adding the stock to your shopping cart.

Stitch Fix (SFIX 15.73%) stock has bounced around for the past year between a low of $17.89 and a high of $33.78. It seems every time the stock starts to trend upward, it gets batted back down. Having over 40% of the shares' float held short by investors betting against the stock is partly to blame.

SFIX Chart

SFIX data by YCharts.

However, it's also possible that many don't understand enough about the company to see the long-term upside of its personalized approach to selling clothes online.

Here are five things investors may be getting wrong about Stitch Fix.

1. The competition isn't Amazon

"What about Amazon Prime Wardrobe?" is a question Stitch Fix CEO Katrina Lake gets a lot. It's usually followed by some form of "Are you worried?" Her answer may surprise you. After acknowledging the company is keeping an eye on the competitive landscape, she indicates that it's still in the early days of consumers buying clothes online and "the real opportunity is the 80-some percent of apparel that is still bought in stores."

Confused-looking man with numerous question marks surrounding his head

Image source: Getty Images.

In the U.S. and the U.K., where Stitch Fix has a presence, $431 billion was spent on apparel, footwear, and apparel accessories in 2018, with 21.7% purchased online. This market is growing and expected to reach $527 billion by 2023, with more than a third of that purchased via e-commerce. Compared with its $1.7 billion annual revenue run rate, there's plenty of room for growth for selling apparel without a monthly subscription fee.

2. It's not a subscription business

Sometimes the company gets compared to a business where you pay monthly for a service, but that's not how the process works. Stitch Fix serves its clients upon request, and it only makes money when customers find items they love and want to keep. In fact, Lake doesn't like it when people use the word subscription. this idea of paying, charging somebody in the background for something that they're not getting value out of, that's absolutely not what we do. And that's part of the reason I bristle a little bit when people use the word "subscription" with our business.

This approach creates alignment between Stitch Fix and its clients and creates an incentive for it to deliver a great customer experience. Evidence shows that this focus is paying off. The average revenue per active client has increased for the last six quarters in a row. 

Combination bar and line graph. Line represents revenue per active client by quarter starting with $433 in Q1-2018 and rising gradually to $485 in Q1-2020. Bars show year over year percentage growth starting with -1.4% in Q1-2018 and -3.9% in Q2-2018, then rising every quarter to 9.5% in Q1-2020.

Data from quarterly shareholder letters. Chart by author. YOY = year over year. Quarters are fiscal quarters with Q1-2020 ending November 2, 2019. 

As of the most recent quarter, active clients spent an average of $485 a year, an impressive 9.5% more than the same number a year ago. Investors may think this success is all about improving its apparel-selecting algorithm and getting more data, but that would be missing a key element.

3. It's not just the data science

Stitch Fix has more than 5,100 employees working as stylists to ensure every "fix" (a set of five items shipped together to a client) is perfectly tailored to each of its 3.4 million active clients. When a stylist is building a fix, they have a tremendous amount of information available to help make great selections: 90-plus data points from the client's profile (even including pictures), feedback from previous fixes, recommendations from the algorithm, and any specific requests or notes the client has for the fix (such as needing a dress to attend a family wedding). 

Lake describes stylists as the "heartbeat" of the company and "what makes the magic of Stitch Fix work." The short video below highlights the criticality of the role.

Video source: Stitch Fix Careers YouTube Channel.

Stylists have been an important part of the selection process since the company was founded, but it's starting to branch out, allowing customers to buy items directly. 

4. It's not just about the five-item fix

It all started with a concept of the five-item fix, where clients sort through the fix, keep (and pay for) the items they want, and return any they don't. This is still the company's marquee service, but it has broadened its offerings considerably. Customers can now add extras such as socks and undergarments to their fix, buy something previously purchased in a different color or size, or pick from 30 to 40 personalized items selected by the algorithm with a process called Shop Your Looks. This program is still in trial mode, currently available to about a third of its women's clients.

A culture of experimentation and willingness to learn from the experience is a powerful advantage for Stitch Fix. Style Shuffle, which started as a prototype process for clients to provide a thumbs-up or thumbs-down on specific clothing items, has now collected over three billion ratings from over 80% of its customers. It's likely that this feature contributed to the 17% improvement in first-time fix success rate from 2018 to 2019.

Having a wide selection of items for clients to choose from is one of the key elements that makes this model successful. Some may be surprised to find out that brands realize multiple benefits by working with Stitch Fix.

5. Actually, brands love working with this smaller retailer

Many times, large manufacturers stay away from choosing small retail partners, especially ones that may only have an online presence, but with Stitch Fix, that's not the case. More than 1,000 brands currently partner with the company to have their products available for its clients. One thing brands like is that this unique platform often can introduce new customers to brands in a way that preserves their pricing power. Additionally, there's a feedback loop that doesn't exist with brick-and-mortar retailers. Clients provide specific feedback on 85% of shipments, including information about size, color, or even if the sleeves were too tight. This data is shared with brands to help them be more successful beyond just their partnership with Stitch Fix.

Wrapping up

Understanding more about this disruptive growth company may encourage you to add this up-and-comer to your portfolio or watch list. Who knows -- with its long-term revenue goal of 20% to 25% annually, it just might be a monster stock in the making.

John Mackey, CEO of Whole Foods Market, an Amazon subsidiary, is a member of The Motley Fool's board of directors. Brian Withers owns shares of Amazon and Stitch Fix. The Motley Fool owns shares of and recommends Amazon and Stitch Fix. The Motley Fool has a disclosure policy.

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