But this pullback provides investors an opportunity to get a discount on a quality, founder-led company. I've owned this personalized online clothing retailer for the past three years, but in April, I added to my position twice. Here are five reasons I bought more shares.
1. It's disrupting the classic brick-and-mortar shopping experience
Stitch Fix was founded on the concept of providing its customers with a personalized clothes-shopping experience without brick-and-mortar stores or sifting through an endless selection of items on an online website. The process is designed to be easy: clients provide information about their size and preferences upfront and a stylist (with the aid of data science) selects a "fix" of five items to ship to the customer. Shoppers then try on the clothes in the comfort and privacy of their homes, return things they don't like, and pay only for the items they keep.
This business model is superior to the classic brick-and-mortar store with high fixed costs, low inventory turnover, and a reliance on discounting. With $440 billion in sales of apparel and accessories in 2019 in the U.S. and the U.K., Stitch Fix can tap into a huge addressable market.
2. Its growth proves the model works
Clients love the personalized styling experience and the element of surprise when a fix arrives. As of the fiscal 2020 second quarter (ended Feb. 1), the company reported 17% growth of its active clients to 3.5 million. Not only is the client base growing, they are buying more.
Revenue per active client has seen seven consecutive quarters of growth. This number most recently topped out at $501 but will likely decrease in the coming months as people cut back on discretionary spending.
What's important for investors is that this trend shows its matching process is improving, which is likely driving additional fixes throughout the year.
3. Its leadership has a long-term mindset
Katrina Lake founded the personalized clothing service in 2011 and has been CEO ever since. Her employee-centric perspective, innovative approach, and financial discipline are qualities that investors should look for in leadership. As the pandemic made its way to the U.S., Lake and the management team looked for ways to help employees. They granted four weeks of paid flexible leave, created an employee emergency fund, and set up a program to provide support to single parents in the warehouses who are affected by school closures.
Lake's innovative approach has not only started a disruptive company but has enabled it to iterate and expand on the model, which has driven additional ways to capture revenue and improve the service. Style shuffle (a simple and fun way to capture more preference data from clients), Shop Your Looks, and a kids' focused offering are just three examples of this.
Lastly, her financial discipline has set the company up well to weather this pandemic.
4. It's set up to withstand an economic downturn
Stitch Fix's history of cash-flow positive results since 2014 has helped build a rock-solid balance sheet with $300.6 million in cash and short-term investments and no debt. Its business model allows it to control costs as demand wanes with an asset-light structure (no brick-and-mortar stores and high inventory turnover), along with a large segment of its labor being variable (stylists and warehouse personnel).
In addition to being fiscally healthy, the company is using this time to move faster on pilot programs. It's diverting engineering resources to enhance the direct buy experience, experimenting with different inventory models, and piloting new ways for stylists to engage with clients.
5. Its stock is priced for uncertainty
The stock is priced around $19 per share as of this writing, which is more than 40% off its 52-week high. Its price-to-sales ratio is just 1.1, a significant decline from a year ago when it was nearly 2.0.
This depressed price is not without reason. The market is currently discounting Stitch Fix along with other retailers as a recession will likely curtail discretionary purchases for an extended period of time. It's entirely possible that the stock could drop further if purchases get delayed, as people don't have as many reasons to update their wardrobes if remote work arrangements become more commonplace, and large social gatherings remain limited.
How about joining me?
Stitch Fix is a quality business with a large opportunity and excellent leadership. Its business model is set up well to compete against brick-and-mortar retail as customers get more comfortable buying clothing online. Growth is likely to stall in the coming year, but this proven company should come out of this pandemic with a stronger offering that will continue to win customers for years to come.
If you have a long-term investing mindset, consider joining me in adding this disruptive apparel retailer to your portfolio.