Unconscious bias influences much of our thinking. Considering the sheer number of decisions we make in a day, it's often helpful to simply go with our gut, eliminating lengthy internal deliberation. But unconscious bias can wreck your portfolio by flippantly dismissing great companies before digging deeper.
With that context, Pinterest (PINS -0.74%), Peloton Interactive (PTON -0.24%), Stitch Fix (SFIX 2.54%), and The RealReal (REAL 1.32%) are four stocks I initially shunned. I didn't investigate more, because I figured I basically knew what they were all about. But once I finally did the research, I realized all four were the real deal.
Pinterest: The international engine
Pinterest is one of the top social media apps in the world with over 367 million users. But its average revenue per user (ARPU) is lackluster at just $0.77 as of the first quarter of 2020 -- that was only a 7% improvement from the prior-year period. That doesn't sound like a great investment at first, but I believe the company's international user base is currently distorting this revenue metric.
Consider that Pinterest reported international user growth of 34% in the first quarter, far outpacing the 6% user growth for the U.S. But the ARPU for international users is just $0.13. That said, engagement (activity on the platform) is up, and the company has several ways it's working to increase monetization. As bad as the ARPU for the international segment is, it was a 76% improvement from last year. ARPU for U.S. users only increased 18% year over year to $2.66.
So the larger international user base is dragging down overall metrics. But this base is growing faster than its U.S. counterpart, and its monetization is gaining momentum. If these trends hold, it won't take too many years before Pinterest's financial profile looks vastly different, proving it's the real deal.
Peloton: Unbelievable customer retention
We all know someone with a treadmill or exercise bike in their home, collecting dust. So pardon me if I initially dismissed Peloton's business of selling premium home-exercise equipment.
One can't deny Peloton's growth. For example, in the third quarter of fiscal 2020, the company's revenue from connected fitness products (sales of its stationary bike and treadmill) was up 61% year over year. But maybe the sales trend merely reflects a faddish brand that will eventually fall out of style. Furthermore, home-exercise equipment works for a long time before needing replacement, so one would expect the market to be saturated sooner rather than later.
Those arguments miss a significant aspect of Peloton's business. Its products are designed to connect to Peloton's subscription service. At $39 per month, it seems steep, but a stat in the company's prospectus blew me away. It said that of all its exercise products ever sold, 92% still had active subscribers. That's unbelievable customer retention.
That was as of June 30, 2019. And there's reason to believe it still holds true. As of the fiscal third quarter, Peloton had retained 93% of customers over the past 12 months. And its monthly churn rate (the net number of customers leaving) was the lowest it's been in four years.
Turning one-time hardware sales into monthly subscription revenue streams is why Peloton is the real deal.
Stitch Fix: Data-driven inventory
Stitch Fix combines a personal stylist with a fashion e-commerce experience. But one of the hardest challenges in clothing retail is inventory management. Fashion not only changes with the season, but things can also fall out of style year to year. If you overstock items, merchandise is moved via discounts, hurting profits. Sometimes, excess inventory even becomes a balance sheet write-off.
Here's where Stitch Fix excels. At the end of 2019, inventory was turning over more than six times annually. It's like selling out every two months. And no panicked promotions are needed to relieve inventory glut.
Stitch Fix does this because of the data it acquires running its business. All of its customers provide information about themselves, and the company then sends them a "fix" (a box with multiple clothing items). Based on who buys what, and how much is kept, Stitch Fix can use that demand-side data to make supply-side decisions.
Stitch Fix justifies all of its inventory with data, and that's why this company is the real deal.
The RealReal: Acquiring the right buyers
Most businesses spend money to acquire customers, known as the buyer acquisition cost (BAC). Legitimate business models earn more money from customers than they spend to get them. Reverse that order, and profits remain ever elusive.
The RealReal's BAC decreased 20% year over year in the first quarter of 2020. Average order value was flat because of the coronavirus. Even so, newly acquired buyers spend enough to repay the BAC in less than three months. From there, it's icing on the cake. For example, buyers acquired in 2015 earned The RealReal about 3.5 times the initial acquisition cost in gross profit after three years.
These business trends aren't one-quarter anomalies. The RealReal spends to acquire loyal customers who make money for it in short order, and that's why I consider this a real-deal stock.
I must make one final comment: Just because these stocks are the real deal, they're not all necessarily buy recommendations. When investing in stocks, more should be considered than the few points I've made here. Factors like valuations, total addressable markets, and the threat of competition are all very relevant.
The main takeaway is: Don't dismiss a company's business model before digging deeper. And dig deeper you should. These four companies are worth your consideration.