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Has Wayfair's Stock Gotten Ahead of Itself?

By Lawrence Rothman, CFA – Jul 8, 2020 at 9:45AM

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Wayfair's stock has been on a roll, but is this justified for a company that hasn't produced a profit?

Impressively, Wayfair's (W -5.82%) share price has more than doubled since the start of the year. The company has a history of strong revenue growth, and this continued in the first quarter, when its top line increased by nearly 20% year over year to $2.3 billion.

Even though investors are enthusiastically scooping up shares, there are reasons you should take a cautious approach before purchasing the stock.

A woman sitting at a computer with a credit card in her hand.

Image source: Getty Images.

Yet to show a profit

While Wayfair has reported strong revenue growth over the years, this has not translated into profitability. In 2015, its revenue was $2.2 billion, which more than quadrupled to $9.1 billion in 2019. In just the last three years, active customers (those who purchased an item within a year) nearly doubled from approximately 11 million to over 20 million. However, over the last five years, its loss widened from about $77 million to $985 million.

So, while the company did a nice job attracting customers and growing its top line, its costs increased at a faster clip. These included selling expenses, operations, and technology costs to improve the customer experience. In more recent years, management also accelerated spending on advertising and customer service.

Despite Wayfair's first-quarter revenue growth, its loss widened to about $286 million compared to a $200 million loss in the year-ago period.

Lots of competition

Wayfair has been spending money to draw customers and build the business. However, it is confronting intense competition from behemoth (AMZN -1.57%), whose virtues, namely competitive prices and quick delivery, are well-known. Other formidable competitors are furniture companies like Raymour & Flanigan and Ethan Allen Interiors (ETD -1.40%) that have physical stores as well as an online presence.

Management has been hoping to increase revenue faster than expenses. In the first quarter, it did so for customer service and advertising costs, which is a positive step toward achieving profitability. The coronavirus pandemic kept many people at home and management saw a positive response, including during the first month of the second quarter, and it expects that it gained customers. Still, slowing ad spending could hurt Wayfair's revenue down the road.

Although the company had been achieving strong revenue growth in a growing economy, this is no longer the case.

Founded in 2002, Wayfair has increased its revenue annually from 2007 to 2009 during the last recession. At this time, the company was building size and scale while converting people to online purchasing. However, the exact impact on revenue growth during the last decade's recession is not available, since public data only dates back to 2011.

"We likely will deal with a recessionary environment and there will continue to be global and domestic turmoil. But we believe we are now well-positioned to thrive regardless," Chief Financial Officer Michael Fleisher said on the first-quarter earnings call.

Still, the current economic situation warrants a healthy dose of skepticism. While some people may turn to Wayfair's online platform for the first time, high unemployment could certainly cause people to hold off on discretionary spending, particularly on major purchases such as furniture. And the company's revenue growth is likely to feel the effects this time around.

Management deserves credit for building an online home goods business. It has gained a loyal following and proven it can grow revenue. However, it hasn't shown it can generate a profit, and a tough economy will make that a challenge. For now, you are better off not adding Wayfair's shares to your shopping cart.

John Mackey, CEO of Whole Foods Market, an Amazon subsidiary, is a member of The Motley Fool's board of directors. Lawrence Rothman, CFA has no position in any of the stocks mentioned. The Motley Fool owns shares of and recommends Amazon and Wayfair and recommends the following options: long January 2022 $1920 calls on Amazon and short January 2022 $1940 calls on Amazon. The Motley Fool has a disclosure policy.

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Stocks Mentioned

Wayfair Inc. Stock Quote
Wayfair Inc.
$32.55 (-5.82%) $-2.01, Inc. Stock Quote, Inc.
$113.00 (-1.57%) $-1.80
Ethan Allen Interiors Inc. Stock Quote
Ethan Allen Interiors Inc.
$21.14 (-1.40%) $0.30

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