Please ensure Javascript is enabled for purposes of website accessibility

3 Reasons Stitch Fix Still Has Huge Upside Potential

By Jeremy Bowman – Sep 24, 2020 at 8:10AM

You’re reading a free article with opinions that may differ from The Motley Fool’s Premium Investing Services. Become a Motley Fool member today to get instant access to our top analyst recommendations, in-depth research, investing resources, and more. Learn More

A post-earnings sell-off doesn't cloud the long-term picture for this online styling service.

Stitch Fix (SFIX 1.80%) has long been a battleground stock.

Nearly 40% of the float is sold short, and shares of the personalized online styling service almost always move by double digits following its earnings reports.

That pattern was on display after the latest round of results this week, even though the company easily beat top-line estimates and also posted a narrower loss than expected after adjusting for a special tax expense, though investors seem to be judging it based on generally accepted accounting principles (GAAP).

Guidance for the first quarter may have also disappointed as the company called for growth between mid-single and high-single digits, representing a deceleration from the fiscal fourth quarter, the period that was just reported.

While it's certainly disappointing to investors to see the stock fall again by double digits, there are a number of reasons to believe in the company's long-term success. Let's take a look at three of those reasons.

An open box of Stitch Fix clothes

Image source: Stitch Fix.

1. The tech keeps getting better

What separates Stitch Fix from nearly every other clothing company is its emphasis on data science in managing its inventory and curating its selection for clients. The company receives feedback on every "Fix" -- a box of five clothing items -- that it sends customers, and uses that information to improve its own algorithms and future selections for that client.

Almost every quarter, the company announces improvements to its algorithm. In July, for example, the company introduced a new recommendation engine for its Direct Buy program, which delivered promising results. Management said, "Compared to our prior Fix-based recommendations, clients purchased more items on average, bought products with higher average prices, and converted at higher rates."

It's also seeing improved success rates in other areas as it gets better at styling clients. Stitch Fix isn't a tech stock in the traditional sense, but its focus on data science means it will keep improving, giving it an advantage over the vast majority of apparel retailers.

2. There's plenty of optionality in Direct Buy and beyond

For a clothing business, Stitch Fix has a ton of optionality, or the ability to develop new business lines. Direct Buy is the best example of that. Using data from client preferences, Stitch Fix now allows customers to shop a highly curated assortment of merchandise directly on the site without having to go through the process of getting a Fix. It's easy to see why this would be appealing to customers. While it's nice to have clothes hand-picked, it also makes sense to offer customers the ability to choose clothes themselves, and once again, data science gives the company a competitive advantage.

Results from Direct Buy so far have exceeded management expectations as the percentage of women clients now using it are in the high teens. With the help of data, return rates are also less than half those found in traditional apparel e-commerce, helping to keep shipping costs down. 

The company also recently introduced "Trending For You" in the quarter, giving customers a new way to shop on the site and opening up Direct Buy to new customers, unlocking more potential business. In the first two weeks after Trending For You was introduced, Direct Buy sales rose 30%. 

Beyond Direct Buy, there's plenty of room for expansion into geographies, new product categories like home goods over the long term, or even the ability to license its recommendation engine to other businesses who could be potential partners. Similarly, its appeal to brands (especially younger ones) is unique as the company can send items directly to customers, upending the traditional marketing process. That position should allow Stitch Fix's negotiating power (and therefore its margins) to get bigger as it grows.

3. The market is moving online

The coronavirus pandemic has been a clear setback for the company as it was forced to shut some of its distribution centers and pull back on marketing, affecting both supply and demand. The typical use case for the company, buying work clothes or outfits for going out, has also mostly disappeared with Americans avoiding the office and social occasions.

However, over the long term, the pandemic could be a net positive for the company as it is driving a number of Stitch Fix's competitors into bankruptcy and pressuring brick-and-mortar apparel retailers across the board, especially in malls and department stores. That will accelerate the shift in clothes shopping to e-commerce.

The company estimates that over the next 12 to 18 months, $30 billion in apparel market share will move online, and it expects to get more than its fair share of that. Additionally, the end of the pandemic and the reopening period should drive pent-up demand to Stitch Fix as customers will again need clothes for the office as well as social events.

While the last two quarters have been challenging for the company, new customer acquisition is up as first fixes in women's apparel increased 25% in the fourth quarter, pointing to a brighter future.

Stitch Fix is unlikely to return to full health until the pandemic is over, but once the crisis ends, the business should be humming, and technology improvements and new platforms like Direct Buy have the potential to drive its long-term growth for several years into the future.

 

Jeremy Bowman owns shares of Stitch Fix. The Motley Fool owns shares of and recommends Stitch Fix. The Motley Fool has a disclosure policy.

Invest Smarter with The Motley Fool

Join Over 1 Million Premium Members Receiving…

  • New Stock Picks Each Month
  • Detailed Analysis of Companies
  • Model Portfolios
  • Live Streaming During Market Hours
  • And Much More
Get Started Now

Stocks Mentioned

StitchFix Stock Quote
StitchFix
SFIX
$3.95 (1.80%) $0.07

*Average returns of all recommendations since inception. Cost basis and return based on previous market day close.

Related Articles

Motley Fool Returns

Motley Fool Stock Advisor

Market-beating stocks from our award-winning analyst team.

Stock Advisor Returns
326%
 
S&P 500 Returns
102%

Calculated by average return of all stock recommendations since inception of the Stock Advisor service in February of 2002. Returns as of 10/02/2022.

Discounted offers are only available to new members. Stock Advisor list price is $199 per year.

Premium Investing Services

Invest better with The Motley Fool. Get stock recommendations, portfolio guidance, and more from The Motley Fool's premium services.