Stitch Fix (SFIX -1.73%) is one of the top-performing stocks coming off the broad market lows from March 2020. Shares traded for as little as $11, but they have rebounded tremendously, skirting past the $100 mark in January. However, since it broke through to triple digits, the stock has fallen around 30% and currently sits at around $76 per share. As long-term investors, is it time to hop on the Stitch Fix train with shares trading at a discount?

Two women try on clothing and accessories taken from delivery boxes

Image source: Getty Images.

The business is doing well

One reason Stitch Fix stock has done so well since March is the performance of the underlying business. If you don't know, Stitch Fix is a data-focused online styling service. Users sign up and go through a measurement and styling quiz before the company sends a box to the client with five items of clothing (a "fix"). Stitch Fix charges a $20 styling fee for each fix, but it applies that fee to the purchase price as long as the customer keeps at least one item from the order. Customers enjoy a 25% discount if they keep everything from the fix.

At the end of Stitch Fix's fiscal 2021 first quarter, the service had 3.76 million active clients, up 10.2% year over year. Revenue followed suit, growing 10.3% to $490.4 million. Investors shouldn't expect explosive user or sales growth from this company -- the onboarding process has some friction and convincing someone to have $200 worth of clothes shipped to their house is not an easy task. But with its data expertise (145 data scientists on staff) combined with a human touch (5,600 stylists), the service should improve for customers over time, which will hopefully lower churn and increase the lifetime value of an active client.

While the styling service is still going well, Stitch Fix thinks it has found a new growth opportunity with what it calls Direct Buy. This is a more typical e-commerce experience where Stitch Fix users can browse various items on a web page. However, since each user has provided the company with hundreds of data points, the company still uses its algorithms to curate what items to display based on user preference, which reduces page clutter and increases the quality of merchandise a user sees. So far, the "trending for you" page has gotten strong traction with new features like "categories" in beta-testing now. Management talks about Direct Buy being a bigger part of its growth story over the long term, and it is a large factor in management's relatively strong revenue guidance of 12% to 14% growth for the quarter that ended Jan. 31, 2021. 

But how's the valuation?

You don't want to anchor mentally to when Stitch Fix was trading around $11 per share last year, as that has no bearing on whether the current share price gives investors an opportunity to grow their wealth over the long term. But shares are still trading at a premium multiple when you look at its price-to-sales ratio (P/S) and when you consider the potential margin profile of the business at maturity. With a gross margin around 45%, management thinks the company can get to a 10% to 12% operating margin at scale. So while a current P/S ratio of 4.5 seems cheap when compared to software stocks, Stitch Fix's valuation is not cheap when you take into account the unit economics of the service.

Stitch Fix shares might not be a bargain, but they don't appear to be overly expensive. If you believe this company can grow its users, sales, and profits steadily over the next five years and beyond, buying shares at these levels is reasonable, even for risk-averse investors.