What happened

Shares of The Honest Company (NASDAQ:HNST), a company that makes chemical-free diapers, cosmetics, and other household products, fell on Thursday after the company released financial results for the first quarter of 2021. This was its first quarterly report since its May initial public offering (IPO) but it seems investors didn't like what they saw. As of 10:45 a.m. EDT, the stock was down 9%.

So what

In the first quarter, Honest generated revenue of $81 million, up 12% from the $72 million it generated in the first quarter of 2020. However, the company registered a net loss of $4.5 million compared to a better than $0.5 million profit last year. Wall Street's reaction to this was mixed. For example, a Guggenheim analyst downgraded the stock to neutral following the report, according to The Fly. But other firms upgraded and raised price targets. 

A person looks frustrated while sitting in front of a computer.

Image source: Getty Images.

Now what

On one hand, I can appreciate some factors that could be weighing heavy on investors today. For example, Honest's gross margin dipped slightly in Q1, going from 36% last year to 35% this year. The short story is inflation is making it more expensive to make the company's products. This isn't a problem unique to Honest. But it is nonetheless challenging for a consumer-discretionary company. It might need to raise prices to offset its higher costs, but that comes with the risk of turning off customers.

That said, Honest shareholders should be extremely encouraged by its growing diversity in revenue. In the first quarter last year, the company's diapers and wipes segment accounted for a whopping 70% of revenue. But in Q1, this segment was just 61% of revenue as its other categories enjoyed robust growth. That's a good trend and one that could make this small-cap stock a less risky investment over the long term.

This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium advisory service. We’re motley! Questioning an investing thesis -- even one of our own -- helps us all think critically about investing and make decisions that help us become smarter, happier, and richer.