There's a disconnect between Stitch Fix's (NASDAQ:SFIX) market potential and its current growth pace. The online apparel giant pioneered a new selling model that resonated with shoppers over the last several years and helped it grow to over 4 million active users, each spending more than $500 a year on regular deliveries.

However, in its latest earnings report, management offered a weak growth forecast that sees revenue gains slowing to less than half the pace that shareholders saw in the previous year.

Person sitting on a couch with an open laptop in their lap and a credit card in their left hand.

Image source: Getty Images.

While Stitch Fix is making big moves into new demographics, geographies, and shopping models, its downbeat outlook clashes with that bright long-term potential. But is the fiscal 2022 slowdown just a speed bump on the way to much faster sales gains ahead?

Let's take a closer look.

The growth flywheel

Most of the ingredients were present for Stitch Fix to generate solid growth through the quarter that ran through late October. A growing base of clients is spending freely on apparel even as the chain expands its addressable market.

Stitch Fix boosted its user base by 417,000, or 11%, in Q1. That new client addition rate was slow, but the average customer spent $524 in the previous year, up 12%.

These metrics combined to push revenue higher by 19%, outpacing most investors' expectations. Executives said they were happy with what they described as "strong top line revenue growth with continued momentum in women's as well as kids, and in the U.K.," its biggest market outside of the U.S.

Margin wins

The news was better on profitability, where Stitch Fix set new records for the business. Gross profit margin reached an all-time high of 47% of sales compared to 45% in fiscal 2021 and 44% in each of the two prior full years. Selling expenses were modest, too, and advertising declined as a percentage of sales.

Incorporating all of these shifts, Stitch Fix's adjusted earnings margin shot up to 7% of sales, or $38 million, compared to 1% of sales, or $7 million, a year ago. Management credited sales growth, higher selling prices, and reduced shipping costs for driving the earnings spike. "These ... results reflect a strong performance in our business from both Fix [deliveries] and Freestyle [direct-buy purchasing]," CEO Elizabeth Spaulding said.

The weak outlook

The problem with the report is that management's short-term outlook is weakening despite that strong start to the year. Stitch Fix predicted almost zero growth in fiscal Q2 as adjusted earnings margin falls back down to about 1% of sales. The wider forecast dropped, too, and now calls for revenue to rise by less than 10%. Management three months ago had predicted greater than 15% annual growth following last year's 23% increase.

It was jarring for investors to see that fiscal 2022 forecast fall despite the industry's expansion and Stitch Fix's push into big new niches like direct e-commerce shopping. Management said in a conference call with investors that the key factor was sluggish customer additions in recent weeks. Stitch Fix's direct-buy offering may be reducing demand for its subscription-based services, executives explained. But competition could be taking its toll in this crowded industry, too.

Worse yet, Stitch Fix is expecting its client base to decline next quarter before returning to growth in fiscal Q3. Sales will also be pressured by tight inventory in some apparel categories.

The supply chain issue is temporary, but investors are right to be worried about Stitch Fix's stagnating user base. While record spending per client implies solid engagement, the company can't expect to return to over 20% annual sales growth without big improvements to its pace of customer additions.

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.